Quote of the week:

“The person that turns over the most rocks wins the game.” (Source)

Inefficient market hypothesis 

The best way to forecast the future is to study the past. In that spirit, this week I spent time reading some older analysis of the October 1987 crash, which happened precisely 35 years ago this week. I’d like to share a few of my favorite pieces here.

The first piece I’ll highlight came out in November 1987. It was published by the Nobel Prize-winning economist Robert Shiller (who back then was a 41-year-old researcher for the National Bureau of Economic Research). The day of the crash, Shiller had a good idea: He sent a survey to 175 institutional investors and 125 individual investors asking them a simple question: “So, what the heck just happened?” (I’m paraphrasing, here…)

Shiller’s resulting study offers a few powerful observations on psychological behavior and investor sentiment. Perhaps most importantly, Shiller exposes the relative absurdity of the efficient market hypothesis, as applied to price movements in the short-term. 

“In interpreting the lack of an identifiable proximate cause for the drop,” Shiller writes, “it should be borne in mind that there is a growing literature that calls into question the ‘efficient markets’ theory that all price movements must be interpretable by information about economic fundamentals… there is statistical evidence that suggests the stock market may have a life of its own to some extent, unrelated to economic fundamentals.” He continues: 

“Since no news story or any other recognizable event from outside the market appears to be immediately responsible for the market crash, we will thus turn to consideration of a theory of the crash as being determined endogenously by investors: that the timing of the crash was related to some internal dynamics of investor thinking, investor reaction to price and investor reaction to each other.”

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Why the 1987 crash didn’t scare Peter Lynch

In 2001, a PBS interviewer asked Peter Lynch about his thoughts on the 1987 crash. His answer: “1987 wasn’t that scary because I concentrate on fundamentals. I call up companies. I look at their balance sheet. I look at their business.” 

Lynch acknowledges that in the short-term, market prices and macroeconomics will naturally get the most attention from investors, media, and the general public. But over the long-term, there is nothing more important than company fundamentals and an individual firm’s growth trajectory. He says: 

“Well, they should think about what’s happening. I’m talking about economics as forecasting the future. If you own auto stocks you ought to be very interested in used car prices. If you own aluminum companies you ought to be interested in what’s happened to inventories of aluminum. If your stock are hotels, you ought to be interested in how many people are building hotels. These are facts. People talk about what’s going to happen in the future, that the average recession last 2 years or who knows? There’s no reason why we can’t have an average economic expansion that lasts longer. I mean I deal in facts, not forecasting the future. That’s crystal ball stuff. That doesn’t work. Futile.”

Philip Fisher’s most important lesson 

Concluding this (arguably macabre) Nightcrawler edition on the anatomy of the 1987 crash is a wonderful Forbes interview with Philip Fisher published on the morning of Black Monday. In the interview, Fisher was asked about the most important lesson from his decades as an investors. His answer: Just play the long game.

Like Lynch would later argue, Fisher makes the case that letting your winners run is the single most important contributor to outperforming.  “It is just appalling the nerve strain people put themselves under trying to buy something today and sell it tomorrow,” Fisher says. He continues: 

“It’s a small-win proposition. If you are a truly long-range investor, of which I am practically a vanishing breed, the profits are so tremendously greater. One of my early clients made a remark that, while it is factually correct, is completely unrealistic when he said, ‘Nobody ever went broke taking a profit.’ Well, it is true that you don’t go broke taking a profit, but that assumes you will make a profit on everything you do. It doesn’t allow for the mistakes you’re bound to make in the investment business. Funny thing is, I know plenty of guys who consider themselves to be long-term investors but who are still perfectly happy to trade in and out and back into their favorite stocks.” (H/T Rishi Gosalia)

A few more links I enjoyed: 

The science of happiness – via Peter Attia Drive
“Arthur Brooks is a social scientist, professor at Harvard University, a columnist for The Atlantic, and the bestselling author of From Strength to Strength. In this episode, Arthur explains how intelligence changes as we get older, and how to take advantage of this to maximize our happiness and success. He distills truths about the meaning of happiness and its three main components: enjoyment, satisfaction, and purpose. He goes into detail about many of the keys to a happy life, including the importance of cultivating virtuous relationships. On the flip side, Arthur warns of the dangers of social comparison, ‘success addition, and the four worldly idols—money, fame, power, and pleasure—that drive many of us. Additionally, Arthur provides examples of exercises that can guide one in the right direction, overcome fear, and cultivate habits that can lead to a happier life.” (H/T Trey Kuppin)
We Will See the Return of Capital Investment on a Massive Scale – via The Market
“First of all: avoid government bonds. Investors in government debt are the ones who will be robbed slowly. Within equities, there are sectors that will do very well. The great problems we have – energy, climate change, defence, inequality, our dependence on production from China – will all be solved by massive investment. This capex boom could last for a long time. Companies that are geared to this renaissance of capital spending will do well.”

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