At a recent Wesco Financial (WSC) annual meeting, Wesco Chairman and Berkshire (BRK) Vice-Chairman, Charlie Munger was asked a question about what tools or courses one could take to become a better investor. Munger quickly quipped, that all one needs to understand investing and to become a better investor is a basic course in economics.
The key--and brilliant, I might add--insight here is that to become a good investor, one just needs to understand basic supply and demand interactions in markets. Essentially, all that one needs to do to make money by investing is to sell assets that are in high demand (low supply), and buy assets that are in low demand (high supply), and wait for markets to return to equilibrium. Like all great insights this one is also simple, yet why is that so few people can actually execute it?
In my view, the difficulty for most folks is that it is incredibly hard for them to wait for opportunities (supply/demand imbalances) to invest, and then to also wait for markets to recover and clear (supply/demand equilibrium). It can often take years for these events to occur, and time and time again it’s evident that the average investor just doesn’t seem to have the emotional temperament to be patient and wait. But is it their fault?
Perhaps, but I don’t think most Wall Street professionals help the average investor to understand these basic economic concepts either. Most Wall Street professionals make money for themselves by living off of the buying and selling of their clients. As a result, it’s in these professionals’ interest for their clients to do anything but be patient and wait. Rather, they’d like to have their clients make as many transactions as possible, as frequently as possible. In my opinion, the way that Wall Street achieves this “transaction volume” is by creating so much noise and esoteric terminology, that the otherwise patient investor becomes so confused about what is going on in the world, that they are eventually cajoled into making a move—often at exactly the wrong time.
The irony is that while short-term transactions are being promoted from far and wide, most individual investors actually have a long enough time horizon to be patient and wait for both opportunities to present themselves, and then to also wait for markets to recover. Given this time horizon advantage, how can individuals tune out Wall Street’s noise and apply a basic economic framework to long-term investing?
Let’s think about today’s markets. Fear is widespread. Predictions of doom and gloom are rampant. And as a result, the demand for US Treasury bonds (safety) is so high, that even as the Treasury has upped its own issuance of debt—thereby increasing supply--short-term bills are still, in some cases, returning negative rates of return—i.e. buy $1.00 and get $0.98 back. Taking it one step further, the prices of Treasury bonds today actually have no where to go, but down. Stated interest rates cannot—by definition—go lower than 0.00%, and when they eventually rise, the price of these bonds will fall, as supply would begin to outstrip demand.
Almost all other assets--stocks being one of the major ones--have seen their prices fall, as supply is currently much greater than demand. Basic economic theory would suggest that when supply and demand eventually adjusts again (similarly as described above), it will force supply and demand in other markets (such as stocks) to also adjust, perhaps eventually creating greater demand for these types of securities. And within these markets, this type of economic analysis could be performed on a more micro, or granular, level on the individual securities themselves to identify imbalances. This is no great insight. It is just a simple extension of a basic economic theory developed centuries ago, and applied to a modern market. So, if this appears to be so simple, what is the great equalizer?
It has everything to do with time and temperament. On the former, one has to consider if they have a long enough time horizon to wait for markets to stabilize or return to equilibrium, whenever that may be. On the latter, all one can really do is not watch the hourly market gyrations or listen to the myriad of daily prognosticators--maybe just turn them off--and trust that logic and rationality will eventually return to markets in the years and decades ahead.
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You might also be interested to know that this article was also recently featured in a MarketWatch article, which I've linked here.
Justin
