After 4 years of over-confidence about the powers of central bankers, market psychology is now swinging from believing in magic to recognizing downside risks to previous irrational expectations. That doesn’t make the sell off to date irrational, not yet anyway.
Realizing that you have made classic errors and massively overpaid for assets is a rational epiphany when it finally hits. Then selling before prices plunge further can also be a rational response to avert financial catastrophe. This is especially true where buyers used margin or levered bets on the way up and are now hemorrhaging capital on the way down. Selling to stem bleeding becomes simply pragmatic and necessary in such cases.
As a result, those who were indiscriminate buyers as prices rose, become indiscriminate sellers as prices fall. This swing is what finally opens up value for the few discriminate buyers–who know value when they see it because they have done critical analysis in advance–as others are liquidating.
For a visual reminder of how investor sentiment moves, see the Emotional Cycle for typical investors as well as the inverse cycle for those using a valuation discipline– as we do at my firm Venable Park.
In order to survive and thrive over full market cycles one has to have the valuation discipline that others lack and have the fortitude to exercise buy and sell decisions accordingly. Howard Marks explains these concepts in this clip.
Howard Marks, co-chairman at Oaktree Capital Group, discusses his latest investor letter and examines markets, China, and investing. Here is a direct video link.