Reason vs. Emotion
“In my opinion, investment success will not be produced by arcane formulae, computer programs or signals flashed by the price behavior of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace.” —Warren Buffett
Stock markets had a down week, with the S&P 500 falling about 1.3% and the Nasdaq dropping 1.9% in the holiday-shortened week.
We’ve spoken about the power of emotion and psychology in this newsletter on several occasions because those things are important. They drive markets. They drive prices (in the short run). And they create opportunities—if you take advantage of them instead of succumbing to their negative influences. As investor Howard Marks has written, you must combat them with reason:
The power of psychological influences must never be underestimated. Greed, fear, suspension of disbelief, conformism, envy, ego and capitulation are all part of human nature, and their ability to compel action is profound, especially when they’re at extremes and shared by the herd. They’ll influence others, and the thoughtful investor will feel them as well. None of us should expect to be immune and insulated from them. Although we will feel them, we must not succumb; rather, we must recognize them for what they are and stand against them. Reason must overcome emotion.
Much is different about the market and the economy today than it was 20 or 50 or 90 years ago. But one thing that hasn’t changed is the emotions of the people that buy and sell stocks. Human nature is what it is, and while one needs to keep learning to adapt to new businesses and business models over time, the discipline needed to be successful hasn’t changed all that much.
Author Roger Lowenstein wrote about this in the sixth edition of Security Analysis, which was published in 2008:
The changes in the marketplace have been so profound that it might seem astonishing that an investment manual written in the 1930s would have any relevance today. But human nature doesn’t change. People still oscillate between manic highs and depressive lows, and in their hunger for instant profits, their distaste for the hard labor of serious study and for independent thought, modern investors look very much like their grandfathers and even their great-grandfathers. Then as now, it takes discipline to overcome the demons (largely emotional) that impede most investors. And the essentials of security analysis have not much changed.
While the markets have seen some pickup in volatility, there seems to be much more volatility in business results recently—and the surprises have skewed negatively.
It is hard to predict whether or when we’ll see more of the effects of higher interest rates and less stimulus move from business results to the markets. But markets have a history of getting choppy in September and October—so it might be a good time to make sure you’re emotionally prepared in case Mr. Market gets a little moody during the next couple of months.
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