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What Investors Don’t Know Will Hurt Them Most

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Investors have by and large lost an essential protection against financial pain, whose absence will likely intensify the effect of the next financial crisis.

That is the warning of Tocqueville Asset Management founder Francois Sicart, who illustrates his point with a simple 36-year chart of U.S. interest rates.

The three-and-a-half decade long bull market in bonds means that most market participants have no professional memory of rising interest rates.

“They may have read about such periods and even studied them in school, but they have never actually experienced the pain that results from them,” the veteran fund company manager writes in his latest letter to shareholders, which he titles “The Discovery of Ignorance.”

Sicart cites the conclusion of Israeli historian Yuval Noah Harari, author of the bestselling “Sapiens: A Brief History of Humankind,” that the most important discovery of the 16th and 17th century scientific revolutions was not confined to any specific law of nature or invention but rather the awareness of human ignorance — the rejection of the previously held assumption that all that there was to know of importance was already known.

Applying that insight to the world of investing, Sicart warns that a similar ignorance is handicapping investors because, he argues, experience teaches that the critical ingredient of survival is, well, experience.

The intellectually oriented fund exec cites a recent article in the January/February issue of Foreign Affairs by Nassim Nicholas Taleb — of “black swan” fame — and Grergory F. Treverton that compares the recent experiences of Syria and Lebanon.

Despite its reputation, Lebanon experienced less violence than Washington, D.C., in 2013, a year in which Syria’s death toll exceeded 100,000.  Why has Lebanon achieved stability while its close neighbor spirals out of control?

“Countries that have surived past bouts of chaos tend to be vaccinated against future ones,” Sicart summarizes.

Applying the principle, he extracts insights from investors with documented long-term records such as Peter Lynch and Warren Buffett and economists who correctly anticipated past financial crises, like Hyman Minsky and Taleb.

The former call economic forecasting futile.

“To me, being prepared means being suspicious of trends that common sense tells us cannot last forever, and yet have been in force for so long that a majority of investors sees them as being ‘normal,’” Sicart writes.

And the latter — the great economists — warn that “extended periods of stability in major economic or financial variables tend to encourage risk-taking by market participants — whether they realize it or not — and thus worsen the effect of the next trend reversal.”

What this all means is that investors generally lack access to experienced, self-aware leaders who possess this “vaccination” against future turmoil.

And the quiescence of a 36-year period of low rates has grown more acute over the past six years, when rates have hovered around zero.

While zero interest rate policy and quantitative easing have encouraged risk-taking among real estate investors, hedge funds and the like, Sicart warns that one needn’t borrow or speculate oneself to wind up in a world of pain.

“You could suffer along with them when they are forced to sell their assets acquired on credit.

“As a reminder,” he adds, “margin borrowing at NYSE member firms currently stands at a record.”

The ignorance Sicart identifies as today’s problem can only be rectified through the increasingly scarce quality of self-awareness. As he puts it:

“In my experience, when business and money managers fail, it’s usually not because they don’t know business, economics, or finance. They fail because they don’t know themselves: They haven’t discovered their own ignorance.”

Sicart says investors would do well to put their money in companies whose leaders have seen market upheaval and are likelier to have been vaccinated against future bouts of turmoil.

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