In his book, The Most Important Thing, Howard Marks explains why being alert to what’s going on and taking the market’s temperature, can help us gain a better understanding of the investment climate and make better investment decisions. Here’s an excerpt from the book:
When I say that our present position (unlike the future) is knowable, I don’t mean to imply that understanding comes automatically. Like most things about investing, it takes work. But it can be done.
Here are a few concepts I consider essential in that effort.
First, we must be alert to what’s going on. The philosopher Santayana said, “Those who cannot remember the past are condemned to repeat it.”
In very much the same way, I believe those who are unaware of what’s going on around them are destined to be buffeted by it.
As difficult as it is to know the future, it’s really not that hard to understand the present. What we need to do is “take the market’s temperature.”
If we are alert and perceptive, we can gauge the behavior of those around us and from that judge what we should do.
The essential ingredient here is inference, one of my favorite words.
Everyone sees what happens each day, as reported in the media. But how many people make an effort to understand what those everyday events say about the psyches of market participants, the investment climate, and thus what we should do in response?
Simply put, we must strive to understand the implications of what’s going on around us. When others are recklessly confident and buying aggressively, we should be highly cautious; when others are frightened into inaction or panic selling, we should become aggressive.
So look around, and ask yourself: Are investors optimistic or pessimistic? Do the media talking heads say the markets should be piled into or avoided? Are novel investment schemes readily accepted or dismissed out of hand?
Are securities offerings and fund openings being treated as opportunities to get rich or possible pitfalls? Has the credit cycle rendered capital readily available or impossible to obtain?
Are price/earnings ratios high or low in the context of history, and are yield spreads tight or generous? All of these things are important, and yet none of them entails forecasting. We can make excellent investment decisions on the basis of present observations, with no need to make guesses about the future.
The key is to take note of things like these and let them tell you what to do. While the markets don’t cry out for action along these lines every day, they do at the extremes, when their pronouncements are highly important.
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