“The four most dangerous words in investing are ‘This time it’s different.'”
– Sir John Templeton (29 November 1912 – 8 July 2008)
In 2005, the late Sir John Templeton penned a memo, which wasn’t discovered until after his passing in 2008. It was eerily pithy, almost ‘prophetic’ – as the first two words were bolded in its original text and begins as follows:
“Financial Chaos – probably in many nations in the next five years. The word chaos is chosen to express likelihood of reduced profit margin at the same time as acceleration in cost of living.”
Sir John had already correctly predicted the Dot-com crash and his predictions of a housing bubble (that will eventually burst) and subsequent stock market fall all came to pass. However, those with views similar to Sir John back in 2005 would generally have found their concerns of the housing market pooh-poohed by the proponents of securitization as the US housing market has ‘never experienced’ a simultaneous nationwide fall.
Time and again, investors have always used the words “this time it’s different” or many of its variants to justify our actions when we rush headlong into a bubble. Caught up in the euphoria of a bull run, we post-rationalize our thoughts and seek out ‘evidence’ to support our hypotheses. Much like when we suddenly decide to purchase a car of certain make and color, we tend to notice it a lot more often on the road. As our paper wealth increases, we use that as justification or worse, as ‘proof’ that our earlier convictions were indeed ‘correct’. Perhaps it is cognitive dissonance – not too dissimilar to a smoker who is perfectly cognizant of the health risks yet continues to feed his habit by inhaling from the cancer stick. Psychologists have shown that we have a tendency to underestimate the risk of an activity when we ourselves are engaged in it. We also have a penchant to indulge in intellectual materialism where we treat our ideas like possessions. We find it difficult to admit we were ‘wrong’ in light of new contradictory information and as a result, we hang on to our ideas for far too long. Perhaps this could be a reason why economic bubbles continue to persist despite ever more efficient markets.
Hindsight is a beautiful thing or, as I always say, “hindsight vision is always 20/20”. From the tulips mania in 1600s and the South Sea bubble in 1720, to the Housing bubble in the 2000s – it was never a bubble in foresight, only in hindsight. To quote the ‘greatest stock operator’ that ever lived:
“There is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.”– Jesse Livermore
The whole premise of efficient markets lies in the fact that overvalued stocks should theoretically attract short sellers to bring it back in-line. Arbitrageurs should keep the markets in check. However, as Yogi Berra once said “in theory there is no difference between practice and theory, in practice there is” and as we now accept, the markets are not always rational. In fact, I would go as far as to argue rationality itself is an arbitrary concept.
Keynes once remarked “The markets can remain irrational longer than you can remain solvent.” Even the best investors have painfully discovered that being early and right is the same as being wrong.
Michael Burry of Scion Capital faced an investor revolt when he bet too early on the recent subprime mortgage crisis. The housing bubble continued to inflate before his predictions came true and the investors that stuck with him made a tidy profit. Scion ultimately returned almost 500% (net of fees and expenses) from November 2000 until June 2008 whilst the S&P returned just over 2% over the same period.
Even the likes of George Soros, his once right-hand man, Stanley Druckenmiller of the Quantum Fund and Julian Roberston were not spared from the ‘irrationality’ of the markets. Each man, a titan of the industry and a legend in their own right, has paid dearly for being ‘right too early’ at one point or another in their careers. If being right too early equals being wrong, does being ‘wrong’ too early equals being ‘right’? Is it homogeneous and symmetrical? (More on this later.)
Julian Roberston’s Tiger Fund paid the ‘ultimate price’. Robertson correctly called the tech bubble in the late 90s but had to unwind the legendary fund in March 2000 ̶ just before the NASDAQ tanked. Since there was no hope of bucking the trend as momentum traders continued to ride the wave, hedge funds mostly jumped on for the ride. Only the bravest or perhaps the foolhardiest would even dare consider trading against this mania.
Perhaps the bravest of all was Julian Robertson who suffered heavy losses when everyone else surfing the wave was making extraordinary profits. Faced with a flood of redemption requests from investors as the bubble drove the price of tech stocks to dizzying heights, Robertson who famously refused to partake in the Internet craze just couldn’t hang on long enough. He had repeatedly warned the ‘day of reckoning would come’ when internet companies which had never turned a profit continue to skyrocket against a backdrop of collapsing stocks elsewhere.
In March 2000, Robertson decided he had enough of waiting and closed down the battered Tiger fund. At around the same time, the NASDAQ crested to mark the beginning of the end for the tech bubble. But for Robertson and his Tiger fund, the end just could not have come soon enough. The ‘day of reckoning’ did come on 13 March 2000 when the sell off began, but for Robertson it was too late. The market had remained irrational longer than he could stay ‘solvent’. Over the next 20 months, the NASDAQ fell from 5038 to a bottom of 1114. At its peak, Tiger had well over $20 billion in assets under management and Robertson was second to none when it came to stock picking.
Back in 1867 John Stuart Mills noted “Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive work”. The same lesson could still be applied to the Stock Market Crash of 2000-2002 which wiped off $ 5 trillion in the market value of companies.
Perhaps it is no wonder that Sir Isaac Newton famously said ‘I can calculate the motions of heavenly bodies, but not the madness of people’ when the genius himself got caught up in the South Sea bubble and reportedly lost £20,000 (equivalent to £ 3 million today).
Earlier, I argued that rationality itself is an arbitrary concept and posed the question “If being right too early equals being wrong, does being ‘wrong’ too early equals being ‘right’?” Think about it, if everyone in the world suddenly became ‘irrational’, would that not make you the irrational one (at least from a medical standpoint)? If rationality is defined by consensus, by implication, rationality is a moving target. Hence, when the market is acting ‘irrationally exuberant’, do you try to remain ‘rational’ and short the market (like what Robertson did)? Or do you act ‘rationally’ by jumping on for the ride to profit from it (like what Druckenmiller eventually did)?
George Soros famously said “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong”. I would venture as far as saying when it comes to the markets, there is no such thing as ‘wrong’ or ‘right’. There are strategies that are profitable, and strategies that blow you up. That’s it.
Fortunately, in finance, economists have another term called ‘profit-maximizing’ which is often used interchangeably with ‘rational expectations’. However, as investors we may not always have the luxury or liberty to consider etymological and philosophical questions when our portfolio is haemorrhaging money. If it walks like a duck, quacks like a duck and looks like a duck, for all intents and purposes – it is a duck!