Decision principleObservationInvestingPsychology and behaviourCrises and market history
When investing, pessimism is your friend and euphoria the enemy
Warren Buffett · Berkshire Hathaway's 2008 letter to shareholders · 2009
The idea
The same 2008 letter that admits a several-billion-dollar mistake in ConocoPhillips argues that markets had swung from underpricing risk to overpricing it, and suggests the Treasury bond bubble of late 2008 might rank with the internet and housing bubbles. The point is not that a crash is always a buying opportunity. It is that the price of risk moves with mood, and the investor who can act when the mood is darkest buys the same cash flows at the lowest price. Reading the letter beside the ConocoPhillips confession shows the other half: the same investor overpaid at the peak of a different enthusiasm, and said so.
The price of risk tracks the mood, so the useful time to buy is when the mood is worst, and the dangerous time is when it is best.
When it works
Any question about market timing, contrarian investing or what to do in a crisis.
When it may fail
Pessimism is a friend only to someone with capital and no forced sales, which in 2008 was a short list. For a levered investor the same moment is the end.
How to use it
When a market is described as uninvestable, write down what the cash flows of a good business in it would be worth at a normal price of risk. The gap between that and the quote is the premium the mood is offering.
Where it came from
Letter Berkshire Hathaway's 2008 letter to shareholders · Warren Buffett
What the source says. Buffett argues markets had swung from underpricing risk to overpricing it, suggests the late-2008 Treasury bond bubble may rank with the internet and housing bubbles, and admits buying ConocoPhillips near the peak in oil prices cost several billion dollars.
“When investing, pessimism is your friend, euphoria the enemy.” · Warren Buffett
Connected ideas
Takes it further
Beware of geeks bearing formulas: a model built on calm history cannot see the stormAsk what period a model was fitted to, and whether that period contained the event you are worried about.
Supports
Compounding needs an uninterrupted run more than it needs a good yearDuration beats brilliance in compounding; arrange your life and portfolio so you are never forced to stop.
Says something similar
In a crash, long-duration cash flows move far less than the price, if you stay solventState the liquidity first, because the argument that prices overshoot value is only available to those who can wait.
Concepts
Put it to work on L3VLUP
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