The trend isn't your friend. Says who? The investor Warren Buffett admires.
"When I see memos from Howard Marks in my mail, they're the first thing I open and read. I always learn something, and that goes double for his book," is Warren Buffett's view on Howard Marks, who I've mentioned here before.
Mr Marks is the founder and chairman of Oaktree Capital Management, a value‑oriented American fund management firm, and the author of The Most Important Thing -- one of the best investment books I've read.
The book owes much to Mr Marks' habit of periodically sending pithy, well-argued memos to his clients -- with the memos in question being those that Warren Buffett was referring to.
Handily, Mr Marks has just sent out another memo, prompted by spending a sleepless night on a business trip re-reading The Death of Equities, an article published by Business Week magazine back in 1979.
Yet another lost decade
Cogently argued, The Death of Equities surveyed the investing climate back in 1979, and noted persistently high inflation, low levels of interest among mutual funds for holding equities, a move into fashionable overseas and alternative asset markets, and 10 years of exceptionally low returns by historic standards.
As an investment, it concluded, equities were dead: it was time for investors to find other places to put their money.
Sounds familiar? It certainly should.
Our own present 'lost decade' for equities regularly brings out doomsayers, invariably pointing out that the FTSE 100 is lower now than in 1998, and that buying shares is a mug's game.
Missing the bottom
The trouble is, 1979 didn't mark the death of equities. As Mr Marks observed, it actually marked the beginning of the greatest bull market in history.
And when the author of The Death of Equities was complaining how cheap shares had become relative to the underlying assets in question, he was actually signalling that the stock market was a screaming buy.
But he missed it. Most private investors and the wider stock market missed it. Commentators and business school types missed it. Mutual fund managers missed it.
"Common sense isn't common: the crowd is invariably wrong at the extremes," says Mr Marks. "In the investing world, everything that's intuitively obvious is questionable, and everything that's important is counter-intuitive... Four of the most dangerous words in the investment world: it's different this time."
And, of course, it wasn't different this time. For, as Mr Marks observes, the S&P 500 gained 18.4% in 1979, the year that The Death of Equities was written. It then went on to average 18.9% for the next 20 years.
The trend is not your friend
What are investors getting wrong? Simply put, says Mr Marks, they're extrapolating the recent past into the future, instead of looking at the fundamentals and then applying a little logic.
"Trends that lead up to a point in time have a profound effect on people's thinking," he writes.
The result? They're too pessimistic at the bottom of the market -- and too optimistic at the top. Which is where they went wrong in the late 1990s, imagining that stock market gains of 30% and more a year could continue for ever. Ditto, more recently, March 2009, which saw the FTSE bounce back from 3,461 to 5,602 exactly 12 months later -- a rise of some 62%.
And investors are also getting it wrong today, he argues. While the situation isn't as dire as in 1979, eerie parallels can be drawn:
- The S&P 500 is 8% below its 2000 high, while earnings per share have nearly doubled.
- The 30-year return on shares is below the return on bonds.
- The P/E of the S&P 500 is in the low double digits, cheap by historic standards.
- Investors are pulling money out of shares, and buying bonds.
History rhymes
Don't be fooled, argues Mr Marks. Take the long view, look at the facts and not the hype.
"The media usually gets it wrong, and the pieces that get the most attention tend to be highly sensational, and get it the most wrong," writes Mr Marks. "Most things eventually prove to be cyclical, and tend to swing back from the extreme towards the mean."
All of which sounds sage advice to me.
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