Every generation has to get his own head chopped off in its own way — throughout history there have always been bubbles and busts — yet they take us by surprise every time. The less prudence with which others conduct their affairs, the greater prudence with which we should conduct our own affairs. Warren Buffet, 1988
What is prudence?
Prudence is a virtue that few people have really heard of lately. A deep dive on the word teaches us that it comes from the Latin prudentia, which translates roughly to “seeing ahead.” In classical literature it is one of the seven virtues and depicted as a woman holding a mirror and a snake, judging between the virtuous and vicious, appropriated for the time and place. The English language eventually took a lot of the meaning away from the Latin so now it’s synonymous with caution, and even avoidance of unnecessary risk.
Warren Buffet said this shortly after the 1987 stock market crash. Numerous studies of the 1987 market crash reveal that it was a combination of computer-driven trades and a series of poorly executed monetary and foreign trade agreements. In short, the United States worked with the G-5 to depreciate the US dollar in the international currency markets to curb trade deficits, which was accomplished by Q2 of 1987. The US then tightened monetary policy to stop deflation, and when this was combined with inflated stock market valuations the Dow Jones dropped 22.6% on October 22nd, 1987. After this crash, the Federal Reserve installed circuit breakers into their processes to avoid similar crashes in the future.
I’d like to believe that Buffet probably saw some of the policies and no doubt the extreme stock valuations, and in turn shored up his investments out of prudence. It would pencil as both economic virtue and investor caution, not getting caught up with the excitement of a bull market while studying the true value of his investments. If you check out this list of stock market crashes around all world markets, you’ll notice that not all market drops are caused by one thing. Greed, miscalculation, war, and recently a virus, can reveal serious underlying mistrust. For reference, the US market is bookmarked by 5 significant crashes: 1929, 1987, 1999-2000, 2008, and 2020.
This has happened before.
Prudence means to see ahead, but to do so you must know what preceded. If you have some time, I would highly recommend digging into the history behind each of these crashes. Studying history has a way of easing the mind, because too often we think that “this has never happened.” The reality is that while this combination of events has never occurred before, or the magnitude has never been experienced there is still a pattern to be found somewhere to show the light at the end. To make it easy, Ray Dalio has a series running on LinkedIn right now, reviewing the current market conditions against historic crashes as well as historic pandemics and health crises. There are several other historians, economists, and scientists that are worth digging into right now.
Above all right now, study prudence. Make decisions based on your personal observations and beliefs, because the news headlines will change again tomorrow. Prudence will protect you from fear and the fearful. And take note that there are less prudent folks around you right now, so follow Buffet’s wisdom from 33 years ago and conduct your own affairs with even greater prudence.