If you spend enough time managing money you learn that extremist views are extremely dangerous. Being a permabull is usually right in the long-term, but can expose you to getting crushed at times along the way. Being a permabear will look very right on rare occasions, but will crush you consistently in the long-term. And while both of these positions are dangerous they are dangerous in very different ways.
I use a top-down perspective to understand just about everything in my life.¹ This means I try to understand the big picture and then breakdown that big picture into lots of smaller pictures. So, for instance, if I want to understand how I can build a boat to get me from point A to point B I first need to understand the dynamics that allow for a boat to operate in water. I then need to build the boat so that it meets the stresses of that macro environment. And then I need to get all the little details right about how the boat will actually get there (navigation, power, maintenance, etc).
Having a high probability of success in investing is much the same. You need to understand certain macro operational realities of the world we live in so you can implement a micro plan that will work. When it comes to the financial markets I start with one overarching macro reality:
- Capitalism rewards progress by enriching those who are innovative and productive.
This is a simplistic statement of fact. But the kicker is, if you live in a capitalist system you’re very likely to live in a system that will make progress over the long-term. Now, your definition of “progress” might not be the same as a capitalists, but that is not the point here.² The point is that being a permanent pessimist in a capitalist financial market is the equivalent of swimming against the tide. You are fighting a very powerful long-term trend in which millions of people are waking up every day thinking of ways to prove you wrong.
Of course, we shouldn’t take this view to an extreme either. Being a permabear is particularly dangerous because the high probability trend over the long-term is higher levels of output and profit in a capitalist system. But the financial markets are not the economy. And the financial markets, being a partial function of human psychology, can do whacky things at times. This is why equity portfolio insurance (bonds, options, etc) can be a very smart way to improve the certainty of uncertain future outcomes. In other words, tempering your long-term bullish macro bias is a very smart way to operate because it reduces the variance with which the equity market crowd tends to operate. But that is a more micro discussion inside of my more macro point.
The key lesson here is, when we understand the financial markets inside a capitalist system our natural starting point is one of progress, of optimism. In my opinion, this is the great lesson of the financial crisis. Despite all the excuses portfolio managers have made in the last 9 years (ZIRP, QE, the Fed manipulated this or that, Congress manipulated this or that, etc) the one overarching reality is that life went on. People continued to get up in the morning and think of ways to make a profit and make goods and services that would provide value to their customers. And that overarching reality is the trend that broke the permabear back. More importantly, this macro operational reality is why it is (usually) smart to start from an optimist’s perspective of the financial markets.
¹ – This is not true in the case of my wife. In her case I start with the micro case (her) and end with the micro case (her). After 15 years together this approach seems to be working marginally well.
² – In the eyes of a capitalist “progress” means higher profits. Higher profits should not necessarily be confused with higher living standards. While higher profits generally mean that people are paying for goods and services to improve their own living standards it is not a statement of fact that higher profits mean higher living standards.
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