The Dow Jones Industrial Average decline 22.6% on just that one day
In a speech in 1974 Ben Graham remarked that investing did not require genius: “What it needs is, first, reasonably good intelligence; second, sound principles of operation; third, and most important, firmness of character.” This is quoted by Roger Lowenstein in (Lowenstein, Buffett 1995,2008)p.160.
Imagine a scale with ‘rose coloured glasses optimists at one end with ‘grim end of world’ pessimists at the other end. How an investor ranks on that scale is part of their ‘character’. Those who generally see the world on the side of the proverbial glass being half full say they have the character to take advantage of opportunities when the world is risk averse. Those who generally see the world on the side of the proverbial glass being half empty say they are realists who have the character to avoid risk seeking behavior. Who’s right?
Sir John Templeton was educated at Yale and Oxford and founded the Templeton Growth Fund in 1954. In his 1980 book The Money Masters, John Train reports that over the 20 years ending December 31, 1978 The Templeton Growth Fund was the top performer of all funds over the previous 20 years. (Train, 1980)p.160. Templeton pioneered global diversification in the mutual fund industry. He was probably one of the two or three greatest investors of the 20th century.
Greatest ever one day plunge
For decades the most popular investing show on television was Louis Rukeyser’s Wall Street Week on Friday nights on PBS. John Templeton appeared frequently on the show and one memorable program was the Friday following October 19, 1987 that saw the Dow Jones Industrial Average decline 22.6% on just that one day.
Yes, you read that correctly, the market declined 22.6% in one day. Investors with seared memories of March of 2020 and the fall of 2008 might reflect that extreme stock market volatility is not a recent phenomenon.
Scott Phillips provides a partial transcript of show:
“Louis Rukeyser: What is your advice to people in terms of the stock market now?
Sir John: Patience. Be a long-term investor. Be prepared financially and psychologically to live through a series of bull markets and bear markets because in the long run common stock will pay off enormously and the next bull market will carry prices far higher than this one.
Louis Rukeyser: Why?
Sir John: Because the whole nation is growing more rapidly. Gross national product of the nation will double at least in the next ten years. We think the gross national product of the nation forty years from now will be sixty-four times as high as it is now and that will be reflected in sales volumes and profits and share prices….” (Proctor & Phillips, The Templeton Touch, 1983, 2012)p.222
John Templeton was able to quietly and confidently say that when the stock market had just suffered a massive one day plunge!
Sir John was always optimistic
Marty Flanagan tells us that the experience of working closely with John Templeton during the crash of October 1987 is credited by him with helping to keep perspective during the bruising market collapse in the fall of 2008 when he was CEO of Invesco, one of the largest global asset managers in the world. Flanagan reports: “Honestly, those experiences helped me during this last crisis. He [Sir John] was always optimistic, he always took the positive point of view, and that would be an influence on how I approach things. If you think that way, if you think optimistically, you also see the opportunities.” (Proctor & Phillips, The Templeton Touch, 1983, 2012)p.191.
But, there’s a problem. Optimism can lead to overconfidence. Daniel Kahneman, tells us: “Subjective confidence in a judgment is not a reasoned evaluation of the probability that this judgment is correct. Confidence is a feeling, which reflects the coherence of the information and the cognitive ease of processing it.” (Kahneman, 2011)p.212. Subjective Confidence can even lead experts (or at least supposed experts) to misunderstand the limits of their own expertise. (Kahneman, 2011)p.242.
There is a behavioral bias that leads directly to overconfidence. Kahneman calls it the Optimism Bias. It seems to exist at the intersection of confidence, optimism and courage.
This intersection is critically important to investors who want to buy with a margin of safety or buy at the time of maximum pessimism (to use John Templeton’s phrase). At such times Mr. Market’s self-confidence will have ebbed to a low point. At such times the inexperienced investor will be lacking in confidence. The thoughtful investor will need confidence, optimism and courage. But, there are dangers.
Kahneman writes: “Most of us view the world as more benign than it really is, our own attributes as more favorable than they truly are, and the goals we adopt as more achievable than they are likely to be. We also tend to exaggerate our ability to forecast the future, which fosters optimistic overconfidence. In term of its consequences for decisions, the optimistic bias may well be the most significant of the cognitive biases.” (Kahneman, 2011)p.255. (emphasis added)
Back to Templeton
Proctor feels that the essence of Templeton’s personality was his ‘positive thinking’. But, he quickly adds: “But it’s also essential not to allow an emphasis on his positive thinking to overshadow the realism of his in-depth market research and the hard-headed way he evaluates one corporation against another. He’s certainly no Pollyanna when it comes to dumping a loser in favor of a stock he considers a bargain.” (Proctor & Phillips, The Templeton Touch, 1983, 2012)p.124.
Back to Daniel Kahneman
Kahneman tells us that: “Optimism is normal, but some fortunate people are more optimistic than the rest of us.” (Kahneman, 2011)p.255. It is apparent from this that Kahneman doesn’t put himself in the fortunate optimist camp.
Kahneman writes: “An optimistic attitude is largely inherited, and it is part of a general disposition of well-being, which may also include a preference for seeing the bright side of everything.” (Kahneman, 2011)p.255. He adds: “In terms of its consequences for decisions the optimistic bias can be both a blessing and a risk, you should be both happy and wary if you are temperamentally optimistic.” (Kahneman, 2011)p.255. Put another way, he writes: “…the blessings of optimism are offered only to individuals who are only mildly biased and who are able to ‘accentuate the positive’ without losing track of reality.” (Kahneman, 2011)p.256. (emphasis added)
The message from Kahneman is that those who are only mildly optimistic do not suffer from Optimistic Bias as long as they stay well connected with reality. Buffett and Templeton seem to stay grounded. I’m not sure I would describe the world view expressed by Warren Buffett and John Templeton as mildly optimistic. It’s more, really really optimistic. Somehow they are able to be both supremely optimistic and grounded in reality. So, I have to disagree with Kahneman. Some investors are supremely optimistic but are still able to stay grounded and resilient in face of setbacks.
Back to Ben Graham’s idea that ‘character’ is required for successful investing. One side of character is toughness when faced with difficulties. Kahneman tells us: “The main benefit of optimism is resilience in the face of setbacks.” (Kahneman, 2011)p.263. I think investors with an optimistic outlook on life will be more likely to have Ben Graham’s ‘character’.
Optimism seems to be a personality trait that is largely bread in the bone. Some people are naturally more optimistic than others. But, as said of Templeton: “…it’s also essential not to allow an emphasis on …positive thinking to overshadow the realism.”
Other posts on investment psychology
This post is part of a series. Readers are invited to read Investment psychology explainer for Mr. Market – introduction This will give you a better understanding of some of the terms and ideas and give you links to other posts in the series.
For readers wishing to dig more deeply into the character traits necessary for successful investing please see Chapter 20. The Right Stuff
This Chapter continues with these Sections:
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