14 Jun The bloke in the pub
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There are some subjects on which just about everyone has an opinion. Politics and sport come to mind immediately and the strongest opinions are often found among those whose experience of the particular field is limited to what they observe via the media rather than any personal involvement. The strength of someone’s opinion on a subject need not have a positive relationship to their knowledge of it but that is no guarantee that they will hold back from telling anyone who will listen what they think.
Inevitably, the world of investing also attracts its share of pub (or golf club, or dinner party) experts who are always willing to share their self-perceived wisdom with those in the vicinity. Their view of the market is generally at one extreme or the other – either relentlessly positive or relentlessly negative. Whatever the news at the time, it can always be adapted to fit their particular world view. The really persuasive or entertaining (if you have never seen the US show ‘Mad Money’ with Jim Cramer, you can see a clip here) may even end up writing a newspaper column or having their own TV show. These days they may even be writing a blog (hmmm…).
It may therefore come as a surprise that many of those whose knowledge and experience might reasonably qualify them to express such opinions tend to be rather less strident in their views. They have learned from experience and the application of rigorous analytical discipline (rather than by consuming the endless output of marketing departments) that markets are inherently unpredictable and therefore outside the ability of an investor to control. Instead they focus on those variables over which they can exercise some control.
One of the most popular assertions of the pub expert is that smart investors can identify (in advance, obviously – anyone can do it after the event) which investments will deliver the best returns and buy into them before everyone else recognises them as such. This may involve intensive study of the underlying businesses and formulating a view of their prospects (and thus their future returns) based on a forecast or even a gut feeling.
The other old favourite is that investors should aim to time their entry into markets according to the outlook, particularly once the current volatility has reduced. If I had a pound for every time I had heard the phrase “The markets are uncertain currently”, I would probably no longer be working for a living. Warren Buffett, writing in 1979 (shortly before the start of a massive bull market), said, “Before reaching for the crutch (market timing), face up to two unpleasant facts: The future is never clear [and] you pay a very high price for a cheery consensus. Uncertainty actually is the friend of the buyer of long term values.”
By ‘high price’, he means this literally. If everyone is expecting prices to keep on rising, they will keep buying and that increased demand will push them still higher. The higher prices go, the lower the future expected return. At some point, investors will realise that the implied future returns are no longer as attractive as they were and they start to sell. Once that starts, others join in so as not to be the last out and the bubble bursts. At some point prices will fall to a level at which the expected return again becomes attractive and those who were not wiped out by buying at the top and selling at the bottom will buy and the cycle begins again.
Charles Ellis, a long time commentator on markets, suggests that the truth is rather different in relation to either approach: “The best way to achieve long term success is not in stock picking and not in market timing and not even in changing portfolio strategy.” Although there are always winners who make the news, they tend to disappear before long as success is hard to maintain and not all the stories that trumpet their brilliance are entirely accurate. Instead, he says, “The great pathway to long term success comes via sound, sustained investment policy, setting the right asset mix and holding onto it.”
The ‘right asset mix’ in this context is not the one which will deliver the highest return but the one which is consistent with each investor’s particular goals, time horizon and their willingness and ability to take risk in pursuit of them. Nobody can manage returns because nobody knows what they are going to be, so the only effective decision that we can take is how much of which risks we are willing to accept.
Needless to say, the chap propping up the bar will not be able to provide insight into any of these essential factors. Not that it will keep him quiet….