the practice of tending to the present moment – responding to prevailing conditions rather than relying on forecasts – is central to our investment discipline.
Focusing on the present moment doesn't imply ignoring the past or failing to consider the future. It's clear, for example, that we put a great deal of attention on estimating future cash flows and discounting them appropriately in order to evaluate whether various investments are priced to deliver satisfactory long-term returns. We certainly devote our attention to macroeconomic pressures and latent risks that threaten to become full-blown crises later. Still, we rarely make near term forecasts.... The reason we avoid forecasts, very simply, is that they are not required, and that they can be a hindrance.
Rather than treating the next week, month, quarter or year as a horizon that demands a specific “forecast,” we simply treat each realization as part of a “repeated game,” and rely on the law of large numbers – that is, the idea that if we follow our discipline period after period after period, over time our inevitable errors will average out, and our long-term results will be largely what we expect. The best way to take good care of the future is to take good care of the present moment.
We must see the world as it is at the present time, and deal with those conditions.
Even if we could assume that the recent crisis was a standard post-war downturn, and that we are now in a standard post-war recovery, valuations would still concern us because at these levels, stocks are not priced to deliver satisfactory long-term returns in any event. However, we would have a greater willingness to take a moderate speculative exposure based on market action and prospects for sustained economic improvement. On the other hand, when we include other post-crash periods into our data set, and allow for the possibility that those instances better describe present conditions, the case for accepting speculative exposure is much more limited. Of specific concern is the tendency in those periods for strong advances (as we've seen in recent months) to be followed by spectacular failures.
It is absolutely necessary to look for flaws and contradictory evidence in one's theories. You must see all the facts or you do not see clearly.
As Thay says, “We practice not to be influenced by the name, because when we are caught in the name, we can't see reality.” The picture in our head can be very influenced by the words we attach to it.
Imagine that you see the word "green," but it is printed in red ink. Your mind will have to shift from the word it expects to see--red--to the word actually printed--green. (The Stroop Effect.) The mind fills in the gaps with what we expect to see when we don't look beyond the surface.
In Zen, there is a teaching tool known as a “koan” – a question that serves as the object of meditation, and is intended to reveal something about teachings like mindfulness and interconnectedness. Western observers sometimes mistake these for riddles, non-sequiturs, or nonsensical statements, but if you look at them carefully, they are questions or stories intended to prompt the listener to see things as they really are.People make mistakes in reasoning because they don't realize they are unconsciously avoiding information they don't want to hear or see. They avoid this information because it upsets them and they are accustomed to repressing their emotions to avoid emotional pain. They will say that black is white and become enraged when you disagree with them, for you are forcing them to face something they are trying to avoid. And it applies to all areas of life.
When we think about events, either in our daily lives, or in the market or the economy, it is important that we don't think of them as simply existing or coming out of nowhere. This is, because that is. This is not, because that is not. We cannot create or remove a condition, expect it to emerge or expect it to disappear, without understanding the seed that produces it, and the causes and conditions that allow it to spring up.
Many of my concerns about the markets in recent years have emerged because too often, financial market participants and policy makers focus on manifestations rather than causes and conditions. This is why investors produced the dot-com bubble, the tech bubble, the mortgage bubble, the debt-financed private equity bubble and the commodity bubble without thinking of the seeds of crisis that were latently emerging, or how violently they would manifest. Our policy makers have bailed out poorly run financials by creating massive federal deficits, and think they've solved the problem in the same way as someone who runs over a weed with the lawnmower. The roots have simply grown deeper, because the seeds are still there, but we've applied a few conditions in the opposing direction. Those of you who have read these missives for a long time know that my geopolitical views are largely the same. This is, because that is. This is not, because that is not.
We can have an overvalued market and the seeds of a bear market, but if we apply opposing conditions in the form of easy money in order to prop up the market and prevent the consequences of bad behavior, the seed will simply grow stronger, and its ultimate manifestation will be more powerful. We can have a mortgage market that is setting new records for delinquencies and foreclosures every month, combined with increasing unemployment and a heavy reset schedule on Alt-A's and option-ARMs that is just now picking up. But we lower the bar on financial reporting, fail to restructure debt, and ignore the strengthening seed because we're single-mindedly enthusiastic about the thin-rooted green shoots of stabilization – born solely of a burst of fiscal profligacy – then we'll predictably be blindsided when the problems re-emerge.
Predictably blindsided. That's happened again and again in recent years. And it happens when we fail to think about the seeds we are watering. If we look only for fruit and ignore the seeds of crisis, then every bit of fruit will be followed by crisis, and nobody will understand why.