Wednesday, 12 November 2014

Be Cautious While Being Greedy

The roller-coaster ride of the stock market this past month has brought back memories of the events 6 years ago. Whenever I write about the Global Financial Crisis (GFC), it invariably comes with a tinge of pride. After all, it was a major crash and we managed to recover from it. However, was victory assured right from the beginning, that all we had to do was, in the words of Warren Buffett, to be greedy when others were fearful, or was it a narrow victory snatched from the jaws of defeat? In other words, was buying at the depth of GFC a wise decision or was it a reckless decision that turned out to be lucky? Does this question still matter, since the outcome was positive? My opinion is that it matters, because Lady Luck would not always stand on your side. Although Man proposes, Heaven disposes, we still need to make wise decisions.  

What prompted me to pull the trigger at the depth of GFC in Oct 2008? It was a combination of game plan, indicators, news and history. Info on my game plan and indicators that I consulted are described in Have a Plan, Knowing When Others Are Fearful and Structured Warrant Statistics. The news that caught my attention was the European governments coming together to work out a plan to save the economy (see Declaration on Concerted European Action Plan). As you know, Europeans usually do not readily agree with each other, but the fact that they were ready to put aside their differences and work together signalled that we could begin to see light at the end of the tunnel. And a review of the history of the stock market shows that in the long run, stock market crashes are usually temporary bumps in the long march upwards.

There are, however, 2 problems with history. Firstly, history is written by those who survive the event or those who just watch the event from the sidelines. History is usually not written by those who do not survive the event. And if they were to tell their version of history, the history that they tell could be very different from the history that we know. I once had a colleague who refused to touch stocks again and never spoke about his experience. I guessed he lost heavily in the stock market before. His history will never be known. But could his history not befall on us? 

The second problem with history is that you do not really know which history is playing out when you are in the thick of the action. Was it going to be the history of the Asian Financial Crisis, when stocks rebounded about 15 months after the start of the event, or was it going to be the history of the Great Depression, when stocks found their bottom only 3 long years after the onset? If it was the latter, it was going to be a long road down.

Overall, do I think the decision to invest during the depth of GFC was a wise decision or a reckless decision that just turned out to be lucky? In truth, I believe I have quite seriously underestimated the potential consequences of GFC due to a lack of knowledge of how the economy and the financial world works even till today. So, it certainly wasn't a wise decision that considered all risks. It was at best a decision that was calculated, but had not understood all risks. 

It is particularly instructive to understand what Warren Buffett, the owner of the famous quote "Be fearful when others are greedy and greedy when others are fearful" did during the same period. True to his words, he invested a total of US$20.2 billion in some fixed-income securities with equity participation between Sep 2008 and Apr 2009 (see Buffett's Crisis-Lending Haul Reaches $10 Billion). These securities have both downside protection as well as upside potential. If the stock market dropped further, he could count on receiving dividends from the securities. Conversely, if the stock market recovered, he could convert some of the warrants into equities and profit from the rise in equity prices. His largest equity investment during that period, a US$34 billion acquisition of a railroad, which he described as an "all-in wager on the economic future of the United States", occurred in Nov 2009, when events were more stable (compare Berkshire Hathaway's equity holdings in 2007, 2008 and 2009 in their annual shareholder letters).

What can we learn from this greatest investor in the world? It is that it is not good enough just to be greedy when others are fearful. We also need to be cautious when being greedy. Sometimes, it might just be better to wait until the coast is clearer before making your moves.

In conclusion, while being greedy when others are fearful could help one to make money during "normal" stock market crashes, being cautious regardless of whether others are fearful could save one's skin in an extraordinary stock market crash. Hence, the main reason why I could still be blogging is because the crash did not turn out to be a Great Depression type of crash. For this, we have Ben Benanke, the former Federal Reserves chairman, to thank for. Thanks for saving the whole world from another Great Depression.


  1. It is good to find out how they lost their money and chopped their fingers so we can learn to avoid the same mistakes.

    One of my relatives lost heavily and almost bankrupt in AFC due to share financing scheme and CLOB Saga.

    1. There are many ways in which people could lose money, it could be leverage, CLOB, S-chips, penny stocks, etc. Being cautious could help some people avoid some of these pitfalls.

  2. So scary, .... Especially I only have 1 asset class. equity, and I don't even keep big warchest

    thats why equities, is one asset class. Regardless, you buy reits or shares or perhaps even bonds...

    But for the non-altra rich, most just hold cash and equity, the more able ones, has properties, cash and equity.

    Anyway having more than 3 asset classes should not be worrying anyway...

    1. Actually, in times of crisis, the correlation among different asset classes can move close to one, i.e. all fall at the same time. This was what happended during the Asian Financial Crisis, when shares, bonds & properties all dropped.

  3. Hi Chin Wai,

    Good post. Because of the experiences of AFC and GFC, most investors assume that the recovery from a bear market would be fast (i.e. within a couple of years). Even I am susceptible to this thinking.

    It's interesting to note that it took the DJIA a quarter of a century to rebound back to the pre-GD level.

    Many investors also underestimate the role of luck in their successes.

    1. True. When people are making money, most will think that it is due to their skills. This can be a very dangerous thing. The sooner they realise it, the better it is for them.