Don't be a victim

"When markets are at extreme highs or lows, the essential requirement for achieving a superior view of their future performance lies in understanding what's responsible for the current conditions. Everyone can study economics, finance, and accounting and learn how the markets are supposed to work. But superior investment results come from exploiting the differences between how things are supposed to work and how they do work in the real world. To do that, the essential inputs aren't economic data or financial statement analysis. The key lies in understanding prevailing investor psychology."

As the Indian equity markets flutter around their all-time highs, these words from a recent memo published by famed investment manager Howard Marks on the website of his firm Oak Tree Capital should be carefully read and understood by investors who find themselves obsessing with the level of the markets. Marks could have been writing about what is going on in India at the moment, even though he wasn't. Marks has been a successful fund manager who is, somewhat unusually for a professional fund manager, also known as a very good writer about investing. His writing is generally in the form of well-known memos on investing that he sends out to his investors, as well as posts on the firm's website. Even Warren Buffett has said that when a memo from Marks arrives, he drops everything to read it.

The impact of market highs on investor psychology is quite remarkable. As the high comes tantalisingly near, and then is reached, and then keeps repeating itself, more and more investors go into a frenzy of investing and a sort of a 'buying panic' breaks out. There's nothing strange in what I'm saying - everyone who has been investing for years or decades has seen it - and even felt it - many times. That's what Marks means when he says, "... the essential inputs aren't economic data or financial statement analysis. The key lies in understanding prevailing investor psychology."

In his memo, Marks discusses "taking the temperature of the market." These amount to understanding this psychology that he speaks of. He recommends that one should "Watch for moments when most people are so optimistic that they think things can only get better, an expression that usually serves to justify the dangerous view that "there's no price too high." This is the buying panic that I often warn investors from getting into because market highs are actually a risky and dangerous time.

Marks goes on to say, "Remember that in extreme times, because of the above, the secret to making money lies in contrarianism, not conformity. When emotional investors take an extreme view of an asset's future and, as a result, take the price to unjustified levels, the 'easy money' is usually made by doing the opposite. This is, however, very different from simply diverging from the consensus all the time." This is an important distinction he makes. Much of the time, markets are neither too high nor too low. They are in the 'OK zone'.

An important thing that we should appreciate is that Marks is a professional investment manager. When he talks about the psychology of the mass of investors and how he takes advantage of that, he's talking about people like us, about our psychology. Investors who make psychological mistakes give away their money to smart investors. 'Victim' is a harsh word to use, but in a way, it's quite appropriate in this context.

If an expert and experienced investor is saying that the key lies in understanding investor psychology, then for the individual investor, the key lies in understanding one's own psychology. Whether your investments make money for you or they make money for someone else depends on whether you do this. If there is a lesson that individual investors should draw from this, then it should be: Don't be a victim.

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