First Level Thinking

• Posted by Robert Sinn
• on May 25th, 2012

I came across an interesting survey by Gallup on American’s top long-term investment picks (h/t @abnormalreturns). One table and one chart in particular really stood out to me from the Gallup piece:

 

Gallup is polling average Americans including many people who have little or no investing experience or knowledge; therefore, you get a pretty good grasp of the general public’s perception of “what is working now”. The vast majority of respondents are what Howard Marks refers to as “first level thinkers” when it comes to investing – for example a first level thinker will think and say things such as “It’s a great company, I use all of their products so I will buy the stock” or “The stock is up 40% this year, I think it’s going to continue to go higher so I will buy the stock”. 

Notice in the above table that in August 2011, less than two weeks before gold reached its all-time high above $1900/ounce, 34% of respondents chose gold as their top long-term investment pick. Eight months later in the same survey with gold trading nearly $300 lower only 28% of respondents chose gold as their top long-term investment pick – liking an investment less because its price has fallen is classic first level investment thinking, shouldn’t you like it more because it is cheaper?

Perhaps even more interesting is that the people who left gold appear to have moved to saving accounts/CDs (essentially cash given that interest rates are at record lows). It is really hard to imagine how someone can possibly believe that a savings account that pays less than 1% interest will be the best long-term investment. However, it is a bit easier to understand when one considers that precious metals ($GLD $SLV) have fallen hard during the last eight months while many people have already been badly burned by real estate and/or the stock market. This leaves bonds which many don’t understand or have access to (other than mutual funds) and cash, so they chose cash basically in a sign that they have pretty much given up on everything else.

 10-year Chart of the Perceived Best Investment by Gallup Survey:

This chart is a picture perfect example of first level investment thinking. Two things stand out:

1. Stocks were the place to be in the mid-late 90s but after the dot-com bust real estate gained much more favor as stocks faded in popularity among average investors. Real estate was by far the most popular investment choice by respondents before 2007 – 2007 was the year that everyone became aware of serious cracks in the US real estate market’s foundation even though prices had already peaked in mid-2005. During the last several years real estate has stabilized around the 30% level while stocks have seen a small resurgence in popularity as the S&P 500 has more than doubled from the March 2009 bottom (more first level thinking as people favor assets which have recently experienced price appreciation).

2. Savings accounts & CDs gained tremendously in popularity between 2007 and 2009 as both real estate and the stock market rolled over and eventually plunged. Once again this speaks to my point about people having given up on everything else – to have 34% of respondents choose cash with interest rates near zero as the best long-term investment highlighted the unusually high amount of fear and extreme uncertainty which most people had in early 2009 when it came to investing their money. As is often the case it just so happens that the point in time at which the highest percentage of respondents chose savings accounts/CDs also happened to coincide with the March 2009 stock market bottom.

In March 2009 a second level thinker would have seen an exceptional conglomeration of factors which might have indicated to him/her that it was a great time to invest: Cash wasn’t offering any return, the S&P 500 was at its lowest level in twelve years, the herd was preaching “cash is king”, and reflationary Fed monetary policy actions were likely to benefit equities even if the economy was still in decline over the near term.

Of course this is hindsight but it is no less useful to see the mistakes and opportunities of the past in order to learn for the future. What is the first level thinking of today and what are the second level thinkers thinking about tomorrow?

I plan to write more about this over the coming weeks, however, i’ll start it off by saying that there is a lot of first level thinking on the euro ($EURUSD $FXE) right now i.e. “there is a flight to dollar safety” “the euro looks ugly” “A Greece exit will lead to contagion and bank runs in the core” etc. etc.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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