The end of a speculative boom can be inevitable but not predictable. Unsustainable things can last a long time. Identifying something that can’t go on forever doesn’t mean that thing can’t keep going for years. Years and years and years.
Part of it is emotion. During the Vietnam War Ho Chi Minh said, “You will kill ten of us, and we will kill one of you, but it is you who will tire first.” Emotional trends aren’t beholden to logic, which can keep them going far past any point of reason.
Part is storytelling. Unsustainable trends have life support if enough people think they’re true, and once people believe something’s true it gets hard to convince them it’s not. Or put differently: If enough people believe it’s true it’s just as powerful as actually being true.
Every investor is making bets on the future. It’s only called speculation when you disagree with someone else’s bet.
In hindsight there was as much speculation in the 1990s that Kodak and Sears would keep their market share as there was that eToys and Pets.com would gain market share. Both were bets on the future. Both were wrong. It happens.
Of course there’s a speculation spectrum. But let’s not pretend that others speculate while you only deal with certainties.
The willingness to believe crazy things increases when it feels like the world is dangerous and falling apart. Chronicling the Great Plague of London, Daniel Defoe wrote in 1722:
The people were more addicted to prophecies and astrological conjurations, dreams, and old wives’ tales than ever they were before or since … almanacs frighted them terribly … the posts of houses and corners of streets were plastered over with doctors’ bills and papers of ignorant fellows, quacking and inviting the people to come to them for remedies.
Optimism always overshoots. It has to. The correct price of any asset is what someone else is willing to pay for it, because all asset prices rely on subjective assumptions about the future. And like a blind man who doesn’t know where a wall is until he bumps into it, markets cannot know exactly how much people are willing to pay until they go a little too far and say, “Ah, in hindsight, that was the limit.”
The peaks of market cycles always look irrational in hindsight, like they went too far. But in real time markets are just trying to find the limits of what people can endure. And they have to, because if you don’t know exactly where the boundaries are it’s possible there’s opportunity left to exploit, and someone, somewhere, will step in and try to exploit it.
Correlations go to one during wild times. Everything goes up regardless of merit, then everything goes down just as indiscriminately. So everyone feels like a genius on the way up and a moron on the way down. But neither is true. As Scott Galloway says, “It’s never as good or as bad as you think.”
Investors play different games. GameStop at $400 a share makes no sense if you’re a long-term investor. But if you’re a day trader betting it will go to $401 in the next hour, it might be a great buy. A lot of financial debates don’t reflect people actually disagreeing with each other, but people playing different games talking over each other.
Jim Grant once put it: “To suppose that the value of a stock is determined purely by a corporation’s earnings discounted by the relevant interest rates and adjusted for the marginal tax rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin and believed Orson Welles when he told them over the radio that the Martians had landed.”
Optimism is the best long-term mindset. And it requires a certain level of believing things that can’t be verified, either because you don’t have the technical skills to verify them – nobody knows everything – or because something hasn’t happened yet but you think it will happen in the future. Not enough speculation is just as dangerous as too much speculation.
“You only live once” is just as compelling a reason to not do something. Buffett: “If you risk something you need in order to gain something you don’t need, that is foolish. It’s just plain foolish.”
When interest rates are zero, stories about what could happen in the future are more powerful than facts about what’s actually happening today, because there’s no return in bonds that anchor people back to reality.
Investing is not the study of finance. It’s the study of how people behave with money. And sometimes those behaviors are absolutely wild.