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Some Things about the Markets That Will Never Change

Ben Carlson accepts that this is the craziest market he has ever seen. The pandemic somehow turned a bunch of people into day traders. At first, in the US, they were buying beaten-down airline and cruise stocks. Now they’ve moved on to buying shares of companies that have filed for bankruptcy. Many companies that have filed for bankruptcy recently but have seen massive price swings over the past week. It’s easy to “tsk, tsk” these types of speculative moves in the markets but this type of behaviour is nothing new.

This year is unlike anything we’ve ever seen before in terms of market and economic dynamics but there is plenty of investor behaviour that has been around since the dawn of markets.

Here are some things that will never change about the markets:
Lottery ticket stocks will always find a buyer. Our brains are wired such that expecting to make money feels even better than the act of making money itself. It’s the anticipation that puts your brain on high alert. This is why investors and gamblers alike are rarely satisfied with a single win. Your brain always needs another shot of dopamine to get that high again. It’s not enough for speculators to simply accept the market’s return during a massive recovery from a bear market. This is why we’ve seen a move from sector ETFs to beaten-down companies to bankrupt companies. And the temptation to speculate increases when we watch others around us getting rich.

People with no skill or knowledge about the markets can still make money. Some of the smartest, most sophisticated investors on the planet have been caught off guard by the market surge in recent months. Not only have these titans of the investment industry watched as the market has passed them by, but the biggest beneficiaries of the rise seem to be tiny retail traders. The market doesn’t discriminate between professional and amateur and there’s no IQ test required to buy a share of stock. The market cashes checks from anyone who plays, regardless of where they have an account or how much capital they have at stake. This is not to say this will continue indefinitely but to paraphrase Keynes, “The market can keep the irrational investor solvent as long as you remain bearish.”

The “dumb” retail money will occasionally beat the “smart” professional money. Legendary investors like Druckenmiller, Tepper and Buffett have all admitted to being positioned too defensively during this rally. This doesn’t make these legends idiots just like it doesn’t make day trading investors geniuses. This is just the way things work sometimes. No one bats a thousand.

No one is right all the time. Renaissance Technologies, likely the greatest hedge fund machine ever created, has claimed to be right on just 51% of their trades. No one is going to nail every top and bottom, especially in a market environment like this where things are happening at ludicrous speed.

Cycles tend to feel like they will never end. When stocks were getting thrashed on a regular basis in March it felt like the selling pressure would never let up. Lately, it’s felt as if stock gains happen every day. Markets are always and forever cyclical and no trend lasts forever.

Hindsight capital remains undefeated. It’s easy to look back at what’s transpired this year and come up with perfectly logical reasons for the market’s manic behaviour. And there are plenty of logical reasons for a market crash that immediately turned into a roaring bull market in the span of 3-4 months. But there are no counterfactuals. Things didn’t have to happen this way. Markets have shown this year how they can be equal parts resilient and fragile.

Certain investors will always worry more about being right than making money. Markets would be a whole lot easier if hard work translated into better results; if intelligence guaranteed alpha; if fundamentals always carried the day; and if the markets always made sense. Unfortunately, that’s not the case.

Carlson concludes that simplicity often beats complexity. Temperament matters more than intelligence. And sometimes markets just don’t make sense.

The Uncomfortable Truth

Jon wonders on his blog as to what’s the biggest determinant of investing success? Smarts, information, strategy, or skill are all worthy possibilities.

The market naturally triggers emotional responses that lead to mistakes. Those best equipped to handle those triggers are more likely to succeed. That shouldn’t come as a surprise. Most things in life worth achieving require mental toughness to get through the obstacles that are certain to arise. And investing is full of obstacles. For example, markets can trick people into thinking that investing is ridiculously easy. Raging bull markets, especially, create the illusion that you can earn returns without risk and get rich quick. But once the bull market ends, as they all do, the bear market that follows presents investing as a certain money loser. And to add insult to injury, the market spreads bull and bear markets out far enough for investors to forget how the last one ended.

It’s at these opposite extremes, the major turning points in the market, where the right temperament is in short supply but needed most. Successfully navigating major market turns requires a willingness to think and act against the crowd. Stock prices reflect the obvious, not the obscure.

If the crowd believes a bull market will continue, then it’s obviously already priced in. Which means anything that might disrupt that trend is not. It’s not even an afterthought in the most enthusiastic bull markets. But you can’t wait for the disruption to surface because once the trend breaks, once the crowd realizes it, then the selling begins, and it’s too late. So you have to be willing to be early. You have to be able to sell when prices are rising while the bull market seems endless. But you also must be willing to buy when prices are falling, while the bear market appears to only get worse. Both are difficult. (If it were easy everyone would do it. And if everyone did, the market turns would just happen sooner.)

The final twist in this saga is that betting against the crowd usually fails. It’s only at the turning points where it succeeds. Except, bull markets and bear markets don’t come prepackaged with expiration dates. Being invested during the length of a bull market is very profitable. Getting out early, while profits look good, is hard. Because betting against it, will certainly look wrong, but being wrong is costly. And few investors are willing to stomach that.

Jon concludes that to be successful you have to be independent and decisive, with the courage to appear wrong but ultimately proved right. That’s why the greats stand out. That’s the uncomfortable truth.