Market Euphoria: Too Happy for Too Long

The other day, I was talking to a friend who asked me about the direction of markets and what could happen post-Budget. Not that I was interested in predicting specific levels, I said, "if people are too happy for too long, that itself is the biggest risk." As it goes on, keeping people happy for too long, can turn into a national disaster, much like other disasters where ultimately the government is blamed.
 
                                                The Dangers of Overconfidence

Among the investing legends, I have lot of liking for Howard Marks and his insights about human behaviour, market cycles and many other things like second order thinking and going against the crowd. In his recent memo he writes (Most interesting lines in my view), The adage "success is a dangerous neighbour" is particularly relevant in investing.When individuals achieve financial success, they often attribute it to superior skill and knowledge. This overconfidence can lead to a dangerous illusion of control.

“Sometimes things go as people expected, and they conclude that they knew what was going to happen. And sometimes events diverge from people’s expectations, and they say they would have been right if only some unexpected event hadn’t transpired. 
 
But, in either case, the chance for the unexpected – and thus for forecasting error – was present. In the latter instance, the unexpected materialized, and in the former, it didn’t. But that doesn’t say anything about the likelihood of the unexpected taking place”

Fooled by Randomness

The element of luck and randomness has produced many investing heroes. Can this randomness sustain for a very long?  Marks often cautioned against the perils of "second-level thinking," a concept that underscores the importance of looking beyond the obvious. While the market's ascent might appear to be a testament to economic prosperity, it's crucial to delve deeper and question the sustainability of such optimism.

He once said, "You can’t predict, but you can prepare." This philosophy is particularly relevant during periods of market euphoria. He emphasized the importance of recognizing where we are in the market cycle and preparing for the inevitable downturn. He argues that understanding cycles is crucial for making sound investment decisions. "There are times for aggressiveness; there are times for caution. One of the most important things to understand is which is which."

Happy Compounding
Jitendra

Caution: These are my personal views and shared only for the education and knowledge purpose.