The Current Market, Warren Buffett, Cinderella and Known Unknowns
- Oops!Something went wrong.Please try again later.
- By Rupert Hargreaves
Over the past few weeks and months, I've read a lot about the market's current state. The most common observation is that we are currently in the middle of a bubble reminiscent of the late 1999s.
There are certainly indications that this might be the case.
However, I've also seen the comparisons to the 1960s and '70s when the so-called Nifty 50 became the hottest stocks on Wall Street. There are also parallels with the mid-2000s and mid-1920s.
Looking for patterns
It's relatively easy to look back and say we are currently seeing a repeat of something that happened in the past. Humans' brains are always looking for patterns in the data, even when they may not exist. That's why the easiest method to understanding what's happening in the markets today is to compare it to another era.
I think that's far too simplistic. What we see today is not like anything that has happened before. That's not necessarily a good or bad, but it gives us something to work with.
Known unknowns are things that we know we don't know. For example, we know that buying stocks at egregious valuations tends not to work in the long term. However, the known unknown is that we don't know when it will stop working.
To give one example, as far as I can remember, shares of Amazon.com Inc. (NASDAQ:AMZN) have always been overvalued relative to other investments. The fact that Amazon was overvalued was well known. The known unknown was, and to a certain extent remains, for how long can it sustain this valuation? The big unknown unknown has always been: Is it really worth the price investors are willing to pay?
What we don't know
In the end, it all boils down to understanding what we do and don't know. There are so many uncertainties in the stock market and the business world in general. It is important to acknowledge what we don't know rather than trying to guess and end up making the wrong decision.
This is not just relevant for the current market. It is applicable for any market situation. There are always egregiously overvalued stocks, stocks that look like a bubble, penny stocks that have surged in value and companies that may or may not be frauds. It is possible to make money in these businesses, but the chances of losing money are significantly higher.
Whenever I see euphoria taking over in the market, the words from Warren Buffett (Trades, Portfolio)'s 2000 letter to investors always spring up in my mind:
"The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There's a problem, though: They are dancing in a room in which the clocks have no hands."
Buffett wrote these words around the time of the dot-com bust, but they are always relevant. The line between investment and speculation is blurry, but knowing the difference between know unknowns, unknown unknowns and known knowns should help point investors in the right direction.
If something seems too good to be true, then it probably is. If one cannot understand why a company is attracting so much attention, it may be best to stay away. Only when one knows exactly why a company is making money and what it will produce 10 years from now can one reliably make an investment. These comments are applicable for any market.
Disclosure: The author owns no stocks mentioned.
Read more here:
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
This article first appeared on GuruFocus.
