Don’t summarize at cycle apex

Chen Jiahe Chief Investment Officer of Jiuyuan Qingquan Technology


In the securities market, many investors are very diligent and good at learning the latest knowledge, and they are always surrounded by the latest research reports, news and analysis articles every day. But what is interesting is that the securities market is not a place where “the harder you work, the higher your returns”. Studying the latest knowledge too diligently is likely to lead yourself into a misunderstanding: summarizing at the apex of the cycle.

Everyone has their own thoughts on why the price of a certain security is going up and why it is going down. However, when the price is deduced to the extreme and the cycle reaches its peak, the vast majority of voices will tell us that “the price is right”, that is, “there is a reason for being expensive, and there is a reason for being cheap.”

Taking the crude oil market as an example, the price of international crude oil surged above US$100 for a while and fell below US$30 for a while. We’ve seen the top (and bottom) of cycles quite a few times in the past.

So, how much should the international oil price be in US dollars? In fact, if we look at production costs, in 2022, the average cost of international crude oil producers will be around $60 per barrel.

Of course, no market stays near the cost line all the time, especially a volatile commodity like crude oil. Then, when crude oil rises above $100, the best explanation should be “the oil price is too expensive, and it will fall with a high probability in the long run.” On the contrary, “Oil prices are too cheap and will rise in the long run.”

For the “reversion from the cycle apex to the mean” of oil prices, Howard? Mr. Marks gave a more specific description.

When the price of oil is much higher than the cost of production, oil producers will increase supply (after all, more oil will make more money), while consumers will use less, and more people will buy small-displacement cars, even electric cars, and plastic recycling. The intensity will increase, and so on.

Conversely, when the oil price is much lower than the production cost, the oil miners will reduce production (after all, there is not much profit, and the oil will not be damaged if it is not extracted, and it will be sold in the future when it is expensive), while consumers will increase consumption. As soon as the supply decreases and the consumption increases, it will lead to the return of oil prices to the mean.

The above logic is the logic we should really think about at the peak (or bottom) of the oil price cycle. However, recall that at the peak and bottom of each oil price cycle, we hear the most popular and latest logic in the market. Is it the above logic?

Absolutely not. When the oil price is at the peak of the cycle (such as $140 in 2007), the latest logic in the market is often this: international political instability leads to a shortage of oil supply; oil reserves are exhausted, so the supply will be less and less; China There is huge room for economic growth in India and India, so in the future, oil will become less and less; the excess issuance of the US dollar will cause oil prices to rise. All of these are trying to prove to us that the current high oil prices will be eternal.

Conversely, what do we hear when oil is cheap (like $20+ in 2020)? The economic depression has led to a decline in crude oil consumption; oil suppliers are at odds with each other, so no one is willing to reduce production; the development of new energy sources has led to a decrease in demand for crude oil. All logic is trying to tell us that oil should be cheap.

For those investors who diligently study the latest popular theories, they have learned these logics at the peaks and troughs of cycles. However, these logics are wrong. Their appearance is not the result of careful reasoning, but rather a piece of logic cobbled together to explain prices far-fetched because prices are what they are.

These pieces of logic are like shooting an arrow first and then drawing a target: it seems that the arrow hits the bullseye, but it is actually useless to improve combat skills. The logic of these investments, it seems, can explain the current high price (or low price), but it is actually useless to improve investment skills.

Not only crude oil, but in the stock market, the bond market, the real estate market, and even the collectibles market, we also see countless conclusions made at the peak of the cycle. All of these conclusions justified the outrageous prices at the time, but looking at them in a few years, none of them are ridiculous.

So why, at the apex of the cycle, is the summary logic we see so often wrong? This is because, at the apex of the cycle, it takes enormous pressure to make a logical analysis that goes against the market price.

Think about it, the whole market is willing to pay a high price for a certain asset, the fund manager likes it, the salesman in charge of sales also likes it, and the investors who bought it two days ago also made a lot of money, even when the real estate is expensive. Sometimes, your mother-in-law also likes to let you buy a house. At this time, in the face of such a prosperous asset, how much courage does it take to write an analysis of “this asset is too expensive”?

From ancient times to the present, what can be written with courage must not be easy to write.

Back then, Zhu Di, the king of Yan in the early Ming Dynasty, rebelled, and after several years of arduous battle of Jingnan, he finally won the city of Nanjing, drove out his nephew, Emperor Jianwen, and wanted to be the emperor himself. Zhu Di, who was at the height of his power, asked Fang Xiaoru, the leader of the people in the world at that time, to write an edict for his enthronement.

Fang Xiaoru refused, but Zhu Di forced him. As a result, Fang Xiaoru took up the pen and wrote four big characters: “The thief of Yan usurped the throne.” Zhu Di was furious, beheaded Fang Xiaoru in the waist, and annihilated ten of his clans. Eight hundred and seventy-three people were killed. (In Chinese history, only nine clans were often exterminated. Zhu Di added Fang Xiaoru’s friend clan to create the famous “annihilation of ten clans”.)

Therefore, it is said that there are many people who tend to be inflamed in the world, and few people who are fighting for it according to reason. How many Fang Xiaoru can there be in the ages? What needs courage to do, naturally not many people do it. Only things that can get immediate benefits will make people flock to them.

Now, you should understand why it is difficult to hear the true logic in the market at the peak of the cycle, right? So, at the apex of the cycle, can we easily draw conclusions about investing based on the prevailing logic everywhere?



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