Charlie Munger - His latest and past thoughts on investing
Legend:
As with all pages the ‘✙’ sign is there to warn you/put in a “first do no harm” designation notification.
A ‘do not pet that dog 🐻’ notification means you should stay the hell away or completely distrust whatever that product/security/site/external piece of advice is. It could also mean: “Don’t be dumb” To understand where the ‘do not pet that dog’ reference comes from watch this video here: link
Recently, Munger outlined his thoughts on the current investing environment here.
“There was a lot of low hanging fruit in the early days to our operation, you don't have any low hanging fruit that's easy right now," he said. "low hanging fruit for the idiot is not gone, but it's very small."
What he says makes sense as well in the broader market when looking at the Shiller P/E ratio (‘a valuation measure usually applied to the US S&P 500 equity market. It is defined as price divided by the average of ten years of earnings (moving average), adjusted for inflation.’). It gives an idea of if the S&P (the 500 largest publicly traded companies in the United States) is overvalued or not. A high P/E ratio indicates you are spending too much for every dollar of earnings received:
For context (as of 2023):
Mean: 17.06
Median: 15.95
Min: 4.78 (Dec 1920)
Max: 44.19 (Dec 1999)
^ If we assume an eventual return to sanity reversion to the mean, we can assume that the S&P should fall by about half over a short period at some point, or else stay at its current valuation and have terrible returns for a very very long time. Grantham seems to think so, and the data certainly support this. But there’s no way of really knowing over what time frame or when such a decline may occur.
All I can say for certain is that the market is overvalued. If beef was selling at a premium, say… $10 per pound (in 2023 dollars), would you still buy it even if your neighbor was, or because “everyone else” is doing it? Hopefully not, especially if there were cheaper alternatives available. The same dynamics apply to stocks as well. There’s little point in buying stocks at a premium, and plenty of downside to doing so, since you could lose money, or have your stock values go down for a very long period of time, during which you may be forced to sell for a variety of reasons.
Fortunately, higher interest rates have made US Treasuries quite attractive, many yielding at or over 5% as of 2023, particularly when buying on the secondary market and including any discount.
✙ Some BBB rated corporate and baby bonds are approaching equity-like returns while having relatively acceptable risk for some investors.
All well and good. However, there are other aspects of Munger’s overall outlook on investing and thought which bears some attention here too:
Briefly, we’ll address all three (for a deeper dive see the links above). All are critical for the serious investor:
The Latticework of Mental Models
The idea behind the ‘Latticework of Mental Models’ is to look at an idea/problem/situation with a variety of perspectives. Kind of like “putting yourself in someone else’s shoes” but in a broader sense.
In other words, to paraphrase Munger: “You can’t just memorize facts in isolation” you need a mental framework to tie those facts together to be useful. There are many mental models one can use (you can find some here).
Problem inversion
One such mental model is listed above, problem inversion. The idea is to take a difficult problem and invert it. Instead of saying “Where is the safest place I can go to in my country”, you can also ask “Where is the most dangerous place I can go to in my country” and then, of course, don’t go there. You could also see patterns and attributes of safe and dangerous places, and look for those with both perspectives, instead of just one set of perspectives.
Here’s another example: Suppose I’m planning for retirement and I say, “How can I maximize my return?” You might assume that to do so, you should be mainly invested in stocks. You might also erroneously assume that because stocks have performed well in the past, that you can falsely extrapolate that they will always do so in the future in aggregate. You would be wrong:
In March of 1968, the S&P 500 stood at 901.63 points. It then promptly declined to 576.89 by June of 1970. It would bounce around, but it would not even match its valuation of 901.63 nor surpass it until January of 1992 at 911.17. A period of nearly 24 years. During that time, inflation went on a tear: The average inflation rate of the dollar between 1968 and 1992 was 5.95% per year, bear in mind that we currently feel inflation is “high” at only a mere 3.7%. (The historical rate of inflation is roughly 3%).
So much for the myth of stocks “beating inflation”. Bonds did considerably better over that period of time by the way, which also disproved the idea of stocks “always beating bonds over the long run”. A good book called “The Little Book of Safe Money” by Jason Zweig goes into more details on these and other such fallacies.
Now instead of asking, “How can I maximize my return”. You could also ask, “What would I do if I wanted to minimize my return?” You could (and probably should) also ask: “How can I minimize my risk of not having enough money in retirement.” For the average person, the second and especially third question is the correct mental model to have. It inverts the problem as well.
Asking the question the second way immediately shifts your attention to risk mitigation, whereas the first perspective tends to shift your attention towards maximizing return (even if it means unnecessarily taking on some additional risk). For the average person, you are primarily concerned with having enough for retirement, not with trying to have way waaaay more than enough for retirement.
Because you are not an institution, and have a finite life span, you can’t just “wait out” a down market, or “keep working” after your health or life circumstance prevents you from doing so. In short, you can only accept so much risk. As you will soon see again as you saw a few paragraphs before, the market can take long periods to recover, and in such periods you could be dead due to old age while “waiting”.
Rational thinking
Both of the preceding concepts are ways to help you think rationally when you otherwise might not. I should point out the obvious: If you are in a situation where you don’t have much experience or don’t know very much, it’s easy to be prone to irrational behavior or thinking.
You can be highly intelligent, but if by the fact you are making decisions in an area outside of your circle of competence (such as an engineer trying to do heart surgery) or because of temperament (such as a hotheaded aggressive fighter trying to practice/teach meditation) then you will likely make mistakes and/or behave irrationally. In such circumstances, emotions in the brain can control your impulses and actions.
The human mind craves certainty. In the absence of information, much is uncertain. In the absence of knowledge, much is uncertain (or worse, misunderstood). Even worse, such a person could have overconfidence that they “know” things when really, they know nothing and are making baseless assumptions. Sometimes the mind can inject certainty falsely and predispose one to “justify” the assumptions one has.
One way to fight against this justification: If you are bullish on a company and your thesis for investing in it, come up with the bearish case and why you would short it instead. This forces you to think differently about the situation, and truly tests your theories.
It is partly in this way that investors make mistakes and lose money. Irrational behavior throughout financial history explains why markets can be overvalued, and why they subsequently are bound to crash.
In June of 1932, the 500 largest corporations in the US were valued at 100.26 points. Not twelve months earlier in Aug of 1929 it stood at 564.15. Irrational exuberance in 1929, begat irrational despair in 1932. A 82.2281% decrease. Now think about this…
Was 82%+ of US farmland destroyed? No. Were 82%+ of US industrial resources vaporized into non-existence? No. Did 82%+ of the US workforce die all of a sudden? No. (Also unemployment in 1932 stood at 23% not 82%).
Now that’s not to say there wasn’t much to fear in 1932. Certainly there was. The preceding 2 years were a terrifying time for much of the country in economic terms. But by 1932, investor fears were far outstripping even the grim realities of the Depression. By June of the following year, 1933, the values stood at 264.40, more than double what they were a year before. I can assure you that most Americans were not suddenly giddily dancing in the streets in 1933. The United States would not fully recover from the Great Depression until 1939, and in my view that is colored by the war. In some ways, we didn’t really fully recover until the 1950s, when the market finally equaled it’s previous 1929 high. More than 20 years later.
If you had been a person in retirement relying partly on stocks (much less mostly on stocks), that would have been a crazy and ruinous ride. Such a ride could test the rationality and emotional capacity of any investor. Some investors were able to keep their emotions in check, such as John Maynard Keynes. He created a portfolio of equities called the “chest index”. It outperformed the broader UK market pretty consistently after 1932:
Keynes is reported to have said: “It is the duty of the long-term investor to endure great losses with equanimity.” A lesson we should all take to heart.