No two periods in financial history are the same. Different people, technologies and cultures will necessarily interact in unique and interesting ways that will create different types of markets. However, all humans are fundamentally emotional creatures, and the tendency to behave emotionally rather than rationally is key to the boom and bust cycle.
For this reason, we can talk in generalities about different types of market events. For instance, in a recent speech at the Wharton School of Business, value investor Howard Marks (Trades, Portfolio) said he believes all bull markets have three main stages.
Lack of information is not a problem
Marks pointed out that these days, there is very little private information that drives markets. Almost everyone has access to the same data:
“If you think about it, everybody receives the same inputs. We read the same newspapers, the economic news is the same for all of us, the corporate news is the same for all of us, the TV says the same things to all of us - some of us see the news and the prices as a buy signal, just when most people see the news and prices as a sell signal, and vice-versa. And you want to be in the minority.”
This represents an interesting shift from how investing used to work. Back in the days before there were strong rules and regulations surrounding public disclosure and insider trading, private information played a much bigger role in the functioning of public markets. This isn’t to say that insider trading does not happen today - it happens all the time - but in general it has become harder to find and utilize truly valuable private information. To put it another way, the problem for investors used to be not having enough information. Now, perhaps it is a problem of too much information!
Be optimistic when everyone else is pessimistic
My point is that the difference between great investors and the rest of the field is not (usually) access to better data or superior quantitative skills - it is in the ability to be optimistic when everyone else is pessimistic. This difference between investors creates the three stages of any bull market:
“Back in the early '70s, somebody gave a great gift and told me about the three stages of a bull market. The first stage is when only a few unusually perceptive people believe that there could be some improvement. The second stage is when most people accept that improvement is actually taking place. And the third stage is when everybody and his brother believe that everything can only get better forever. You make a lot of money if you buy in the first stage, you lose a lot of money if you buy in the last stage. You buy the same things, but what matters is: when do you buy them and at what price?”
The idea that “you buy the same things” is particularly powerful and demonstrates just how much price can deviate from intrinsic value. If you can learn to correctly estimate the latter, and to ignore the opinions of those who tell you that low price is a sign of risk, then you will be well on your way to mastering the three stages of a bull market.
Read more here:
- Seth Klarman: How to Identify Market Mania
- Warren Buffett: Do Not Fear Volatility
- Warren Buffett: Are Stocks or Bonds More Risky?
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