For the true connoisseur, the finest expression of the art comes when a high-profile investor identifies a bubble, perhaps even makes money out of it, exits in time – and then gets sucked back in only to lose everything in the resultant bust.
An early example is the case of Sir Isaac Newton and the South Sea Company, which was established in the early 18th Century and granted a monopoly on trade in the South Seas in exchange for assuming England’s war debt.
Investors warmed to the appeal of this monopoly and the company’s shares began their rise.
Britain’s most celebrated scientist was not immune to the monetary charms of the South Sea Company, and in early 1720 he profited handsomely from his stake. Having cashed in his chips, he then watched with some perturbation as stock in the company continued to rise.
In the words of Lord Overstone, no warning on earth can save people determined to grow suddenly rich.
Newton went on to repurchase a good deal more South Sea Company shares at more than three times the price of his original stake, and then proceeded to lose £20,000 (which, in 1720, amounted to almost all his life savings).
This prompted him to add, allegedly, that “I can calculate the movement of stars, but not the madness of men.”
In Buffett’s words, we spend a lot of time second-guessing what we hope is a sound intellectual framework. Examples:
- In a world drowning in debt, if you must own bonds, own bonds issued by entities that can afford to pay you back;
- In a deleveraging world, favour the currencies of creditor countries over debtors;
- In a world beset by QE, if you must own equities, own equities supported by vast secular tailwinds and compelling valuations;
- Given the enormous macro uncertainties and entirely justifiable concerns about potential bubbles, diversify more broadly at an asset class level than simply across equity and bond investments;
- Given the danger of central bank money-printing seemingly without limit, currency / inflation insurance should be a component of any balanced portfolio
- Forget conventional benchmarks. Bond indices encourage investors to over-own the most heavily indebted (and therefore objectively least creditworthy) borrowers. Equity benchmarks tend to push investors into owning yesterday’s winners.
In the words of Sir John Templeton,
“To buy when others are despondently selling and sell when others are greedily buying requires the greatest fortitude and pays the greatest reward.”
So be long “pretty much everything”, or be long a considered array of carefully assessed and diverse instruments of value. It’s a fairly straightforward choice.