Every bull market turns some investors into speculators. People happy with a slow and steady pace of making money get tired of watching other people lap them in a few short months.
It happens in every cycle. Little to do they know that easy money can be lost just as quickly as its made.
Edwin Lefevre, of Reminiscences of a Stock Operator fame, wrote a series for The Saturday Evening Post to kick off 1929. It was a warning that could have been written today.
The price at which a stock sells has never mattered much in bull markets. The unsheared optimist of 1928 blithely bought packages irrespective of contents. His hopes made the wrapper glitter until it looked like solid bullion. It is one of the common pieces of Wall Street experience that when the public goes stock mad and the market leaders are filled with the arrogance of prolonged success, such little things as high money rates or decreases in earnings or unraised dividends have no instant effect on the market — that is, on the state of mind of the speculating public. In the end, of course, all violations of the fundamental laws of economic or financial common sense are paid for; but every bull thinks he will unload before the break. Why shouldn’t he think so, when he has made up his mind to escape in time? That is why they all run past the signal.
The trading favorites in 1928 were high-priced, untried and unseasoned stocks that made one wonder whether the public did not think that the higher the price the better the stock.
Like all good warnings, Lefevre’s came early. He saw the signs of euphoria. The stock market filled the headlines. Everywhere he went people talked about stocks. They shared stories of huge paper profits, stock tips, and hope.
Most importantly, a fast-growing number of people had access to stocks that never did before. The telegraph, telephone, and radio, made brokers, stocks, and stock prices accessible to anyone.
Yet, it would be roughly nine months before everything came crashing down. And each day the bull market dragged on, people saw the warnings as more and more irrelevant. It’s hard to believe a warning when all prices do is go up.
So the money poured into tech stocks. It was radio stocks, like Western Wireless and RCA, in 1928 and 1929. Auto stocks too. They were multi-baggers in less than a year.
What drew people to those stocks? The price action, of course, and no baggage.
Happy is the man who has no past! The same seems to be true of corporations in a bull market. A concern about to enter into a new business has no records to handicap a bull trader in forming an estimate of what the company ought to do in five years…
Why would anyone want to own a company that struggled of late, when there’s an unblemished new company that could take over the world? Why should it matter that speculators expect to earn years of a company’s “unlimited growth potential” in a matter of months? When a new company has little or no history of revenue or earnings to base decisions against, anything’s possible. Right? It’ll just grow into its price — even if the likelihood is nil.
Stop me when any of this sounds familiar because it’s been playing out ever since, including today. The headlines, the ease of access, the rationale toward companies with no history of anything, and the hope.
And don’t forget the newly minted speculators, many with no baggage of their own. They have no experience, no history of investing to draw from, except for the last few years of a bull market. It means all their decisions are based on a sample size of none. Having never experienced the downside of a euphoric bull market, that lack of information gets overlooked. Not knowing what you don’t know can be disastrous.
A paradoxical thing also happens during the accent of a bull market. It messes with our heads. Investors and speculators alike often become more optimistic about risk. They become overconfident in their ability to earn high returns — even though a rising tide lifts all boats. In short, they forget about the downside.
Lefevre’s warning shows that bull markets can outlast common sense. This only adds to the optimism and to the chance of compounding mistakes.
All in all, speculation rarely works out the way people plan it. Many will stake their claim on timing it. A rare few will get lucky. The large majority will pay the price.
This post was originally published on July 29, 2020.
Running Past the Signal, Feb. 9, 1929
Bulls on America, Feb. 16, 1929
The Uncomfortable Truth
Ben Graham on the Risk of Bull Market Optimism
- Richard Thaler: Anybody Who’s Buying and Selling Stocks Thinks They’re Smart – The Market
- Marks Memo: Thinking About Macro (pdf) – Oaktree
- What Drives Bond Yields? – AQR
- When Valuation Matters – Compound Advisors
- The Stuff They Don’t Teach You in Books – Reformed Broker
- Addition by Subtraction – The Better Letter
- When 1 + 1 = 3 – More to That
- The Cognitive Bias Handbook – Curiosity Chronicle
- How Wheaties Became the “Breakfast of Champions” – Smithsonian