The S&P 500 index of the U.S. stock market closed at 3,735 on June 14, 2022, down nearly 23% from its January high, and has entered a bear market. The following text is from the sharing made by the author in the internal investment group in April 2019. It has been slightly edited and is now published.
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Here are some recommended books for you:
By William Bernstein:
1) Rational expectations, asset allocations for investing adults;
2) Master of the word: How media shaped the world from the Alphabet to the Internet.
The author is very interesting. Born in 1948, he has a doctorate in chemistry and medicine, and is a doctor in neurology. Later, in the 1980s, I started to focus on my own investments, and then I wrote a lot of books on investing and asset allocation. I recently read a series of his books, and I feel that some observations are very profound and resonate, and they are close to my practical experience in the past 20 years, so I took them out and shared them with you.
The outline shared today is, to sum up:
When the capital market is bad, it is worse than imagined, and it is much worse.
Bernstein quote: To deal with this worst-case scenario, you have to have “patience, cash and courage,” in that order. (you must have “patience, cash and courage” and in that order. )
(1) How bad would it be?
About two years ago, I shared in the group about the US stock index investment (such as the S&P 500 index fund), and the long-term annualized return for more than 20 years has ranged from 9-13%.
Large index funds such as SPY have an inherent advantage. They will automatically adjust their positions, survive the fittest, kick out bad companies and add good companies. So if you don’t have the ability to adjust your positions objectively and without emotion, you might as well buy an index fund.
Some people will say that since the long-term returns of index funds are so good, then I will close my eyes and fill the index funds, no matter what, I will hold them for a long time. The actual operation is not so simple, and index funds will also have a price drop of 50% or more. If your assets shrink so much, your heart may collapse, and you may constantly question the validity of the concept of “long-term holding”, and then because of life Stress, often at the worst of times, closes out positions.
Many people completely overestimate their tolerance for risk, and they say they understand it. Even if the market falls by 50%, they will not panic, but in practice, they will panic when it comes to this day. Everyone has this stage, which is basically human nature.
There are many definitions of risk. In academic circles, risk is defined as the volatility of the stock, the so-called standard deviation. This model has a major flaw, that is, in the worst case, it cannot accurately describe the actual situation.
William Bernstein’s definition of risk is “bad return at bad times”.
This bad definition does not mean the end of the world, but refers to the phenomenon of serious price imbalance and distortion in the market. The degree and duration of the distortion may exceed everyone’s imagination. Even if it is still optimistic in the long run, most people cannot survive this shock. Inability to stick to the correct strategy.
There are several categories of bad possibilities:
The first type, prolonged inflation, has caused the relative depreciation of cash and bonds, and the relative underperformance of stocks. This happened in the 1970s in the United States, in the 1940s in China, in the 1920s in Germany, and in many countries in Latin America/Eastern Europe/Middle East/Southeast Asia.
The second category is a prolonged period of deflation, a recession, a mess of stock losses, many bond defaults, and only a few government bonds with good returns to preserve their value. This happened throughout the 1930s in the Western world, 2000-2003, 2007-2009, and Japan in the past 30 years.
The third category belongs to the government through taxation or other policies, forcibly depriving or redeeming citizens’ assets at a low price, as well as wars, etc. This has happened all over the world in the past 100 years, but this is not discussed today. within the range.
In addition to the big bear market in which the U.S. stock market index fell by 90% from 1929 to 1932, the well-known U.S. bear market of 2001-2003, and the 2008 global financial crisis, the past fifty years have also included:
1/ From the beginning of 1973 to the end of 1974, because of the war in the Middle East and the oil crisis, the US stock market fell by 48%, and the entire Western world stock index fell by more than 50%.
2/ In October 1987, the U.S. stock market fell 22% in one day, from the August high to the October low, the market fell 34%. Some small brokerages went bankrupt within a day because of this huge volatility.
3/ The flash crash of the US stock market on May 6, 2010, the Dow Jones index fell 1,000 points in ten minutes, some ETF liquidity suddenly disappeared, fell 20%, 30%, or even 40% in a few minutes, although half an hour later Most of them bounced back, but many speculators set a stop loss order, and the result was immediately liquidated and harvested. As for futures speculators, players who sell options naked will finish the game within a few minutes.
4/ UBS has an index fund, code XIV, which is a short volatility strategy. It has performed well before, and it seems to be a waste of money. On February 6, 2018, it fell 93% in two days. The last ETF was liquidated a few days later.
5/ The Swiss franc suddenly depreciated against the euro in 2011, and suddenly appreciated against the euro in 2015 (the futures market rose by 30% instantly), closing down some decades-old stores and funds within a day.
6/ The Nikkei index fell from the historical high of 38957 in 1989 to 7800 in 2003, a drop of 80% in fourteen years.
7/ The Hong Kong Hang Seng Index fell from above 1800 in early 1973 to below 180 in December 1974, down 90% within two years, and only returned to its 1973 high at the end of 1980. In August 1997, the Hang Seng Index in Hong Kong reached its highest point of 16860, and at its lowest point in August 1998, it fell to 6500 points (the P/e ratio was only eight times). At that time, international speculators wanted to sell the stock market and foreign exchange market at the same time. 4000 points, and finally the Hong Kong government intervened to buy stocks directly from 6700 points in August, finally saving the crisis. Investors who are not mentally and materially prepared have no way to survive in this environment.
8/ The Taiwan stock index, which was still 2,300 at the beginning of 1987, rose to the highest point of 12,495 at the beginning of 1990, an increase of as much as six times. Within two years, it fell back below 3,000 points, a drop of nearly 80%. Nearly three decades later, the stock index is now at 10,641, not yet surpassing its high point three decades ago. In the past three decades, there have been five bear markets in which Taiwan’s stock index has dropped more than 40 percent.
9/ The above lists are all indices. Many stocks drop by 80%, 90%, 95% or even more during the crisis. There are also various economic crises in the third world countries.
No one, not even at the highest levels, or who thinks they have comprehensive information, can accurately predict short-term trends. As a recent example, even US Treasury Secretary Hank Paulson, when he put Lehman Brothers bankrupt in September 2008, did not predict that this approach would suddenly freeze the commercial paper market and cause a global financial tsunami. The entire market index fell nearly 50% after half a year. %.
No matter how successful you are in other industries, no matter how much money you have, if you encounter a bear market like this one, because you are not prepared psychologically, mentally, or financially, it is easy to accumulate a lifetime of accumulation in a short period of time. All lost inside. Moreover, successful people in other industries will have a mentality of working hard and fast and resolute. When applied to investment, it will often have the opposite effect.
(2) Classification of investors
Bernstein divides the investors involved in the market into three categories:
The first type is simple and rude. Following news speculation, they tend to buy big when the bull market is nearing the end and sell in panic when it reaches the bottom. This is typical of inexperienced investors.
The second type is the simple and mature type, with a certain asset allocation strategy. If the market falls, you will find a bargain, and if the market is high, you will sell a part. They read a lot, it’s like pilots get trained and run flight simulators for a long time. However, if the bear market is really extremely panicked, I thought I could hold it, but I would panic and be forced to sell. It’s like a novice pilot, when he actually went to fly a plane, he encountered a very extreme emergency, he couldn’t control his emotions, and the plane crashed. Most of the slightly experienced investors fall into this category. Those who have not personally experienced one or even two complete economic cycles cannot say that they can withstand the test of the bear market in practice, and can only say that they are still playing on a flight simulator. Even investors who barely survived the 60% slump in 2009 could just as well go wrong in the next bear market with a 70% slump that lasts longer.
In most cases, the market volatility is relatively small, with moderate fluctuations around an equilibrium point, and everyone is happy to buy low and sell high.
In practice, everyone completely overestimated their psychological (tolerance) and strength (capacity) tolerance for risk.
The most subtle point here is that most people say “I’m greedy when others are fearful”. When the market drops 5%, 10%, they keep buying, but when the market drops 20%, 30%, they just buy Start self-doubt. When the market fell by 40%, or even 50%, everyone panic-sold because they ran out of bullets. The original logic and rationality were all thrown aside. There is no greed capital anymore, and greed is also incapable of being greedy.
Under normal circumstances, when the market falls to a certain extent, you can make money by buying the bottom when the valuation is cheap and selling it when the valuation is high. However, in extreme cases, when the fall breaks through a certain critical point, some funds using this strategy are forced to liquidate their positions, and this liquidation exacerbates the decline, resulting in increased losses, leading to customer withdrawals. This positive feedback loop happens so quickly that people who think they can stick to their strategy (the “simple mature”) panic, and prices can drop to ridiculous levels.
At the same time, during the economic downturn, many people are forced to sell at the lowest price at the worst time because of their reduced income, heavy debt pressure, worsening of the situation, or loss of jobs. assets. It’s not that I don’t want to stick to the strategy, but I really don’t have the ability to stick to it.
“Bad times are worse than imagined”, which can be understood as the positive feedback loop (positive feedback loop) vicious cycle breaking through the critical point, reaching the extreme, far exceeding the small fluctuations near the equilibrium state that everyone was used to before.
Bernstein said: “Long-term, the most important determinant of long-term success in investing is how much cash you have on hand when blood is pouring down the street. Because oftentimes, you’ll lose your job and need the money to buy cheap stock or that coveted mansion from your bankrupt neighbor.
To repeat: “Long-term, the most important determinant of long-term success in investing is how much cash you have on hand when the blood is pouring down the street.”
This is easier said than done, and it takes several economic cycles to truly understand the challenges. Frankly speaking, most of the group friends have experienced an upward trend in the past 30 years, especially in the 20 years after the Asian financial crisis in 1998. It has been going up all the way, with occasional disturbances in the middle, but it has come back soon, so From personal experience, it is difficult for most people to imagine a scenario in which the capital market has been extremely depressed for several years.
Many investors in the market now, especially after the 2009 financial crisis, fund managers who have performed well in the past few years can have many methodologies, but they are actually not prepared for the risk of an extremely ferocious bear market. Because there are some things he thinks impossible and impossible to understand.
This matter cannot be truly understood without experiencing several complete economic cycles in person. A single liquidation may result in a loss of more than 50%, which can only be compensated for by twice the return. If it causes 90% of the losses, it will take ten times to get back, basically it is to take decades of accumulation into it. However, after the damage, the trauma of the soul cannot be recovered for a long time, and the overall double and ten times the return is impossible to find.
Ordinary people can easily become victims of forced selling at the bottom of a bear market if they are not able to plan and prepare mentally and physically.
The third type of investor, which I call the “cold mature type,” has a long-term strategy and takes very specific steps to strictly enforce it. To strictly enforce it, you need to keep asking yourself this question:
If there is a bear market that lasts for more than three years, and the index falls by 90% from the highest point to the lowest point (such as US stocks in 1929-1932, Hong Kong stocks in 1973-1974), I will be psychologically, physically and financially. Is it possible to be disciplined and have a written plan ready to be strictly followed?
To avoid this from happening, be sure to prepare a written plan, even if the market falls 50%, 60%, or even 90% like the United States in 1932, even if it lasts as long as three, four, five years When there is still cash, it is still possible to continue to adjust asset allocation according to the original plan.
Even with the seemingly conservative allocation of half stocks/half cash bonds (50% stock / 50% bond) in the traditional sense, in the face of a truly dangerous bear market, for example, if the stock falls by more than 70%, the overall assets will shrink by 35% , Many people still can’t bear it mentally.
Bernstein put forward a suggestion to strictly separate a part of your future living expenses, which is sacred and inviolable, completely untouchable, and cannot take any risks, and can only be placed in the safest bank deposits or government bonds.
In the case of someone over fifty years old, this amount should easily cover living expenses for at least the next twenty to thirty years. Younger people, this amount of funds will be relatively small. But you must calmly introspect, write a written plan, draw a red line for yourself, and strictly isolate this part of the sacred and inviolable funds.
The purpose of investing is not only to optimize returns and make more money, but also to avoid dying in poverty. When the hedge fund “Long Term Capital” almost went bankrupt in 1998, Buffett commented: “To make the money they didn’t have and didn’t need, they risked what they did have and did need”. they don’t have the money, they risk it with the money they already have and need)
The difference between the third type of investor and the others is not only enough patience, not only enough cash, but not only the courage to buy when the blood is flowing. Moreover, because I have a certain understanding of the history of the financial market and know that the extremely dangerous bear market is unpredictable, but the bear market will come back sooner or later, and it will definitely come, so I will prepare a written plan for myself, with a plan, when this day comes, you can not panic Not busy, patient, according to the plan prepared in the year to implement without compromise.
Others, when the crisis comes, have no money, because they have no money and no courage, or they still have money and courage, but because they do not understand the characteristics of bear markets and lack rules and regulations, they still cannot seize the opportunity.
(3) Institutional investors and quantitative strategies
Bernstein’s book mentions a phenomenon: Over the past few decades, large institutional investors have increasingly managed money. When the factor of a certain quantitative strategy produces negative returns for a long time, many impatient investors will redeem funds from these institutional capital pools, which will lead to a chain reaction, resulting in more and more negative returns. Worse yet, at the end, the “most pessimistic moment”, often when a strategy’s future returns are likely to be very high, institutional investors have the least amount of capital available.
Examples of such strategies include:
Short low interest rate currencies and buy high interest rate currencies;
Venture capital vs fundamental investing;
Growth investing factor vs value investing factor
and many more.
In my own conclusion, in all walks of life in history, especially in the financial industry, we can see such a cycle:
A quantitative strategy was found to be effective
-> More people participate in arbitrage, forming a positive feedback loop. In the early stage of participation, quantitative strategies have higher returns
-> The number of participants reaches a certain level, and the return starts to decline slowly
-> In order to maintain returns, everyone began to increase leverage, but returns still cannot be significantly improved
-> Some kind of external disturbance caused a few people to start closing their positions, terminating the strategy, and all investors who used the strategy began to lose money. External disturbances are only an appearance, not the essential cause of the reversal. The essential reason for the reversal is that the speculators participating in the strategy are saturated.
-> After a critical point, everyone ran away and was forced to deleverage. All strategy users suffered huge losses in a short period of time.
-> Some people even started to get in the way, accelerating its collapse with a reverse strategy.
-> In the end, users of all strategies suffered huge losses, and even for a long time window prices reached absurd levels. For example, the stock price of some debt-free companies is much lower than the cash, the interest on the California state government’s bonds with tax-free benefits was as high as 9% in early 2009 (equivalent to 14% of the interest on ordinary bonds), and the interest on junk bonds reached 20%. % above, etc.
-> People decry the stupidity of this strategy, but it often means that from this point onwards the strategy may pay off well in the long term.
But because most of the time, it is impossible for everyone to have comprehensive and correct information, so it is difficult to know where you are in the cycle most of the time in practice. So out of cycle, isolated discussions about how a certain strategy works is very dangerous and can give people false confidence.
The most dangerous thing here is that a certain fund is very confident in its ability to choose timing, feels that it has the ability to leave before the strategy fails, and then increases leverage, and then a certain external disturbance that it has no ability to see suddenly causes a reaction Rotation, resulting in the rapid failure of this strategy and huge losses, there is no time to withdraw.
Many investors, especially those under the age of 40, have not gone through a real cycle and have not been hit by a really serious economic depression. If you tell them many things, they will not believe them. Either retorted, or verbally believed, or did not really understand the seriousness of the potential risk, and did not prepare mentally/physically.
When old crises are over, people tend to take precautions, so they won’t simply repeat. If history is a guide, future crises may occur in unexpected places and in unexpected ways. So there cannot be any presupposition that this cannot happen.
There is no other shortcut to reducing risk: only increasing the proportion of risk-free assets such as cash and Treasuries.
Only by being able to have a plan for unexpected bear markets and fluctuations, and with sufficient thought and financial preparation, can you truly be fearful and greedy. This is half the success, because any investment you make at this time is often a hit. Great discount. And no one is competing with you.
Also, don’t go empty. The challenges of short selling are that the timing is inaccurate, the return/risk asymmetry, and the long-term shorting after the market reverses. After all, the U.S. market is bullish and bearish as a whole.
The success of an industrialist mainly depends on the external struggle, trial and action. An investor’s success largely depends on the inward, anti-human control of his greed/fear mentality. These two modes of thinking and behavior are often contradictory. Investors who take other people’s money instead of their own funds, such as VC/PE investors, are closer to industrialists in nature and need to take the initiative to attack frequently, because if they lose money, they generally won’t lose their own money, so the investment mentality and The method is not the same. I mainly refer to people who invest with their own funds.
Investors with their own funds cannot compete with professional funds in the accuracy and lag of short-term information collection.
But one of the biggest potential advantages of self-funded investors is that there is no pressure to return, can choose to do nothing, can wait a long time, and can be very patient. This is an advantage that VC/PE investors and hedge fund managers don’t have, and in a very bad bear market, this can be a significant advantage. Because in the big bear market, the source of funds of institutional investors is exhausted, and even if they want to withdraw, they are often forced to liquidate and have no choice at all.
Finally, to sum up, two sentences:
1/ In the long run, the most important determinant of long-term success in investing is how much cash you have on hand when the blood is pouring down the street.
2/ Patience, cash, courage, and planning for the worst, everything else is a note.
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