The stock market’s past performance is never perfectly repeated. Previous events will never be mirrored in future. Investors who rely solely on assessing the stock market, industries or companies based on their past performance may struggle to apportion capital efficiently.
Indeed, Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) Chairman Warren Buffett (Trades, Portfolio) has previously discussed this topic. He said, “If past history was all there was to the game, the richest people would be librarians.”
However, this does not mean history should be completely ignored or overlooked by investors. Certainly, it should not be the only factor that influences decisions when managing a portfolio. But it can still offer a guide to how investors may behave in future and how the stock market, industries and companies may perform.
Human emotions
A key lesson from history is that human emotions never change. For centuries, investors have pivoted from feelings of greed during boom periods to despair during subsequent crashes, and vice-versa. Indeed, investor greed was evident as long ago as the 17th century, when tulips sold across Europe for more than the price of an average home. Similarly, the Great Crash and subsequent Great Depression of the late 1920s and '30s showed that fear can cause asset prices to reach an extremely low ebb.
This constant movement between greed and fear means the stock market cycle will always exist. Asset prices will continually overreach themselves before crashing to extreme lows because of human emotions. Investors who can use this to their advantage may be able to buy high-quality stocks at attractive levels and subsequently sell them when they are overvalued.
Industry and company events
History also teaches investors that no industry or company generates uninterrupted profit growth over the long run. For example, investors in the late 1990s widely assumed that technology companies would experience perpetual growth due to the apparent revolution caused by the emergence of the internet. Similarly, banking stocks were en vogue in the early-to-mid 2000s due to their apparent ability to manage risk and offer high rewards.
However, those industries subsequently experienced major disappointments and challenges that caused severe declines in stock valuations. Investors who can apply this principle to today’s dominant industries and companies, such as those operating in the technology sector, may be better able to manage their expectations and avoid overlooking risks that are inherent in any industry.
A pragmatic approach
Arguably, investors who accept that history is useful, but also has its limitations, may be in a strong position to efficiently apportion capital.
Human emotions are unlikely to change, though the circumstances that prompts them to shift from fear to greed, and vice-versa, are likely to evolve. Likewise, the industries that are seemingly unstoppable will change over time. However, they will ultimately experience major challenges that put an end to their rampant profit growth.
Clearly, the past will never be perfectly repeated. But it does often seem to rhyme.
