While writing out my notes on Why You Win or Lose, two stories stuck out that are worth sharing. The first one is a simple analogy using ice cream to show how investors drive market prices to irrational levels, then see it all come crashing down:
My friend, Willard Kiplinger, well-known savant of Washington, gave me an extemporaneous explanation of how fictitious stock values, forced up by greed, must collapse.
He and I and another friend were having dinner together when Kiplinger remarked: “I suppose the stock market is like this: Here I have a dish of ice cream that cost me ten cents. Robert, the waiter, comes in and says the ice cream is all gone and no more is to be had tonight. My ice cream suddenly seems more valuable to you and you offer me, say, twelve cents for it. Then Bill, who had intended to order ice cream, makes you an offer of thirteen cents. You, being Scotch, can’t resist taking a profit. Bill brags so much about the ice cream that I decide I was foolish to let it go in the first place and buy it back for fourteen cents. About that time I discover, to my dismay, that the ice cream has melted.”
The second story is about the irrational crowd behavior leading up to and following the Great Crash of 1929 (emphasis mine):
Before the Big Crash of October 1929 the public had ample warning that the big fellows were selling and the little fellows buying. Week after week, the published report of the Federal Reserve Banks indicated that brokers’ loans were going up, even though average stock prices were declining. In other words, the growth in loans could not be explained by greater value of stocks, for the price trend was downward. The figures could only indicate that the number of margin accounts — stocks held by brokers for customers, with loans against them — were increasing, while wiser folk, able to own their stocks outright, were selling. The only reason they could be selling was because, from their superior vantage point, they foresaw a decline and expected to repurchase their stocks at lower levels. Nobody could have asked for a better hint to step out of the market. The danger signal was adequate and unmistakable. But how many of us heeded it?
Surely Wall Street’s gigantic Hallowe’en festival provided an overwhelming variety of proof that most people are always wrong. Otherwise the vast majority would not have deliberately placed themselves in a situation where they could be compelled to dump good stocks at hysterically low prices for the benefit of the wiser few. No great feat of logical reasoning was needed to arrive at the conclusion that all these people had been wrong or imprudent even before the catastrophe occurred. When you note that a stock sold for $1 a share when the current quarterly earnings of that same stock are $1.50, you know that somebody has not behaved as a Napoleon of finance. Yet thousands of persons were almost equally foolish.
Wise men — wise, that is, so far as the stock market is concerned — had been selling their stocks at the very time that the general public was most eager to buy. Indeed, the readiness of the public to buy was what gave the cagey ones a beautiful opportunity to sell. One of the reasons for the stupendous size of the selling panic was probably this: When the first warning break came, early in October, the public, instead of selling, mistook the slightly lower prices for bargains and used cash reserves to buy still more stocks. Naturally this added to the burden of protecting their holdings as prices receded and the largest group sold — or were sold out — when most prices reached their exact bottom. As prices went lower, the volume and speed of sales increased! But how many people, aside from the Morgans and the Rockefellers, bought at these incredibly low prices? Bargains that you wouldn’t have believed if you hadn’t seen them were available all over the list, but none of us wanted them, even if we still had money left, because we reasoned: Stocks are in a violent downward trend; therefore, they’ll go still lower tomorrow! Whatever is will always continue!
I’m reminded of the remark of a famous speculator, who after making — and keeping — a big fortune in Wall Street, remarked: “I have done only what other people wanted me to. When they were determined to sell their stocks in a falling market at whatever prices they could get and clamored for buyers, I accommodated them by buying. When they were equally anxious to buy stocks at high prices, I agreeably permitted them to buy mine.”
Imagine being so afraid of stocks that you’re willing to dump your shares at prices well below a PE of 1, just to be rid of them. To be clear on the irrationality, stocks priced at $1 had a “current quarterly earnings of…$1.50.” That’s ignoring the 9 other months of earnings!
Of course, similar episodes (though, not nearly as egregious) have been repeated numerous times since. The 1950s expansion, the Go-Go ’60s and the Nifty-Fifty, the extended bull market ending in the Dot-com Bubble, the Housing Bubble, most recently the Crypto-Craze, and so many smaller bubbles in-between (did you know about the Bowling Bubble?) were all due to misbehavior on the way the up and on the way down.
It’s not that history repeats. It’s that behavior stays the same, so mistakes get repeated.
The key is, if you recognize the repetition of poor behavior early enough, you can stop being the opportunity and start seizing the opportunity.
- There Ain’t Gonna Be No Core – J. Zweig
- Haste Makes Waste – M. Housel
- The Worst Kind of Bear Market – A Wealth of Common Sense
- The Stock Market Crash of 1987 – The Fed
- High and Higher: The Money in Marijuana – Musings on Markets
- Why Our Beliefs Don’t Predict Much About the Economy – R. Shiller
- How the Many Sides to Every Story Shape Our Reality – Farnam Street
- Cognitive Biases: Loss Aversion – UX Collective
- Why Doctors Reject Tools That Make Their Jobs Easier – Scientific American
- Rise and Fall of a Chicago Icon: 132 Years of Sears – Chicago Tribune
- The Internet Apologizes…From the People Who Built It – NY Mag
- That Time an Astronaut Lost His Wedding Ring in Space – Wired