Levy’s successful value investing strategy used to always focus on common sense and he usually stressed on the importance of understanding investor psychology.
“I’ve had two loves in my life: One is the stock market, the other psychology. Nothing ever happens without people making decisions. Even the bubbles wouldn’t be worth talking about without discussing the psychology that drove them,” he wrote in his book,
The Mind of Wall Street.
Born in 1925 in Manhattan, Leon Levy studied psychology at City College of New York. He also served in the US Army and then joined Hirsch & Company as a research analyst in 1948. In 1950, he joined Max Oppenheimer to set up his firm, where he became a managing partner in 1959. He helped Oppenheimer grow into a successful mutual fund firm, before it was sold in 1982 for $165 million.
Levy then set up hedge fund Odyssey Partners with Jack Nash and ran it for 15 years, until he retired in 1997. From 1982 to 1997, Odyssey have an annual average return of 22% versus 16.9% for the market.
Levy’s investment strategy
Levy was a contrarian and invested in companies that he felt were undervalued. In some cases, he looked for shares and bonds of companies that were heading towards bankruptcy, as he felt these companies could either survive or leave sufficient value after their liquidation.
Unlike other investors, Levy hardly paid too much attention to earnings, dividends and the ‘story’ of a stock. Instead, he urged investors to ignore all analyst stock recommendations.
“Value investing is an approach to stocks that is as close as it gets to a golden rule”, he said.
Importance of psychology in investment
Levy said timing of when prices respond to events can be totally affected by psychology. He felt in the markets, timing was often the difference between windfall and bankruptcy.
He believed investing is as much a psychological act as an economic one, and even stubborn investors who think they are basing their decisions on fundamentals, discover over time that there are fashions in fundamentals.
Levy felt the mood or investor psychology is very important to markets just like information and it requires tremendous discipline to apply this understanding to an investor’s behaviour.
“To ignore the psychological component of the flux of the market is to miss seeing the elephant in the room. Psychology plays a role in all events in the market, from the actions of a day trader riding the momentum of Internet stocks to the broad shifts that become obvious and undeniable only over time,” he said.
Levy said most investors are extremely uncomfortable when investing in unconventional ways. He believed investors have the knack of following the herd and are comfortable even with mediocre gains but don’t want to take a contrarian approach.
“Although economic theorists offer an idealised image of investors as rational beings who calmly assess opportunities, the typical investors I’ve met are idiosyncratic, superstitious and perhaps most importantly, prey to fears of the unknown,” he said.
The Mind of Wall Street, Levy gives a number of valuable insights for investors that can help them in their investment journey. Let’s look at some of them.
- Don’t attribute losses to bad luck
Levy believes investors make the mistake of attributing gains to their intelligence, when they are due to luck, and to bad fortune when they are often the product of stupidity or inattention.
- Don’t fall in love with stocks
He says investors often fall in love with a company that is unworthy of their affection. “I’ve been left at the altar by more than one companies. In particular, there were costly financial romances, in which I was blinded by the charm of the business or its management. Disciplined investors must be able to see hidden beauty; conversely, they also must be able to look past the shimmer of some companies to see the rot within,” he said.
Levy says when the market is upbeat, investors tend to ignore the bad news, whereas in a down market, no one trusts good news. He felt investors are very good at recognizing the moods of the past like say the Roaring Twenties, the Great Depression, the Swinging Sixties — but tend to be ignorant to the mood of the present.
“Good times breed laxity, laxity breeds unreliable numbers, and ultimately, unreliable numbers bring about bad times. This simple rhythm of markets is as predictable as human avarice. Regulatory and accounting laxness is easily ignored when stock prices are climbing, but as companies cut corners and hide expenses, they set up a day of reckoning. At some point, bankers, bondholders, or other investors will demand proof that a company has the money to pay its debt. That is when the party ends and the hangover begins. Markets fall, and exaggerated earnings and reduced oversight become very important indeed,” he said.
- Market & investor psychology affect each other
Levy says, the market affects investor psychology, but investor psychology affects the market. He says if he warned young investors constantly about the horrors of a crash or bad market, it won’t make an impression on them if they haven’t lived through the experience and they can certainly forget the temporary downfall of a stock market crash.
Levy advises investors to study the role of psychology in their investment process and answer the questions like-
- What were they thinking or feeling when they bought or sold a stock or bond?
- To what degree did mood and intuition, as opposed to analysis, affect the decision?
- What assumptions caused them to pay heed to a particular piece of information?
- Why did they weigh one piece of information over another?
- What facts did they include in their decision?
Then he recommends investors to try and imagine what the person on the other side of the trade was thinking, as investors tend to forget whoever buys the stocks they sell must have undertaken his own analysis of the situation. “There is a genius on one side of every trade and a dolt on the other, but which is which does not become clear until much later,” he said.
Levy says investors often make the mistake of thinking that even a falling market will not affect their stocks. They believe no matter what happens, they will be able to get out at or near the top of the market. He feels investors who have this kind of a mindset are often heading towards disaster.
- Impossible to have all the information
Levy says investors should realise that there is never perfect knowledge about the world. But he believes there are always clues in the actions of the government and in the behaviour of major economies that offer guidance about developments that often offer opportunities for investors to exploit.
Levy says a good idea, a long-term perspective and creativity to implement a strategy for profit are necessary to do well in investing, but they are not sufficient. He feels investors always require the discipline to stick with their strategy even in uncertain times if they want to achieve success, as they would always be tempted to cut losses and make profit.
“None of these qualities will bear fruit unless you have the discipline to stay with your strategy when the market tests your confidence, as it inevitably will. When you have made a massive bet and markets start to go against you, it is always a good idea to reexamine the assumptions behind your strategy. Even if you are still convinced you are right, however, it is difficult to resist the temptation to cut losses or take a quick profit,” he said.
Levy says both investors and the market have the knack for over-reacting which ultimately creates investment opportunities. “Why should the market be any more perfect than the very human emotions and calculations that drive it? Investors overreact, and so do markets. Investors get swept up in moods, and so do markets. And this interplay creates investment opportunities,” he said.
But he believed investors should keep in mind that ultimately the market does reflect value, even if it may seem to lose its bearings for a very long period.
“Investors must decide how long they are willing to wait. Investors also have to be alert to changes in the market that could change their original assumptions. We may not have an efficient market, but we do have a pretty efficient market,” he said.
- Badly-managed firms can be good opportunities
Levy said some of the best opportunities involve badly managed companies because the situation can improve rapidly with the enforcement of good management. “No matter how bad a company, there is almost always a point where it is a bargain,” he said.
Levy also says there is no sure shot secret to beat the market and to succeed as an investor. One needs to make more correct judgements than mistakes. “There is no system to beat the market. The future is never a simple replay of the past… The market has a life all its own. Succeeding in it is about making more “correct judgments” than mistakes,” he said.
(Disclaimer: This article is based on the book
The Mind of Wall Street by Leon Levy