In the fall of 1929 panic spread. By November 13, 1929, stock prices were down by almost 50 percent in two months. The biggest stock market crash in history was underway, and the worst would continue to worsen.
Yale University Economics Professor Irving Fisher in the midst of the chaos in November 1929 tried to explain what had happened:
It was the psychology of panic. It was mob psychology, and it was not, primarily, that the price level of the market was unsoundly high . . . the fall in the market was very largely due to the psychology by which it went down because it went down.
By 1932 stock prices had fallen 89 percent from their 1929 highs.
Twenty years later, in 1949, stock prices were basically flat from where they were in 1929.
Despite improved economics. And what were now cheap stock prices. No one wanted to own stocks.
Fear had permeated, like a dark cloud rolling across the sky.
What happened after?
From 1949 to 1959 stock prices ripped like they never had before: appreciating by 20 percent per year.
Ten-thousand-dollars invested in stocks in 1949 was worth $62,000 in 1959—just ten years later.
Fear had created the low prices which allowed the high returns.
The pendulum had swung. As it so often does in investing.
Fear
Mark Twain spoke of fear. He said: “I am an old man and have known a great many troubles, but most of them never happened.”
As did Seneca. He said: “We suffer more in imagination than in reality.”
Tom Petty said something similar: “Most things I worry about never happen anyway.”
Fear is a boogeyman.
It scares us more than it harms us.
But fear can cause harm by preventing us from doing the right thing.
The Ultimate Fear
Seneca spoke of the ultimate fear for most of us, dying. He said: “Refuse to let the thought of death bother you: nothing is grim when we have escaped that fear.”
Fearing death can prevent us from living fully.
Just like fearing a stock market crash can prevent us from achieving satisfactory investment returns.
Fear is nothing more than our imagination running wild.
It is chicken little screaming at us, “the sky is falling.”
It mostly turns out to be false.
In investing, as in life, you need to prevent it from misleading you.
Because all too often it turns out to be an imposter.
Seneca put it like this:
There’s nothing either good or bad but thinking makes it so.
How we interpret events is crucial to keeping fear in check.
Recognize fear is nothing more than a masked man.
Unmask him and you’ll see there is nothing much to fear.
Pessimism
Your ultimate friend as an investor is pessimism. That’s what creates high returns, when other people become pessimistic.
Here are the 10-year average annual rates of return for stocks from historic lows:
1949 to 1959: 20 percent
1982 to 1992: 18 percent
2009 to 2019: 15 percent
It was pessimism that drove high returns during each of these periods.
Warren Buffett put it like this:
A climate of fear is your friend when investing; a euphoric world is your enemy.
It’s counterintuitive. You need to go against your emotions. When you’re feeling fearful, it’s usually the time to be buying; when you’re feeling optimistic, it’s usually time to be cautious. This counter-intuitiveness is what makes investing so difficult.
Buffett put it like this:
If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall . . . This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.
It’s sinking prices you want.
Investing at lower prices is what will enable you to get higher returns.
The opposite is true.
Investing at higher prices will give you lower returns.
A rotten stock market is good for you as an investor—as a buyer.
Buffett elaborated further:
Smile when you read a headline that says, “investors lose as market falls.” Edit it in your mind to “disinvestors lose as market falls—but investors gain.” . . . We gained enormously from low prices placed on many equities and businesses in the 1970s and 1980s. Markets that then were hostile to investment transients were friendly to those taking up permanent residence.
He wrote that in 1997.
In 2011, following the Financial Crisis, he wrote this:
Terror over economic collapse drives individuals to currency-based assets, most particularly U.S. obligations, and fear of currency collapse fosters movement to sterile assets such as gold. We have heard “cash is king” in late 2008, just when cash should have been deployed rather than held.
Same story. Different time period.
Fear created opportunity for the rational investor, as it always does.
Optimism
It is optimism that is the enemy of the rational investor.
Optimism creates high prices. And high prices create low returns.
Therefore, if you’re going to be investing for years you should be hoping for pessimism, not optimism.
Howard Marks put it like this:
When buying something has become comfortable again, its price will no longer be so low that it’s a great bargain.
Buying stocks in 2009 was painful, when fear permeated, which made it difficult but such a good decision. Since then, stock prices are up about 15 percent per year on average.
Bottom Line
Fear is your friend as an investor, optimism your enemy.
Avoid being swept away by either emotion.
Going against the grain is often right in investing, and most profitable.