Don’t let yourself get caught up in a tide of optimism or pessimism when it comes to stock market advice.
John Templeton, a 20th century investing master, once said, “The four most dangerous words for an investor are ‘This time it’s different’”. What he meant was that the market goes through recurring cycles of optimism and pessimism, and that prices rise and fall in response. It’s dangerous to let yourself get caught up in a tide of optimism or pessimism and take it to mean the world has changed and end up re-making the same investing mistakes.
One great example is the Internet boom of the 1990s and early 2000s. Many Internet stocks rose to extraordinary heights in those days, based on the number of visits to their websites, rather than dollars in their bank accounts. Back then, lots of analysts and investors believed that “This time it’s different” and that these stocks could go on rising indefinitely. Instead, the Internet stock boom ended suddenly, like most speculative booms. Most of the top Internet stocks collapsed and brought huge losses to investors.
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That’s the kind of risk Templeton had in mind when he made his famous comment about the four most dangerous words.
However, you need to remember that these four words are also easy to misapply. The underlying cycle of optimism and pessimism never disappears, but circumstances and fundamentals do change. I think many investors have misapplied the famous four words in respect to the price of oil over the years
Oil shot up into the financial stratosphere in the early 1970s, partly because of political developments. Since then, its price has repeatedly gone through dramatic moves, up and down. After each plunge, prices rebounded sharply. It’s easy to assume the same kind of rebound will follow the latest plunge.
The improving technology of the past decade has opened up vast new potential oil sources. In the past, much of the world’s oil came from big underground pools, mainly concentrated in isolated areas such as the Mideast, where corrupt, volatile and backward governments were common.
The new technology produces oil from shale, a form of rock. Oil-bearing shale deposits are common and widely spread out around the world.
The new technology faces political and economic obstacles. Costs, however, are likely to fall as the new technology develops. It’s just a matter of time before oil production from shale becomes common around the world. With oil production spread out rather than concentrated, oil prices will generally be lower and less volatile. So the inevitable recovery from the recent oil price plunge may turn out to be weaker and slower than past oil-price recoveries.
My advice is to maintain some exposure to the oil industry as part of the Resources segment of your portfolio. But resist any urge to go overboard, particularly in high-risk oil investments such as junior oils, futures, options and so on. That’s always good advice. They are as risky as ever, but they may fail to thrive in a slow oil recovery.
In my opinion stick with the Successful Investor portfolio approach to avoid re-making the same investing mistakes. It has three key rules:
- Invest mainly in well-established stocks with a history of revenues, earnings and dividends.
- Spread your money out among most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities).
- Downplay or avoid stocks in the broker/media limelight.
Our Successful Investor approach has a big advantage: It’s likely to pay off in the long run, whether we have deflation, inflation, or something in between.
Do you find yourself remaking the same investing mistakes? Do you often get caught up in a tide of optimism or pessimism? Let us know about your experience.