Thanksgiving is an appropriate time to be thankful for the rich bounty from stocks this year, with particularly robust returns in 2024. Still, it is also a crucial time to consider the “turkey problem” as it relates to investing. Nassim Taleb introduced the world to the “Black Swan” and used this tale to illustrate the concept. Imagine the life of a turkey where a kind farmer feeds and tends to it every day until suddenly, on the day before Thanksgiving, the situation takes an irrevocable turn for the worse. The turkey has only observed a positive trend during its lifetime up until that fateful Wednesday. The turkey is at its fattest and happiest at a point that turns out to be the time of maximum risk. Investors must beware when the trends look obvious and making money seems effortless. As Taleb states, “The same hand that feeds you can be the one that wrings your neck.”
This “turkey problem” illustrates the automatic human response in expecting trends to continue, as we all have a built-in tendency to see patterns even when they do not exist. According to Jason Zweig in Your Money & Your Brain, this propensity to look for patterns is part of our evolutionary survival mechanism since our primitive brains were tuned to the immutable physical laws of nature, like when lightning strikes, thunder follows. In addition, humans also suffer from “recency bias.” In other words, we weigh recent experiences more heavily when predicting future outcomes. These biases are why people expect stocks to continue to rise if they have increased recently. Indeed, there is convincing evidence of momentum in stock and other asset returns, but this is not an unfailing natural law. Instead, this tendency for stocks to continue to perform well does not always work, and the signal tends to erode and eventually reverse. Investors using price momentum should have a systematic process to implement the strategy across a portfolio of assets with a strict sell discipline. While these primitive reactions to stimuli kept our ancestors alive, this behavior in the financial markets can lead us to make poor choices. This quote has become the motto of value investors, but Horace was correct when he said: “Many shall be restored that now are fallen, and many shall fall that now are in honor.”
A “turkey problem” period that comes to mind is the technology bubble associated with the rise of the internet. During this period, internet-related companies dominated returns despite, in many cases, having no profits. As a proxy for these tech leaders, the NASDAQ 100 had a total return of 312% versus 63% for the S&P 500 from September 1998 to March 2000. Companies outside the technology, media, or telecom axis were generally laggards. Even Berkshire Hathaway, controlled by the world’s greatest investor Warren Buffett, was among the laggards, which fell by 9% during the same period. During this period, some people posited that Buffett had lost his touch and didn’t understand the positive implications of this new technology.
While the internet certainly changed the world and how we live, many of these companies never survived to profitability or were priced to perfection at the peak of the market. Like the Thanksgiving turkey, the day of reckoning came while the future still looked bright in March 2000. The NASDAQ 100 plunged by a whopping 83% over the next two and a half years and didn’t regain the losses until November 2015! The S&P 500 was almost cut in half during that period but rebounded more quickly to reach its old high in May 2007. Even companies like Amazon.com (AMZN) were dragged lower. Amazon fell to $0.30 per share, and it would take until 2009 to regain its 1999 high stock price. The real lesson here was not to count on price trends or the concept of a bright future; instead, to focus on the quality of the business and its earnings outlook. In addition, the price paid for even a fantastic business matters for future returns.
Stocks since the March 2020 pandemic lows have seen strong returns with technology stocks, and in particular, the Magnificent 7 stocks have been stellar. Recall the Magnificent 7 consists of Microsoft (MSFT), Meta Platforms (META), Amazon.com (AMZN), Apple (AAPL), NVIDIA (NVDA), Alphabet (GOOGL), and Tesla (TSLA). It would be wise not to read too much into these significant returns because stocks were very cheap during the uncertainty of the pandemic, and most of the companies in the Magnificent 7 are exceptional businesses. That being said, it behooves investors not to extrapolate this pace of returns into the future, particularly for the Magnificent 7, with the excitement about the promise of artificial intelligence fueling some of the outsized returns.
Turning to the investment greats can also help in battling the influence of the unconscious mind and being mindful of risk. Warren Buffett said that The Intelligent Investor by Benjamin Graham changed his life and points to chapters eight and twenty as worthy of particular focus. Chapter eight tells us to analyze stocks as businesses, not just pieces of paper. Also, investors shouldn’t react to short-term fluctuations but rather take advantage of the market rather than expecting it to guide their decisions. Buffett says, “If you own your stocks as an investment – just like you’d own an apartment, house, or a farm – look at them as a business.”
Chapter 20 provides the basis for value investing, as investors should buy below the “indicated or appraised value.” Value can be defined as the present value of the cash that the owners will receive from the company. If one buys enough below this estimated value, there should be a reasonable return even if the analysis isn’t perfect. Buffett says, “You can’t precisely know what a stock is worth, so leave yourself a margin of safety. Only go into things where you could be wrong to some extent and come out OK.”
The trend of economic growth, as measured by real (after-inflation) GDP, has been on an upward trajectory since the COVID lockdown lows. Increases in GDP tend to result in increases in corporate earnings. Benjamin Graham, mentor to Warren Buffett, suggested looking at company earnings over a five to ten-year period to smooth out the economic cycles and value a stock based on “normalized earnings.” With the S&P 500 selling for 23 times forward earnings estimates, there is little fear of an economic and earnings downturn discounted in the market today. This may be correct, but one should not be blind to the risks.
After a brutal decline of over 75% from late 2021 to 2022, Bitcoin has seen a monumental rise since its November 2022 low. This rise seems to be fueled by a general rise in risk assets and a belief in Bitcoin’s use as a store of value in retaining purchasing power during inflation. More recently, President-elect Donald Trump’s administration is widely seen as more supportive of digital assets and cryptocurrencies. There is a challenge in valuing Bitcoin or any cryptocurrency because there are no cash flows to discount to estimate intrinsic value. These types of assets are worth what someone will pay for them, which generally leads to more volatility.
Often, when our brain tells us to flee from a falling stock or chase the most recent fad, our long-term wealth would be better served by doing the opposite or just sitting still. When you sit down to enjoy your Thanksgiving turkey, consider this thought attributed to Mark Twain: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”
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