Stock markets, at times, reflect more of what participants want to happen than what businesses are capable of doing. Hope, fear, and greed drive prices in the short run. Business success, or lack thereof, drive prices long term.

Market cycles reflect the shifting mix of the emotional side of market participants and the changing fundamentals of business. At the extremes, emotions carry more weight on market prices.

Behavior follows market prices, unfortunately. Like fanatics with their sports teams, we prefer winning stocks to losing stocks. Winning stocks are rising. Losing stocks are not. And when the market is winning, excitement grows.

The winning is inconsistent, of course. The market rise is pitted with random dips. Each dip a potential turn or pause before a new high. But as more dips lead to new highs, skepticism of a turn in the market cycle grows.

Bandwagon fans jump in as the wins pile up. The longer the market winning streak, the more we expect it to keep winning. In time, hope turns to greed and rising prices are all that matters.

Quote for the Week

To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in—or more precisely not in—the country’s businesses and banks. This inventory—it should perhaps be called the bezzle—amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks. — John Kenneth Galbraith (source)

The biggest risk to a successful strategy might be copycats. Too much money chasing the same thing.

As more and more money pours into the same strategy, the dynamics of asset prices change, and the risk of an unwind grows. The more money, the more violent the unwind could be…especially when debt is involved.

Copycats are not a new concept either. For every Warren Buffett, there are thousands of imitators following his trades, hoping to replicate his past success.

The same is true for any other strategy or financial innovation, however short-lived, that generates an exceptional return. If someone is doing it, and it’s easily replicated, someone else will try it too. Then another and another, until the reasoning behind the initial strategy is lost or replaced with “prices go brrr.” It creates a positive feedback loop that shows up in short-term returns that is, unfortunately, unsustainable.

The latest copycat craze, the crypto treasury companies, harkens back to a time when Wall Street embraced investment trusts in the run-up to the biggest bubble in U.S. market history.

Quote for the Week

Stevenson, you remember, had a coward in his “Suicide Club” who threw dice with Death to enjoy the delights of fear, because when he escaped he tasted the intense joys of living. But he played once too often, did old Mr. Malthus. It is the same in stock gambling — the delightful uncertainty; the grim “now you see and now you don’t” of luck; the little chills of pleasure and the leaden sinking of disappointment; the exquisite expectancy — all this fires the blood of the young, as does love, and of the old, as love no longer can. The stock market “lambs” are like Mr. Malthus — when prices fluctuate they keenly enjoy the delight of riches because they have just jumped from the sorrow of nonpossession. But they too play once too often!

It may be accepted as axiomatically true that a man must possess a high degree of intelligence to be successful in commercial or professional pursuits. So must a Wall Street man, to win a fortune in the stock market and to keep it. But for an “outside” businessman to make a fortune in his vocation, and then to make another in the stock market, and keep both, requires positively the most extraordinary ability. Always on the wave of a general boom, outsiders come to Wall Street — and fail to display ordinary ability. They are ignorant of the basic principles of stock speculation. They are too late in going in and they overstay. They take unduly great risks. — Edwin Lefevre (source)

Quote for the Week

One of the important factors behind the fluctuation between bull and bear markets, between booms and crashes and bubbles, is that investor memory has to fail us – and fail universally – in order for the extremes to be reached. John Kenneth Galbraith said, “Contributing to euphoria are two further factors little noted in our time or past times. The first is the extreme brevity of the financial memory…” If people had good memories, if they could call to mind and derive the significance of the events of the past, they would be less likely to repeat or less likely to go to the same extremes. But most people do not have the ability to bear these things in mind. Some of them happened too long ago.

For example, 1929 was repeated in 2007-2008, but by definition you would have to have been born 100 years earlier to be able to make use of that lesson. Most people who were around in 2008 were not born in 1908.

Memory – and the resulting prudence – always comes out the loser when pitted against greed. There is very little man is more likely to believe than that which will make him rich if true. So the prevalence of greed, self-interest, and wishful thinking has great power to overcome memory and caution. As I said before, what the wise man does in the beginning, the fool does in the end. These trends are always taken to excess. The investors who are not aware of them always pay the price. — Howard Marks (source)