Earlier this week, a friend who works on Wall Street told my wife, “I’m not as optimistic as Jason…but I like his columns.” The next day, as I passed my colleague Evan Newmark in the hallway, he joked, “There goes the last bull on Wall Street.”
Let’s get this straight, folks. I’m not an optimist or a bull, at least not the way most investors usually use those terms. I would not be a bit surprised if the stock market fell another 20% or so from here. But stocks are already on sale – and further markdowns are good news, not bad, for anyone who is not retired or about to be. Since most of us have many years of saving and investing ahead of us, it is in our best interests for the fire sale to last longer and for the discounts to get deeper. As risky assets keep getting cheaper, we get to buy them at prices low enough to take most of the risk out of the equation.
If the history of the financial markets and the psychology of investing have anything to teach us, it is that present emotion and future returns are inversely correlated. Today’s feelings of pain and fear are the building blocks for tomorrow’s wealth. Eras of good feeling are terrible times to buy stocks.
The corollary is that perceived risk and actual risk tend to be polar opposites. When did your house feel like the safest investment? Just as its appraised value hit an all-time high, of course. The Dow felt safe when it was at 14000, and it feels risky as hell now that it is clinging to the edge of 8000 with its fingernails. That’s perceived risk: low when prices go up, and high when prices go down.
But your perception of risk is a lousy indicator of the actual presence of risk. The Dow was vastly more dangerous at 14000 than it is around 8000. Most of the risk of holding stocks has been wrung out of them by their fall in price. Stocks could certainly go lower from here; more likely, it could take them many years to regain their former highs.
But so far as I’m concerned, those are reasons to be cheerful. I’m not a Pollyanna optimist; I guess I’m the Cassandra kind.
Warren Buffett described this inverted form of optimism in this classic passage in his 1997 report to Berkshire Hathaway’s shareholders:
How We Think About Market Fluctuations
A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.
But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.
So, if I am an optimist, it’s not because I see stocks rising any time soon. It’s because I have already seen them falling before our very eyes.