The equity market (as measured by the S&P 500) recently hit a new all-time high and came within spitting distance of hitting the 5,000 level for the first time ever. For those who have some of their savings invested in the stock market, that likely means good news as they watch their portfolio increase in value. It’s ok to be happy about this milestone, but it’s also the time to start thinking about what to do next. As investors, should we be greedy and maybe add more to our equity allocation here, or is it more prudent to be a little fearful and maybe take the
opportunity to reduce our equity market exposure?
Well, if we take the counsel of the “Oracle of Omaha”, undoubtedly one of the best, if not THE
best investor of all time, Warren Buffett, we should be fearful. In one of his annual letters to
shareholders, Warren gave the shrewd advice that the best way to become rich was to “Be
fearful when others are greedy, and greedy when others are fearful”. According to the weekly
survey of U.S. Investor Sentiment produced by the American Association of Individual investors
(AAII) the most recent level of “positive” sentiment has fallen from its three-year peak at the
end of 2023, but remains significantly elevated above the long-term average. So, investors are a
bit less “greedy” than a month ago, but still pretty darn optimistic of a further upward advance.
At its most basic level, the day-to-day movement of the equity market is essentially a reflection
of the opinion of the mass of investors who trade daily. As another great investor, Benjamin
Graham, once famously stated, “In the short run, the market is a voting machine, but in the long
run, it is a weighing machine”. Understanding the behavior of crowds is a very complex, and
often confusing science. It is also one of the many reasons individual investors are probably best
served to take a long-term approach to their investment decisions. I recently read a book by
Rory Sutherland (Alchemy: The Dark Art and Curious Science of Creating Magic in Brands,
Business and Life) that contained an example of how complacency in group decision making in
the short term can sometimes lead to unfortunate outcomes.
Most of us old enough remember the disaster that befell the launch of the Space Shuttle
Challenger on January 28th, 1986. What most of us don’t know, or perhaps don’t remember, is
that the shuttle wasn’t originally scheduled to launch on that fateful day. It was originally
supposed to launch a week earlier on January 22nd. But it was postponed several times (first to
January 25th, then to January 26th due to the delay of another NASA mission). Then rain pushed
it to January 27th. On that day there was an issue with a handle of one of the hatches and by the
time it was remedied the winds had picked up and they scrapped the launch.
On the night of January 27th, the day before the rescheduled launch was to take place, record
low temps descended over Cape Canaveral. One lone engineer, Allan McDonald, who was part
of the team that built the rocket booster, spoke up and warned that the cold might pose a
problem. The rubber O-rings that created the seals in the joints of the rocket boosters could
potentially stiffen and lose their flexibility. Other experts though downplayed the risk, and the
launch went forward. Sadly, 73 seconds into the flight the world would see that McDonald was
right – though at the time no one outside the launch team knew of his warning – and all seven
crew members were lost.
Sutherland poses the hypothesis that the sequence of events leading to the successive
postponements could also have led to the launch team deciding to downplay the engineer’s
warning of the potential failure of the O-rings. The more the launch was postponed, the more
eager was the launch team to get on with the mission, despite the presence of increased risk. It
was the increased pressure of group thinking in making the final decision that potentially led to
the team’s complacency of the risks and its devastating outcome. As he notes in the book, at
some point the question “is it safe to launch?” was replaced by “are we going to delay the
launch again?” It illustrates how the misconceived perception of risk by the crowd and peer
pressure can play a sometimes-large role in decision making. At times, even to the extent of
ignoring reality.
So, I ask again, should we be greedy or fearful with the equity market at all-time highs?
