Month: January 2015

In late 1999, Warren Buffet told the world that the next 10 years will be tough for the stock market. And he was absolutely right. The S & P 500 actually lost 30% in that period.

Jesse Felder has an intriguing post on the subject. He says that some of the current market valuations are even higher than they were in the late 90s. Does that mean that we are in for another rough decade? Maybe. It depends on your market approach.

The period between 2000 and 2010 brought a lot of turbulence for the stock market. We had two “once in a 100-year storms” – the big correction in early 2000, when the Nasdaq Composite had an 80% drawdown and 2008/2009, when the S&P 500 had a 57% plunge. The very same decade also brought us epic bull markets in commodities and emerging markets, monstrous trends in consumer discretionary and technology names like Apple, Google, Monster Energy, Chipotle, Blackberry, etc. These are just a few of the huge multi-year moves that happened during the so called ‘lost decade”. There were countless more 50%-100% moves during each year. There were even more 25%-30% moves within each quarter and even more 10-15% moves within each month.

Even if the next 10 years turn out to be just as volatile and crazy as the first decade of this century; even if the major equity indexes deliver negative returns for the decade and we go through several humongous corrections, there will be plenty of opportunities for shrewd traders and investors to consistently grow wealth. Some things never change in the market. One of these things is the existence of great growth and recovery stories. Financial markets are amazing opportunity machines.

You should always think for yourself and take every opinion with a grain of salt. In this case, it is obvious that I am biased. My financial research business and my personal market approach are based on the deeply ingrained belief that markets are inefficient and could be beaten with proper equity selection and risk management. I am not telling you to stop dollar-cost averaging in indexes and learn how to pick stocks. I am just sharing what has worked for me and where I will continue to focus my efforts.

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The stock market is bipolar creature, driven by sentiment and irrational expectations. One day, it is an ingenious forward-looking mechanism that anticipates and discounts future events beautifully. Another day, it is a stubborn schizophrenic that can’t see further than its nose.

Markets constantly overreact to both, identified risks and opportunities. It is in the nature of financial markets to exaggerate, to magnify. This is why they are not always discounting the future. Sometimes, they are correcting previously incorrect view. Sometimes, they just go bonkers and send prices to levels that cannot possibly be justified by any future scenario. Boys will be boys. Markets will be markets. They’ll fluctuate violently, up and down and to levels that will seem incomprehensible to many. Indexing, robo-advising and social media won’t change that. The Internet might have made people smarter; but it hasn’t made financial markets more efficient. You could complain and whine about financial markets’ irrationality or you could find a way to take advantage of it. Or don’t. It’s your choice.

If you understand people’s incentives, you are very likely to predict correctly their future behavior and sometimes even influence it. Most incentives have expiration date. What is important today, might not be as important tomorrow. This applies perfectly to life, but not always in financial markets that live in their own world. Incentives require the existence of rationality. We have already made the point that more often than not, markets are not rational, but emotional, at least in a short-term perspective. As Howard Marks eloquently puts it:

Psychological and technical factors can swamp fundamentals. In the long run, value creation and destruction are driven by fundamentals such as economic trends, companies’ earnings, demand for products and the skillfulness of managements. But in the short run, markets are highly responsive to investor psychology and the technical factors that influence the supply and demand for assets. In fact, I think confidence matters more than anything else in the short run. Anything can happen in this regard, with results that are both unpredictable and irrational.

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