Montier: Was It All Just A Bad Dream? Or, Ten Lessons Not Learnt
James Montier, a member of fund manager GMO’s Asset Allocation Team, examined whether we learned anything from the market declines of 2008 and early 2009. His answer is, as you would expect, not a lot. Below, is an outline of the ten lessons not learned followed by a link to the full paper. It’s a good read.
Lesson 1: Markets aren’t efficient.
- “As I have observed previously, the Efficient Market Hypothesis (EMH) is the financial equivalent of Monty Python’s Dead Parrot. No matter how many times you point out that it is dead, believers insist it is just resting.”
Lesson 2: Relative performance is a dangerous game.
- “While practitioners are generally happy to reject the false deity of the EMH, they are more inclined to continue to worship at the altar of its offspring – the CAPM…It also leads directly to the separation of alpha and beta, upon which investors seem to spend an inordinate amount of time…The alpha/beta framework has given rise to the obsession with benchmarking, and indeed a new species, Homo Ovinus, whose only concern is where to stand relative to the rest of the crowd.”
Lesson 3: The time is never different.
- Montier has some lovely quotes from serial bubble blowers and deniers Greenspan and Bernanke followed by this: “Contrary to the protestations of the likes of Greenspan, Bernanke, and Brown, bubbles can be diagnosed before they burst; they are not black swans. The black swan defense is nothing more than an attempt to abdicate responsibility.”
Lesson 4: Valuation matters.
- “At its simplest, value investing tells us to buy when assets are cheap and to avoid purchasing expensive assets. This simple statement seems so self-evident that it is hardly worth saying. Yet repeatedly I’ve come across investors willing to undergo mental contortions to avoid the valuation reality.”
Lesson 5: Wait for the fat pitch.
- “According to data from the New York Stock Exchange, the average holding period for a stock listed on its exchange is just 6 months (Exhibit 2). This seems like the investment equivalent of attention deficit hyperactivity disorder. In other words, it appears as if the average investor is simply concerned with the next couple of earnings reports, despite the fact that equities are obviously a long-duration asset. This myopia creates an opportunity for those who are willing or able to hold a longer time horizon.”
Lesson 6: Sentiment matters.
- “Investor returns are not only affected by valuation. Sentiment also plays a part. It is a cliché that markets are driven by fear and greed, but it is also disturbingly close to the truth.”
Lesson 7: Leverage can’t make a bad investment good, but it can make a good investment bad!
- “Leverage is a dangerous beast. It can’t ever turn a bad investment good, but it can turn a good investment bad. Simply piling leverage onto an investment with a small return doesn’t transform it into a good idea… Leverage can limit your staying power, and transform a temporary impairment (i.e., price volatility) into a permanent impairment of capital.”
Lesson 8: Over-quantification hides real risk.
- “Finance has turned the art of transforming the simple into the perplexing into an industry… The reason for this obsession with needless complexity is clear: it is far easier to charge higher fees for things that sound complex… We would be far better off if we abandoned our obsession with measurement in favor of understanding a trinity of risks. From an investment point of view, there are three main paths to the permanent loss of capital: valuation risk (buying an overvalued asset), business risk (fundamental problems), and financing risk (leverage). By understanding these three elements, we should get a much better understanding of the true nature of risk.”
Lesson 9: Macro matters.
- “Ignoring the top-down can be extraordinarily expensive. The credit bust has been a perfect example of why understanding the top-down can benefit and inform the bottom-up.”
Lesson 10: Look for sources of cheap insurance.
- “ The final lesson that we should take from the 2008-09 experience is that insurance is often a neglected asset when it comes to investing… One should always avoid buying expensive insurance. The general masses will tend to want insurance after the event – for instance, when I lived in Japan, the price of earthquake insurance always went up after a tremor! So, as is so often the case, it pays to be a contrarian when it comes to purchasing insurance.
Montier finishes off with this insight:
Will we learn?
Sadly the evidence from both history and psychology is not encouraging when it comes to supporting the idea that we might learn from our mistakes. There is a whole gamut of behavioral biases that prevent us from learning from mistakes. However, just this once I really hope this time is different!
Plus ca change!
Was It All Just A Bad Dream? Or, Ten Lessons Not Learnt – James Montier, GMO