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Howard Marks: The Best Investors Remove Emotion From Their Portfolio

Howard Marks: The Best Investors Remove Emotion From Their Portfolio

Legendary Wall Street guru Howard Marks says the greatest, most underappreciated trait of superior investors is simple: “A lack of emotionality.”

“A lack of emotionality is a gift (in investing, that is, but perhaps not in other areas, like marriage). It’s not my point that emotional people can’t be good investors, but it will require a great deal of self-awareness and self-restraint,” Marks wrote in his latest book, “Mastering the Market Cycle.”

Oftentimes people will get too invested in the stocks they own — emotionally, that is to say.

An excellent article on American Consequences highlights this with a short story that perfectly illustrates exactly what that means:

Years ago, Bill – an affable gentleman in his 60s – shared a personal story with me that I’ll never forget. What made the story unforgettable is that it didn’t have to end the way it did…

Like many people in their 60s, Bill moved to Florida after living most of his life somewhere else – in this case, Corning, New York.

Known as “Crystal City,” it’s also the world headquarters for glassmaker Corning, a Fortune 500 company with dozens of manufacturing facilities around the world. Corning’s roots in this small town started in 1851, dating back to the early days of America’s glassmaking industry.

Bill became nostalgic as he recalled his many years living in Corning. He fondly remembered executives and plant workers routinely “rubbing shoulders” at their kids’ school events and in the town’s shops and restaurants.

Everybody, it seems, was also a Corning shareholder. Bill told me he had owned shares most of his adult life, added to them over the years when he could, and reinvested the dividends. In 1999, Corning’s stock (and Bill’s net worth) suddenly began to soar…

Shares doubled between June 1999 and December 1999… then doubled again as the dot-com mania hit full stride, peaking in August 2000 near $325 (on a pre-split basis).

Corning’s meteoric 1,200% rise in just 24 months meant Bill was suddenly worth millions. With retirement just a decade away, he was set. It was too good to be true… And then, without warning, it wasn’t.

The dot-com bubble suddenly burst… tech stocks crashed… and $5 trillion in paper wealth disappeared.

Two months after hitting an all-time high near $325, Corning shares were down 50%. They wouldn’t stop falling until they hit $3 in October 2002… a stunning 99% implosion.

Tragically, Bill never sold.

It’s said that investors tend to make their biggest mistakes at market extremes, and Bill is a perfect example. He was too emotionally attached to his Corning stock and he wasn’t prepared to let it go because he never thought such a day would come.

Let Bill’s heartbreak serve as an important lesson: It’s easy to get complacent about a stock that has treated you well… But never allow yourself to get so emotionally attached that it clouds your judgment.

As the pendulum of investor psychology swings like a wrecking ball away from flawless and toward hopeless, investors are sure to overreact and create a huge number of attractive investment opportunities.

The Corning story offers two lessons that are becoming important for investors these days…

Marks eloquently sets the stage for them both, with the following excerpt from his book. (As an aside, the seventh chapter, titled “The Pendulum of Investor Psychology,” is a must-read for serious investors.) As he wrote…

In the real world, things generally fluctuate between “pretty good” and “not so hot.”

But in the world of investing, perception often swings from “flawless” to “hopeless.”

The pendulum careens from one extreme to the other, spending almost no time at “the happy medium” and rather little in the range of reasonableness.

First there’s denial, and then there’s capitulation.

During the late ’90s, Corning’s business was “pretty good.” It started doing what many companies do when times are good – acquiring smaller competitors and consolidating the industry.

The acquired companies brought lots of new revenue streams and caused earnings to soar. Investors, in turn, saw the exceptional numbers and assumed Corning’s earnings would be flawless for years to come.

Investors generally figure the near future will look a lot like the recent past. Most of the time, they’re pretty much right. But eventually, the future doesn’t look as good as the recent past, which triggers an abrupt shift in investor expectations… and causes stock prices to plummet.

In the fall of 2000, it became increasingly clear that Corning’s stock was priced to perfection and that its future would likely be far less than that. The pendulum of investor psychology suddenly swung toward hopeless.

Investors anticipated that Corning’s acquisition binge would be disastrous once demand slowed. Sure enough, the company wrote down the value of its newly acquired businesses an enormous $5 billion the next year. It also acknowledged the following…

Most of the impaired facilities are currently available for sale [and] others will be demolished. The impaired equipment will be auctioned, sold, or disposed during 2002.

Four years later, in its 2004 annual report, Corning noted the market was still out of balance, saying…

We see few signs of a broader recovery in overall demand, mix of premium products, and pricing for our products [in the telecom division].

I want you to keep the following in mind…

Strong capital markets and historically low, near-0% interest rates have once again encouraged U.S. corporations to go on a “buy growth” binge over the past several years. As a result, investors have priced stocks to perfection, assuming that this strong growth will continue for years to come. But at some point, the flawless sentiment priced into stocks will start careening the other way.

There’s another important lesson we can draw from Bill’s story…

As the pendulum of investor psychology swings like a wrecking ball away from flawless and toward hopeless, investors are sure to overreact and create a huge number of attractive investment opportunities.

When Corning finally bottomed in 2002 around $3 a share, sentiment was as irrational as it had been at the peak in August 2000. Sure, a full recovery was still years away. But Corning had proven it could weather the worst of storms. It was a classic deep-value moment… where the upside potential far outweighed the downside risk. (Investors that bought Corning stock near its lows in late 2002 made 10 times their money a year later.)

Superior investors learn to exploit the pendulum of investor psychology as it swings between flawless and hopeless.