Why market uncertainty can be your friend | The Informed Investor

In August 1979, Warren Buffett penned an article for Forbes magazine, challenging the herd mentality of investors during a tumultuous economic period. He stated, “the future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty, actually, is the friend of the buyer of long-term values.” This insight remains profoundly relevant today.

The future is perpetually shrouded in uncertainty, like driving through a dense fog. Risk – that the future might be different from what we expect – is omnipresent, regardless of our perceptions. Investors must internalize that truth.

In fact, one could argue that risk and uncertainty are greatest during the times that feel the safest. The market’s optimism can blind us to underlying dangers, leading to complacency.

Conversely, during downturns, pervasive pessimism can lead us to overestimate risks and foster undue fear.

While the market – and emotional investors – often swing from extreme to extreme, I’d encourage the informed investor to stay anchored to the middle-ground.

The illusion of control

We have a natural inclination to seek patterns and predictability. It’s not rocket science to understand why. Our past experiences can guide future outcomes, and the best pattern-seekers survived. “That berry bush was delicious. More please. That saber-tooth ate my neighbor. I’ll run faster.” We’re biologically hard-wired to notice and react to such patterns.

But the stock market doesn’t work that way. It doesn’t adhere to predictable, repeatable patterns. You can try to find some signal in the noise. So-called “technical analysis” attempts to identify patterns in price movements, assuming past trends can predict future performance. However, markets are driven by countless unpredictable factors, making most pattern-based strategies unreliable and prone to failure.

The perils of herd mentality

Buffett’s critique of the herd instinct (his so-called “cheery consensus”) highlights a critical pitfall for investors: the tendency to follow the crowd. When markets are booming, there’s a rush to invest, often without due diligence, driven by the fear of missing out. This collective exuberance can inflate asset bubbles, which eventually burst, leading to significant losses.

Conversely, during market downturns, panic can lead to mass sell-offs at fire sale prices. Investors, driven by fear, may liquidate assets at a loss, only to miss the subsequent recovery. This cyclical behavior underscores the importance of independent thinking and adherence to a well-thought-out investment strategy.

Some investing periods feel optimistic and “cheery.” The irrationally exuberant investor thinks, “What risk?! Stocks can’t possibly go down! This is nirvana!” I can’t blame investors – especially younger ones – for thinking such thoughts after the past 15 years of the bull market.

But what preceded this bull market? I’ve cherry-picked a few headlines from the Great Financial Crisis and subsequent recession that reflect different emotions: fear, pessimism, and panic.

“Worst Crisis Since ‘30s, with No End Yet in Sight,” Wall Street Journal, September 18, 2008

“Global Economic Shock Worse Than Great Depression,” Huffington Post, May 8, 2009

“Financial Crisis is the Worst the World Has Ever Faced,” Daily Telegraph, October 7, 2011

Embracing uncertainty

Uncertainty is not the enemy, though. In fact, it’s a fundamental aspect of investing. As Buffett noted, “Uncertainty, actually, is the friend of the buyer of long-term values.” Periods of uncertainty present opportunities to acquire assets at discounted prices. By maintaining a long-term perspective, investors can capitalize on these opportunities, turning market volatility to their advantage.

Discipline is key. As Buffett quipped, “The most important quality for an investor is temperament, not intellect.” Rather than reacting impulsively to market fluctuations, allowing the herd’s emotionality to infect us, a disciplined investor sticks to their investment plan, recognizing that short-term volatility is a natural part of the market cycle.

Uncertainty, volatility, risk. These are features, not bugs.

The importance of diversification

One effective strategy to manage omnipresent risk is diversification. By spreading investments across various asset classes, sectors, and geographies, investors can mitigate the impact of a downturn in any single area. Diversification doesn’t eliminate risk, but it can help manage it, providing a more stable return over time.

It’s also essential to regularly review and adjust one’s portfolio to ensure it remains balanced with changing market conditions and stays aligned with personal financial goals. This proactive approach allows investors to stay balanced, neither overexposed to risk nor missing out on potential opportunities.

Learning from the past

While the future is uncertain, history offers valuable lessons. Market cycles of boom and bust have occurred repeatedly. By studying past market behaviors, investors can gain insights into potential future scenarios. This doesn’t equate to predicting the future with certainty. Far from it. Instead, it leads to an understanding that downturns are often followed by recoveries and vice versa.

Is a market crash coming soon?

The past 15 years of relative stock market bliss do not foretell an impending crash. None of this is predetermined. But I do think the past 15 years have lulled many investors into a false sense of security. They are thinking the same way as an accident-free driver. “I’ve never been in a car crash. I must be really good. And it must be a tiny risk. Perhaps even zero risk!”

This is dangerous thinking. Just as a good driver should always maintain a defensive approach, so should the investor. And going back to Buffett’s inspirational quote:

“…the future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty, actually, is the friend of the buyer of long-term values.” (Emphasis mine.)

When our fellow investors get too confident, too cheery, when they ignore the omnipresent risks, they incorrectly, dangerously assume that further stock ownership is a zero-downside panacea. I cringe when I see people thinking along the lines of, “The stock market return is 10% per year, guaranteed, forever!”

With such optimism, these investors want more! Their demand for more stock ownership drives prices upward, and as they pay higher prices, they’re reducing their expected returns. Isn’t that an irony? We all pay a price for a cheery consensus.

While a hard pill to swallow, investors would rather have some tumult. Bring on the risk! We don’t mind when uncertainty scares the emotional investors into selling (to us!) at lower prices. Uncertainty, as Buffett wrote, is our friend.

Conclusion

The future is foggy. Always has been, always will be.

Embracing this uncertainty, rather than fearing it, allows informed investors to navigate the complexities of the market with confidence. By acknowledging the omnipresence of risk, avoiding herd mentality and maintaining emotional discipline, investors can turn uncertainty into an ally in their pursuit of long-term value.

Let these ideas guide your investment journey, turning the fog of uncertainty into a pathway to opportunity.

Jesse Cramer is a Relationship Manager at Cobblestone Capital Advisors and co-host of The Trusted Partner Podcast.

The opinions, beliefs and viewpoints expressed in the preceding commentary are those of the authors and do not necessarily reflect the opinions, beliefs and viewpoints of Lehigh Valley Business or its editors. Neither author nor LVB guarantees the accuracy or completeness of any information published herein.