Assumptions are the root of all major losses and if you think back to your last major loss, in the stock market, business or life, you will almost certainly find that it can be put down to "Core Assumption Failure".
Take the global financial crisis. We assumed that homeowners in the US were like us, and would suffer any deprivation rather than miss a payment on their mortgage. We judged others by our own standards. We were "surprised", because it turned out that there were billions of dollars of mortgages in the US sold by people who didn't care to people who were, unlike ourselves, allowed to hand back the keys if it didn't go well. They didn't have our standards. Core assumption failure, the root of all major catastrophes. Add gearing and hedge fund investors, to the failure of these "load bearing" assumptions and you have collapse.
So the next time you are entering any sort of commitment, relationship, marriage, business deal, or just buying a stock, ask yourself, what assumptions am I making, because if you are going to get it wrong, they will be your undoing. Assumptions are the bedfellow of error and surprise.
The market has seen some significant assumption failure in the last year or so, assumptions that would have delivered us a fortune had we but questioned them.
Assuming that the British would never be so stupid as to vote, against economic logic, to leave the European Union, would be an obvious one. That safe income stocks were still worth buying despite the fact they had below-average yields another. The "safe" REIT sector is now down 15 per cent in six months. That Chinese demand for infant formula or vitamins would never be satiated. Bellamys is down 76 per cent. Blackmores is down 55 per cent.
That the Australian dairy industry was a good investment. Murray Goulburn is down 67 per cent since listing. That Woolworths was no longer a core portfolio stock. It is up 30 per cent since the new CEO came on board. That mid-cap growth stocks on a price-earnings ratio over 40x and yields of under 2 per cent were good value.
That the iron ore price and the coal price would never boom again. That thanks to the US shale gas boom the oil price was going to settle at its long-term average under $30 a barrel. That Donald Trump would not get elected. Can we really start listing the core assumption failures related to Trump? That Trump is a fool not worthy of the office of President. That Trump is all campaign promises no action. That Trump will be bad for the global economy.
The market doesn't reward pride or prejudice and there is a lot of money to be made when assumptions are wrong. It is, after all, the things we don't expect that move share prices, not the things we expect. So what assumptions are we making now? Here are a few.
That the stock market always goes up. That the GFC was a once-in-a-lifetime event. That the iron ore price will settle at around $80. That the Chinese economy is stable. That interest in the mid-cap and small-cap growth stocks will never recover. That the property market always goes up. That the Chinese interest in our property market is perpetual. That there will never be an Australian property market collapse. That there won't be a Royal Commission into the bank sector. That the Trump effect is going to be short-lived. That global interest rates have bottomed (that's a big one). That Australian interest rates have bottomed. That the US economy is recovering. That European growth is recovering. That European risk, Greece, Portugal and Spain in particular, is behind us. That European elections don't matter. That fixed interest is not worth investing in ever again. That we will not wake up to a meaningful terrorist event. That superannuation laws won't change. Actually, no one would be stupid enough to assume that last one.
We have all heard of contrarian investing. To many it might sound like betting against the odds. But we should all have the presence of mind and the humility to at least entertain the idea that we, our assumptions and those share prices, just might be wrong.
Marcus Padley is a director of MTIS Pty Ltd, the author of the daily stock market newsletter Marcus Today. For a free trial of the Marcus Today newsletter please go to www.marcustoday.com.au.
