For Charlie Munger the "Efficient Market Theory" and "Modern Portfolio Theory" are "twaddle." Graduate business schools attempt to make investment analysis seem a lot more of a science than it really is. It is Charlie's calls this "Physics Envy _the craving for a false precision. The wanting of formula...". Markets (and economics) are not about science, they are about psychology. On Charlie's side is Jeremy Grantham who says,
"I believe that markets are usually inefficiently (emphasis added) priced, both in detail and in aggregate, and that they are driven by very fallible, emotional investors who have neither the mathematical nor the psychological means to process data efficiently in economic terms, nor, in the case of professionals, the incentive."
Graduate schools teach that the markets are efficient—that stock prices accurately reflect all information that is available. But how can you reconcile this with Ben Graham's bipolar Mr. Market who is wildly optimistic one day and violently depressed the next. I admit to having been attracted to EMT theory when I first read about it. On the surface it seemed to make sense. Eight years of employment as a broker from 1967 to 1975 had taught me a great deal of respect for the markets and absolutely none for market analysts.
Client Letter Comment
For are part we firminly agree with Jeremy Grantham the Mr market is usually inefficent becuse he is bi polar. The following is a list of our Client letters where we have attempted to deal with the subject of human psychology and its impact on the markets we study in some detail
The Price of Easy Money
The problem is that prolonged comfort has conditioned financial institutions globally to price their financial contracts with inadequate risk premiums. If pain is the mother of wisdom, does not comfort make us stupid?" or as Hyman Minsky explained more elegantly "Stability is unstable"There is, for all of the above maladies, one simple physic and it is not a soft landing. What the world needs now is a recession—not because pain is good, but because it is necessary.
Some Thoughts on Risk
There is no such thing as a risk free investment all investments carry some risk... "A good investment is one minimizes the risk that the investor faces, and that pays you well for taking the risk. All investments decisions should start with measuring risk."Were established wisdom says that markets are efficient and all price movements represent rational indications of value, behavioral finance will throw in with Benjamin Graham and accept the premise that markets are bipolar. So risk is dependent to a large extent on current investor psychosis. Strong bullish sentiment driven by good news makes a market more dangerous. At this point, the process of valuing risk becomes counter intuitive. The more the price of a stock goes up, the more risk it carries.
Bond Bubble
About bubbles, the money supply, shorting Treasury Bonds, and the direction of the economy for the rest of 2002. "So is flight to fixed income a rational refection of the economic conditions we can expect in the near future, or is it just Mr. Market scared to death by what he sees in the rear view mirror."Despite the meager returns now available from government bonds, money is pouring into debt. Bond funds experienced a record 28 billion inflow of funds in July. Almost always when you sell money flowing into sector funds it is a sign that the sector is getting overpriced. One is tempted to ask if buying 10 years government 4% is any more rational than buying tech stocks with PE's above 100.
Behavioral Economics and Educated Capital Markets
While Conventional economic theory says the economy and the markets are always rational. Professor Kaheman and Professor Smith, say “not necessarily.”Professor Smith Won his prize for running class room experiments to study the behavior of market participants. When he ran experiments trying to create bubbles he found that it was easy to do.
Bear Markets
Bear markets are powerful demonstration of the workings of human emotion on the equity markets. If the markets were rational why would we need bear markets?
Bear Markets
It will take more than a couple of years to de-lever the world. That does not mean the market will continue lower from here, but I do not see a return to a long term (secular) bull market any time soon.Now let’s take a look at some history in hopes of getting a little perspective on the current stock market. The chart below shows eighty-four year picture of the Dow Jones Industrial Average from 1924 to 2008...The chart nicely identifies two secular (long term) bull markets of the twentieth century. The chart also, very nicely identifies three secular bear periods starting with an 84% crash of the Dow in 1929.
Too Many Bears
The excesses of our recent tech bubble were so extreme that one three-year bear market is simply not enough to cleanse Mr. Market's Soul of his predilection to party on.But as much as I would like to believe that the correction has begun, there are a couple of things that bother me. Specifically there is all this bad news. Good bear markets do not start with bad news—they start when the news is good and everyone is happy, and end when the news is really bad. Sentiment indicators.
Secular Bear Market
In 1966 the market entered a secular correction phase that may or may not prove similar to today’s market. The market did not move straight down to its eventual low and recover steadily from that low. .From 1966 to 1982 the Dow was stuck in a trading range between 577 and 1000. This may not sound so bad but for those of us that were participating, it was a series of dull, slow, bull markets that always petered out at around one thousand on the Dow. These bull markets were separated by grinding gut-wrenching bear markets.
The Bear Market
The truth is it has been fairly easy to beat the market. Over the course of this bear market, all you had to do was to be willing to move in the opposite direction of the big money, and listen to Warren and Charlie.I do not expect the current market environment to change any time soon. The last secular Bull market lasted for 18 years (from 1965 to 1982), so the current roller coaster could easily last another five or ten years.
Bear Tracks
The bear may be loose but the fun has only begun. The good news is that there are many old economy stocks that are attractively priced. When you look at your December statements you will begin to see some new names there. This does not necessarily mean that I think the market as a whole has bottomed. It means that I am finding good companies at attractive prices, and that I am afraid that they may not get much cheaper even if the rest of the market turns back down.
Charlie Munger
Charlie Munger, Berkshire Hathaway’s resident psychiatrist has had a lot to say over the years about the behavior of investors and about the impact of their behavior on the investments. But Prof. Munger's Psych lessons are not just about investing, they are about life.
Perfectly Obvious
"We’re not saying that we do things better, but rather that this is us. We want people with a lifetime commitment to their business. To underscore the values that we have, everything we do is consistent with Berkshire’s culture. Everything they see hear, and read from the company should be consistent…Homes have cultures. Companies have cultures. Countries have Cultures at Berkshires people buy into it and see that it works. This kind of thing doesn’t require mentoring. Managers see consistency in how Charlie and I act." - Warren Buffett
Models for a successful Life
A transcript of a speech given by Charlie Munger in 1994. It is in my opinion a masterpiece of simple logic as developed by a very complex intellect. The basic premise is that a person's ability to deal successfully with life is based the models that they use to interpret events.
Physics Envy
In October of 2003 Charlie gave a lecture to the economics students at the University of California at Santa Barbara in which he discussed problems with the way that economics is taught in universities. One of the problems he described was based on what he called 'Physics Envy.' This Charlie says is 'the craving for a false precision. The wanting of a formula..."
Charlie Munger on the Psychology of Human Misjudgment
From a speech at Harvard Law School. " Although I am very interested in the subject of human misjudgment -- and lord knows I've created a good bit of it -- I don't think I've created my full statistical share, and I think that one of the reasons was I tried to do something about this terrible ignorance I left the Harvard Law School with. When I saw this patterned irrationality, which was so extreme, and I had no theory or anything to deal with it, but I could see that it was extreme, and I could see that it was patterned, I just started to create my own system of psychology, partly by casual reading, but largely from personal experience, and I used that pattern to help me get through life."
Charlie Rules
Charlie Munger at the 2000 Berkshire Hathaway annual meeting. For me the perfect Mungerism Saturday was about the impact of the Internet on corporate profits. "For society the Internet will be wonderful, but it is way more likely to make business less profitable, than more profitable. This is perfectly obvious, but very little understood."