Fear and Greed

Buffett’s saying ‘be greedy when others are fearful and fearful when others are greedy’ is one of his best.

Although this quote is often recited, it would appear that many have become desensitised to its actual meaning. Furthermore, the quote does little to acknowledge how difficult it actually is to be greedy when surrounded by fear.

For much of the last 6 weeks, fear has overwhelmed financial markets. For the first time in more than 5 years, stocks are cheap. Certainly not across the board, but definitely more so than January this year.

James Montier’s (GMO) recent white paper release in late March tells us why humans struggle to be greedy during times like this.

James points to studies that show that our emotions trump cognition in our brain’s function.

Loss aversion is a very real emotional bias. When humans have recently lost money, or, have recent evidence of loss, they are much less likely to take on risk.

James notes that financial markets are one of the few places where people are more comfortable paying a full price over something ‘on sale’.

Right now you can buy $1 of normalised earnings for (in some cases) 50% less than what you could at any time in the last 5–7 years. Despite this, people generally prefer to wait for more stable conditions and even freely acknowledge that prices might be higher then.

James sights Sir John Templeton’s quote “the time of maximum pessimism is the best time to buy”. Note, he doesn’t put any caveats around waiting for data to improve or markets to stabilise. This is because markets usually react favourably to certainty and therefore waiting for that is a missed opportunity.

Howard Marks sighted in a previous article that the bottom of a market is arrived at when fear is at its peak. I have no idea where that is but shopping at the sales / buying cheap is a decent place to start.

Credits: James Montier, Warren Buffett, Howard Marks.