I have just finished another insightful article by Howard Marks from Oaktree. He is one of my favorite financial writers out there. His deep grasp of economic and financial market intricacies always impresses me.
Here is a section:
On the first two days of August, I was in Brazil, where people often asked me to explain the sudden collapse. I referred them to my 2016 memo “On the Couch.” Its key observation was that in the real world, things fluctuate between “pretty good” and “not so hot,” but in investing, perception often swings from “flawless” to “hopeless.” That says about 80% of what you need to know on the subject.
If reality changes so little, why do estimates of value (that’s what security prices are supposed to be) change so much? The answer has a lot to do with changes in mood. As I wrote over 33 years ago, in only my second memo:
The mood swings of the securities markets resemble the movement of a pendulum between euphoria and depression, between celebrating positive developments and obsessing over negatives, and thus between overpriced and underpriced. This oscillation is one of the most dependable features of the investment world, and investor psychology seems to spend much more time at the extremes than it does at a “happy medium.”
Mood swings do a lot to alter investors’ perception of events, causing prices to fluctuate madly. When prices collapse as they did at the start of this month, it’s not because conditions have suddenly become bad. Rather, they become perceived as bad.
Several factors contribute to this process – heightened awareness of things on one side of the emotional ledger, a tendency to overlook things on the other side and similarly, a tendency to interpret things in a way that fits the prevailing narrative.
What this means is that in good times, investors obsess about the positives, ignore the negatives, and interpret things favorably. Then, when the pendulum swings, they do the opposite, with dramatic effects.