Real Investors Root for Down Markets

If we’ve got investing time horizons that span more than a decade (and the majority of us do), it is irrational for us to be rooting for new all-time highs. Real investors don’t get excited by perpetual new highs because they understand that it means lower expected returns on new money invested. They also understand that it makes their jobs harder.

David Merkel (Aleph Blog) frames this issue perfectly:

Every now and then, the market falls apart.  At such a time, two things happen.

1) Because some sector of the economy had too much debt, prices for the stocks and corporate bonds (or trade claims) fall, and the market as a whole falls along with them, though to a lesser extent.

2) During the crisis, many assets get oversold, and those with better knowledge can profit from the overselling.  The best example I can think of all of the hedge funds that bought non-agency mortgage-backed securities, when they were thrown out the window indiscriminately in 2008, and many of those securities have returned to par.

The ability to achieve alpha (outperformance) increases after a crisis.  Some who prepare for that, like Seth Klarman and Warren Buffett, create their own outperformance by taking more risk when other investors are running away in panic.

As my boss asked me in 2007, “Why have you not done so well for us the last few years, when you did so well 2003-5?  I answered, “When I came to you, the market was like an apple cart  that had fallen over and I picked up the undamaged apples.  Today, the market is rational, and there are not a lot of easy pickings to be had.  That is the difference between the bust and the boom.  It is much easier for a fundamental investor to act during the bust.

Assuming you’re continually earning income and rolling the excess into some kind of investing vehicle, what you’d like to see is more upset apple carts, not less. You get more of that sort of thing in a market downtrend, not while the floor traders are wearing funny hats commemorating the latest broken record.


The Investments Matter More than their Form (Aleph Blog)

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Tough Week (TRB)


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