There are two competing ideas around handling financial news. Either check your statements once a year while you try your best to ignore all the
news noise. The other is to listen to everything until you learn to filter the news from the noise. Despite what people say, there are pros and cons to both.
I bring this up because the last post highlighted a Seth Klarman interview in which he was asked about how he avoids groupthink. I touched upon it briefly and wanted to expand on it. The answer he gave was an example:
At our recent investment team retreat, virtually every speaker – many of the leading thinkers in the markets and in business – was of the opinion that terrible problems await in terms of paper money and that gold is an asset investors should seriously consider. Also, the prevailing opinion was that the European Monetary Union is likely to break up. All of our partners instinctively said, “Wow! That’s groupthink. We better be really careful before assuming that because everyone thinks that it is definitely going to happen.
There is always some level of groupthink in the markets. The markets are generally biased toward optimism and moving higher. And there is always some crackpot predicting devastation. That said, Klarman’s example is a solid non-answer to that question.
I believe time and experience are your greatest assets in recognizing groupthink. A little history helps too since hindsight is how most of us figure this stuff out. If you spend enough time – a market cycle or two – paying attention, you eventually reach a point where you know it when you see it.
Groupthink in 2006 and 2007 was that real estate prices would only keep rising. In 1998 and 1999, internet stocks could only do the same. In 2009 and 2010, it was a double-dip recession and out of control inflation.
I think it’s safe to presume groupthink is most pronounced at the peaks and troughs of a cycle. More so, it’s about being aware of a change in the language being used – like a shift from possible to definite – When you see a shift in sentiment is where being a contrarian matters.
Howard Marks covered this on the MiB podcast while explaining market cycles:
Rule #1 – most things prove to be cyclical. Rule #2 – some of the greatest opportunities from gain and loss comes when other people forget rule #1.
The three stages of a bull market: 1) only a few people believe things could ever get better, 2) most people understand improvement is taking place, 3) everyone believes it will get better forever.
The point is you should know which stage you’re in and you should act accordingly.
One potential issue is that finance news is markedly noisier than it was even a decade ago. And today, the internet and social media make it easy to enhance our own biased beliefs. In other words, it’s easier than ever to get lost in a corner of the internet where everyone always agrees with you.
What the human being is best at doing is interpreting all new information so that their prior conclusions remain intact. – Warren Buffett
If you plan on paying attention, you need to deliberately seek alternative views or you risk feeding your own biases. Even then, you still need the willingness to change your mind when the facts change and the temperament to act opposite of the herd. Both are easy things to say, but harder to do.
- Homeostasis and Why We Backslide – Farnam Street
- 12 Things Learned about Investing from the Simpsons – 25IQ
- What Is The Profitability Premium? – L. Swedroe
- Everything Is More Expensive Than It Looks – J. Zweig
- The Perilous Task of Forecasting – P. Tetlock
- No One Knows What Will Happen – A Wealth of Common Sense
- Lessons That Must Be Learned the Hard Way – M. Housel
- The Market’s Buyback Yield Is Not A Timing Tool – Investor’s Field Guide
- The Mistrust of Science – A. Gawande