This year I started writing a tangible journal, penning thoughts on particular themes or questions that cross my mind on any given day. I had figured that sharing a similar type of memo digitally might be a useful exercise in that tangible entries, those isolated to the pages within my journal, have no audience. Writing publicly can be a great way to generate feedback on one’s thoughts.
In Howard Marks’ latest memo, he describes a bull market as follows:
“In a bull market, favorable developments lead to price rises and lift investor psychology. Positive psychology induces aggressive behavior. Aggressive behavior leads to higher prices. Rising prices encourage rosier psychology and further risk-taking. This upward spiral is the essence of a bull market. When it’s underway, it feels unstoppable. The most important thing about bull market psychology is that, as cited in the final bullet point above, most people take rising stock prices as a positive sign of things to come. Many are converted to optimism. Relatively few suspect that the gains to date might have been excessive and borrowed from future returns and that they presage reversal, not continuation.”
I think by now that everyone is familiar with the psychology of the market, as demonstrated in the below image. I can’t be sure where we are today, but the last few years have been a textbook case study of the road up to euphoria and the moment the market lost its footing and slipped into denial only to tumble on a downwards trajectory of anxiety, fear, and so on.
I would argue that we have seen 1.5 of these cycles only in the last couple of years, including one certified case of despondency (albeit, short-lived) in 2020, followed by one serving of euphoria up until the latter half of 2021, concluding in our current freefall. As Joe Frankenfield, of Saga Partners, pointed out, Marks previously urged caution in 2013, 2015, 2017, 2020, 2021, and now 2022. The man who wrote the book on Market Cycles, doesn’t appear to be well equipped to time them, so why should I? Furthermore, I would be inclined to believe that should someone grant me the macroeconomic data for the next 24 months, I would still struggle to work out what the market, let alone individual stocks, would do over the time frame.
I am 25 years of age, soon to be 26. I have endured no major cycles in the market, other than what unfolded during 2018, the short-lived bear market of 2020, and what is taking place now. Prior to that, the period of 2015 through 2019 was quite rosy, by all means. As masochistic as it may sound, I welcome periods like this. The wrong thing to do would be to give up and manifest a feeling that resembles the tagline from ‘Who’s Line is it Anyway?”, where everything is made up and the points don’t matter.
It may feel that way sometimes, but the data shows that corrections, recessions, and even the occasional depression, are all par for the course. Absorbing that data and fathoming how one might react in similar circumstances is one thing, but living through it is the kind of tangible experience that furthers one’s learning. Being so young, with relatively few outgoings, few responsibilities or dependents, I feel I can “afford” these lessons. Assuming that my earnings power is in its infancy and that I can leverage some of the benefits of compounding, the capital I employ today will be dwarfed in the decades to come. Better to lose 20% of my net worth at age 25, than at 40.
There’s this old tale of the Arab and the camel. One cold night, as the Arab lay asleep inside his tent, his camel stood outside. At midnight, the camel awoke his master and requested that he be allowed to put his head inside the tent as it was bitterly cold outside. The Arab allowed him to do so. After a while, the camel asked if he may place his neck inside the tent. The Arab did not object. Soon after, the camel requested that he be permitted to bring his legs inside. The Arab agreed. At this point, the camel now stood completely inside the tent. But as there was no longer space for both the Arab and the camel, the camel pushed the Arab outside to shiver in the cold.
Whilst I am sure there are many analogies that can be related to an investor’s lack of foresight and reasoning, my takeaway would be that should the Arab allow this to happen again in the future, then he has learned nothing from his mistakes. The saying “fool me once, shame on you, fool me twice can’t place the blame on you” is apt here. As some investors lay outside their tents shivering in the cold, reflecting on what led them to that situation is the best approach. Rushing back into bed with a camel without heeding prior consequences would be foolish.
Looking back on my own miscomings, I certainly overpaid for a few companies. The reality is that March 2020 did offer up some bargains, but as the second half of the year panned out, institutional flows carried prices further, as did liquidity, as did the newly energised retail crowd. A culmination of perpetuating forces came together for a once in a lifetime (it will probably happen again in my lifetime) royal rumble that gushed excess for over a year. I like to think (assisted by luck) that my decision to rotate out of my typical barbell style in 2020 was a good one. I did buy beaten-down consumer discretionary stocks, such as Starbucks and MGM Resorts quite aggressively, but I also purchases numerous technology, ad, cybersecurity, and commerce stocks too. So much so, that my “balance” was titled towards those companies which would still earn profits during a global shutdown. Sea Limited, Peloton, and Crowdstrike, are all names that I got in and out of, within a year or so, and made attractive returns.
However, businesses like Redfin and Pinterest cost me dearly. Even names I still own to this day, such as PayPal (owned since 2018), Block (owned since 2020), and Etsy (owned since 2020), have shown me that my discipline with valuation was led astray. I had reasonable entry points in these names, but ignored valuation and bought on the way up. PayPal for instance, a stock I first purchased for $89 in 2018, witnessed me purchase at ranges between $150 and $200 over the following three years, before making a purchase only last month at $89 once again. Thus, I was guilty of holding on too long for some and overpaying for others.
As much as I adore the mantra of Terry Smith, ‘buy quality, don’t overpay, and do nothing’, it’s clear to me that I ignored rules 2 & 3. Thus succumbing to the point Marks made about “most people take rising stock prices as a positive sign of things to come”. Life is hard, and it can be easy to succumb to negativity, self-doubt, self-pity, and in the worst of outcomes, denial. In any event, in life generally, I look for the positives that may be drawn from the outcome.
{Edit} - In hindsight, I realise the omission of suggesting I ignored rule 1, at times, also is a touch contrived. I certainly did that too.
The Magic of Thinking Big, by David Schwartz, is a fairly dated book by today’s standards, but the framing of two competing forces within one’s mind, a positive and negative voice, is one that stuck with me after reading it as a teen. Mr Truimph, the voice which produces positive thoughts “specializes in producing reasons why you can, why you're qualified, why you will”, whilst Mr Defeat “is your expert in developing reasons why you can't - his speciality is the "why-you-will-fail" chain of thoughts”. They say the easiest person to fool is yourself, so my approach is to remain honest, spend the time to reflect on my shortcomings, and then swiftly move on with the knowledge that I may be better equipped to handle similar scenarios in the future.
I have seen other investors get defensive, some realise a renewed love of dividend investing, and some go the complete opposite direction, tripling down on their covid losers. I have even seen one person abandon all other stocks in favour of one that had fallen 70% from ATHs, going all in, only to witness the stock fall a further 60%, now down ~90% from ATHs. I am not casting judgement, just sharing observations.
I feel somewhat less pain on account of the fact that I operate two portfolios. One, largely comprised of ~13 non-dividend paying businesses across ads, dating, payments, digital security, commerce, restaurants, media, and clothing. More recently, that includes a ~12% exposure to the UK. This portfolio is trailing the market, down ~25% this year, and comprises ~58% of my net assets.
The second portfolio is shielded from tax and possesses a greater deal of diversification across geography, with ~20% in the UK, 5% in Asia, and the remainder either largely US-centric, or global. Here, there is a majority weighted towards indexes, with individual stock sector exposure in food & drink, banking, consumer goods, entertainment, stock market exchanges, industrials, and clothing. Most pay dividends and the portfolio, which I regard as my coffee-can-esque retirement account, is only down ~8% YTD, comprising ~40% of my net assets (the other 2% in private equity).
58% x -25% = -14.5% → 40% x -8% = -3.2% → ~ (-18%)
Whilst the primary portfolio may not exhibit the barbell-like positioning it once did, I view my aggregate exposure as meeting that criteria as the two begin to converge in nomial value. If anything, it provides me with some peace of mind.
For the younger readers of Investment Talk, or those of similar ages to me, I hope this provides you with some comfort or at least reminds you that we are not held to the same standards of the professionals or more experienced investors. It’s not about failing, it’s about how you learn from those mistakes, that matter.
Thanks for reading.
Conor,
Author of Investment Talk
Very well put Conor, ty for sharing
I also just read Marks... and your writing really resonated with me, because I also made many many mistakes in my investing career. And the funny thing was that I said, "Ok, now I really know how..." to myself several times in the last few years.
Guess what?
NOW I really know how ... :)