Everyone wants to know what happens next. That’s the nature of market crashes. When will it end? Was that the bottom? What if it falls further?
The questions are asked a hundred different ways and the only good answer is: “I don’t know.” But that’s not what you’ll hear.
Instead, everyone also has an opinion. Many will go out of their way to express it. The trouble starts when people listen and act on it.
Warren Buffett dealt with this situation in 1966. The Dow had a rough six months to start the year. It declined from 969.26 to 870.10. That’s a loss of 8.7% after dividends, a tame decline compared to 2020. A few of his partners felt obligated to tell him what would happen next. This was his response:
I received a few calls from partners suggesting that they thought stocks were going a lot lower. This always raises two questions in my mind: (1) if they knew in February that the Dow was going to 865 in May, why didn’t they let me in on it then; and, (2) if they didn’t know what was going to happen during the ensuing three months back in February, how do they know in May? There is also a voice or two after any hundred point or so decline suggesting we sell and wait until the future is clearer. Let me again suggest two points: (1) the future has never been clear to me (give us a call when the next few months are obvious to you — or, for that matter the next few hours); and, (2) no one ever seems to call after the market has gone up one hundred points to focus my attention on how unclear everything is, even though the view back in February doesn’t look so clear in retrospect.
If we start deciding, based on guesses or emotions, whether we will or won’t participate in a business where we should have some long run edge, we’re in trouble. We will not sell our interests in businesses (stocks) when they are attractively priced just because some astrologer thinks the quotations may go lower even though such forecasts are obviously going to be right some of the time. Similarly, we will not buy fully priced securities because “experts” think prices are going higher. Who would think of buying or selling a private business because of someone’s guess on the stock market? The availability of a quotation for your business interest (stock) should always be an asset to be utilized if desired. If it gets silly enough in either direction, you take advantage of it. Its availability should never be turned into a liability whereby its periodic aberrations in turn formulate your judgments.
Buffett quickly shuts down the idea that anyone knows what happens next, especially him.
Falling prey to the “guesses” runs counter to what he’s trying to accomplish. Imagine selling your attractively priced home because you think the price will fall in the next few months but with the intention of buying it later once prices bottoms.
It sounds silly, but that’s what investors try to do with stocks. Unfortunately, with stocks, it also tends to be an all or nothing decision.
If you have a good home, you should hold onto it. The same goes for the businesses you own through your stock holdings. The good news is, an attractively priced business becomes more attractive, not worse, should prices fall. So you can buy more shares — something you can’t do with your home.
The problem with timing drawdowns is you have to be right twice. You have to be right on the decision to sell and the decision to buy back in. Neither is guaranteed to be right.
It also stops being about what should happen to the business but when it should happen to the stock. What is driven by data and analysis. When is driven by emotions and guesswork.
Buffett is focused on what because that’s all he can control. If his analysis is right about a business, the market will eventually deliver, he just doesn’t know when. His partners are worried about when because selling feels better than the immediate pain of a further decline.
Selling leaves you with the eventual anxiety that comes with deciding when to get back in. It becomes another emotionally-driven guess.
And market crashes can play mind-games. The heightened volatility around crashes will make your decision to sell seem brilliant one day, stupid the next, or both at different times the same day. So, if a market decline drove you to sell, how likely will you dive back in before the market calms down?
That’s why Buffett avoids it:
We don’t buy and sell stocks based upon what other people think the stock market is going to do (I never have an opinion) but rather upon what we think the company is going to do. The course of the stock market will determine, to a great degree, when we will be right, but the accuracy of our analysis of the company will largely determine whether we will be right. In other words, we tend to concentrate on what should happen, not when it should happen.
Instead, he focuses on what he can control — the data and analysis — because he has faith that the market eventually aligns price with value.
Buffett Partnership Letters
- Fear and the Psychology of Bear Markets – J. Montier
- Marks Memo: Weekly Update (pdf) — H. Marks
- Blizzard, Winter, or Ice Age – OSAM
- Long Toilet Paper/Short Equities: Why We Panic Buy and Sell – Behavioral Investment
- A Viral Market Meltdown IV: Investing for a post-virus Economy – Musings On Markets
- Stock Index Weights are…Different – Klement on Investing
- Wounds Heal, Scars Last – M. Housel
- Preserving Optionality: Preparing for the Unknown – Farnam Street
- Corporate Socialism: The Government is Bailing Out Investors & Managers Not You – N. Taleb
- Michael Mauboussin: Investing in times of (the Coronavirus) Crisis (podcast) – Value Investing with Legends