The bipolar moods of Mr. Market
‘Buy low, sell high’ is one of those sage pieces of advice that just sounds too simple, but it can be done.
Stock markets are mean reverting, so although they swing higher and lower through the cycles, over time markets tend to revert towards a long-term mean or average valuation.
Because stock markets are liquid they can be volatile, but this volatility can be both your friend and your opportunity.
Legendary value investor Ben Graham used the analogy of the bipolar Mr. Market.
Some days Mr. Market is depressed and offers you an irrationally low price; other days he is exuberant and offers you a foolishly high price.
You just need to be able to recognise the difference between the two states.
Your ability to buy low has two simple components.
Firstly, the patience to wait for great opportunities to come around, and secondly, acting when the time comes instead of confusing the noise (gloomy media and market commentary) with the investment signal (markets on sale).
Blood on the tracks
What happens when you buy markets when they’re cheap and when there’s ‘blood on the streets’?
The simple answer is massive outperformance:
Source: Meb Faber
Now look at these returns and tell us that buying low is risky!
Source: Meb Faber
There’s an old saying that an investment ‘well bought is half sold’, meaning that as long as you buy cheap the question of when to sell will eventually answer itself.
Note that to take maximum advantage of this strategy you need to be able to buy low and then sell later to lock in your strong gains.
When you back-test the figures it becomes clear that the blitzing outperformance often begins to fade after 12-24 months (this makes sense, since after a strong rebound returns should begin to revert back towards their long-run average).
Buying low in action
Let’s take the contemporary example of the Pakistan ETF, for the simple reason that this has been one of our most recent investments (note: this is a personal investment undertaken by us, not financial advice).
Pakistan’s stock market was savagely hammered from 2017 through to H1 2019 as interest rates suddenly steepled higher (after all, why invest in stocks when cash is paying double-digit returns?).
But remember what happens when you invest in markets that have experienced brutal downturns?
And this was our signal to get buying:
Source: Novel Investor
An interesting point of note is that over the past 15 years Pakistan – alongside Greece – has been one of the worst performing emerging markets.
But that’s precisely the point.
We wanted to invest because it’d become so unloved and cheap (with a healthy dividend yield of 9.5% to boot), and because all countries will have years when they deliver huge returns, both positive and negative:
Statistics over stories
Now at this point people tend to rear up at us with a barrage of emotion-laden counterpoints.
But interestingly they’re normally based upon preconceived notions and biases rather than logically being founded upon any factual evidence.
Don’t be fooled by the folksy bonhomie – great investors such as Warren Buffett beat the market by relying fastidiously on statistics over stories.
Don’t forget that so many of the popular investing mantras are consistently promoted by a self-interested finance industry:
‘The best time to invest is today, so invest for the long term, and stay the course.
You can’t time the market, so you’d better leave it to the professionals…‘.
But that’s advice given to maximise their fees not your returns!
Now, of course, it’s true that you’ll never pick the exact bottom of the market, other than through blind luck.
But by systematically staging your entry into an investment, you can get close enough to the bottom to safely capture the bulk of the upside.
To make outsized, wealth-creating rates of return, with lower risk…buy low and sell high.
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