Arrogance
“We should do everything both cautiously and confidently at the same time.” —Epictetus
Monday of last week marked the end of a strong July for the stock market. The S&P 500 and the Dow were each up more than 3% during the month, and the Nasdaq rose more than 4%.
August started slower, with the indices posting cumulative losses during the first four trading days of the new month. For all of last week, the S&P 500 closed down 2.3%, and the Nasdaq was down 2.9%.
In a 2010 interview with Jason Zweig that was published under the title “Opportunities for Patient Investors,” Seth Klarman described the process of holding cash in the absence of great bargains, and the arrogance involved when trying to buy cheap assets:
When the markets are fairly ebullient, investors tend to hold the least objectionable securities rather than the truly significant bargains. But the inability to hold cash and the pressure to be fully invested at all times meant that when the plug was pulled out of the tub [in 2008], all boats dropped as the water rushed down the drain.
…Our approach has always been to find compelling bargains. We are never fully invested if there is nothing great to do. We test all our assumptions with sensitivity analysis. Through stress testing, we gain a high degree of conviction that we are right. We are prepared for things to go slightly wrong because we adhere to a margin-of-safety principle that gives us the necessary courage to go against the tide.
Yet, we don’t actually think of it as courage, but more as arrogance. In investing, whenever you act, you are effectively saying, “I know more than the market. I am going to buy when everybody else is selling. I am going to sell when everybody else is buying.” That is arrogant, and we always need to temper it with the humility of knowing we could be wrong—that things can change—and acknowledging that we have a lot of smart competitors. Thus, in worrying about all the things that can go wrong, you can prepare, you can hedge—and you must remember to sell fully priced securities so that you are underexposed when things go badly. All these elements give us the courage to follow our convictions.
Despite the market dip at the end of last week, stock markets remain ebullient. But as we mentioned a couple of weeks ago, some areas seem more attractive than others. And if nothing else, 3-month and 6-month Treasury Bills still have annualized rates north of 5.4% as you wait for better things to do with your capital.
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