Buy and What?

Until recently investors had been lulled into complacency by a mantra. They were convinced that the best approach to investing was to buy and hold.

Market analysts used sophisticated charts of past performance to demonstrate that someone who had chosen to weather bear markets had always been bailed out by the ensuing bull markets.

Yet, this analysis was based on the idea that the past will necessarily repeat itself. And this, need I say, is far from guaranteed.

We are assuming, as Keynes wrote, that "the existing state of affairs will continue indefinitely, except in so far as we have reason to expect a change."

Those who were recommending buy-and-hold always factored in the worst that we have ever seen, the Great Depression. They concluded that if it was alright to hold through the depression, it was always right to buy and hold. (For a more detailed explication of Keynes' view, see Paul McCulley's article here.

For now it appears that buy and hold means buy and hold on for dear life.

Take the mutual fund that had racked up year after year of solid and impressive performance, Bill Miller's Legg Mason Value Fund. What could be safer?

Yet, the current market collapse has no spared the fund. In fact, it has erased all of the gains of the past years and then some. Over the past twelve months, the fund is down 63% Over the past five years the fund is down 14%.

Had we given the mantra some thought, we would have concluded that it was too good to be true. It makes you feel that the market is a parent who will always take care of you. It makes you feel like a privileged heir: someone who can get rich by doing nothing.

The buy and hold strategy seemed to suggest that less work was better, that inactive management was better than the more active kind, and that you could get rich by not working.

If the markets are in the business of taking care of us, whatever they take away they will give back many times over. By taking things away they are testing our faith. It is almost as though buy-and-hold was based on the notion of a providential faith that would offer an eternal reward for all of our current sacrifices.

Just as markets move from excessive optimism to excessive pessimism, so do investor attitudes. Nowadays those who have abandoned all hope that the market will ever make them whole again might start believing that the market is in the business of destroying us.

Some believe that the market is an instrument of divine justice. It is punishing people for their capitalistic excesses. Others believe that it was all a fraud to begin with. The market was setting people up, raising their hopes and aspirations... waiting for the chance to crush them underfoot.

Both stories are attempts to deal with a trauma. When people have been traumatized they try to make the trauma make sense by placing it within a narrative. The narrative is like a bridge loan; it is supposed to get you from here to there; to tide you over until the old routines have been re-established. It is not a place where you should put down roots and set up a new life.

The risk is that people take the new story of the crash for the truth about markets. Of course, some will do just that. They might conclude that they should never buy another stock. Or they might believe that they can only restore the old order by enhancing their spiritual virtue. Others might decide that individuals should no longer be allowed to direct their own accounts.

This last sounds the strangest, but keep in mind that the government of Argentina decided a few months ago to confiscate private pensions, on the grounds that individual citizens are not competent to direct them.