I think a recent essay by Howard Marks, co-chair of Oaktree Capital (OAK), bears consideration at this point.
"What's clear to the broad consensus of investors is almost always wrong," he wrote. "First, most people don't understand the process through which something comes to have outstanding money-making potential. And second, the very coalescing of popular opinion behind an investment tends to eliminate its profit potential."
Marks also talked about the difference between what he called "first-level thinking" vs. "second-level thinking":
"First-level thinking is simplistic and superficial, and just about everyone can do it (a bad sign for anything involving an attempt at superiority). All the first-level thinker needs is an opinion about the future, as in: 'The outlook for the company is favorable, meaning the stock will go up.'
Second-level thinking is deep, complex and convoluted. The second-level thinker takes many things into account:
- What is the range of likely future outcomes?
- Which outcome do I think will occur?
- What's the probability I'm right?
- What does the consensus think?
- How does my expectation differ from the consensus?
- How does the current price for the asset comport with the consensus view of the future and with mine?
- Is the consensus psychology that's incorporated in the price too bullish or bearish?
- What will happen to the asset's price if the consensus turns out to be right, and what if I'm right?
Some of the talking points from the famed money manager above talks about ways to look at the stock market and investing in general. I try to approach the randomness of behavior stocks exhibit using "second-level thinking". If you're looking for someone who's reactive, solely influenced by the current price trend and ignores the emerging and changing risk-vs.-reward ratio, stop reading this missive.
But if you're looking for someone who's anticipatory and fully influenced by the difference between current share prices and an analytical assessment of intrinsic value (i.e., risk vs. reward), then understand that is me.
As I've mentioned, I am uncertain in forcasting the markets movements over the short and near term but I do believe long term the general move in stocks is upwards. I recognize that we're in a market that's without memory from day to day, as well as one that might not provide positive returns for the year. In fact, I continue to expect the S&P 500 to ring up a low-double-digit decline for 2016 as a whole. This puts a premium on "gaming" any 5% market moves in order to "make hay when the sun is (briefly) shining."
For now, I'd recommend disregarding all of the sentiment surveys. Instead, take note of the apparent self-confidence that exists in a near-universal belief among technicians and fundamentalists that we're in a bear market where investors should underweight stocks or skip them altogether.
There is no "secret sauce" in my playbook and I do not adhere to a constant investment theme; I'm just trying to deliver good investment returns in a market that intermittently provides opportunity. But let me make clear that while I see current value in stock prices, I'm not positive on stocks right now. Instead, I'm merely trying to be opportunistic. My secular and cyclical concerns remain very much intact, but the stock market's recent dive has widened the gap between current price and intrinsic value for many sectors and individual stocks. Or, as the investment manager mentioned above Howard Marks put it:
"The bottom line is that first-level thinkers see what's on the surface, react to it simplistically and buy or sell on the basis of their reactions. They don't understand their setting as a marketplace where asset prices reflect and depend on the expectations of the participants. They ignore the part that others play in how pries change. And they fail to understand the implications of all this for the route to success."