When the game stops, stop
In today's Exponential Investor...
- Round and round we go, until the music stops
- It's okay to dance, as long as you know when to sit down
- Why people always say things "ended in tears"
In a book I once read that was really good, Thinking, Fast and Slow, there was a fascinating study (one of many). Daniel Kahneman and Amos Tversky were the authors and the architects of this experiment.
A group of volunteers were asked to put their hands in a bucket of painfully cold water for one minute.
Another group was asked to put their hands in similarly cold water. But their buckets were slowly warmed by an extra degree, but they had to keep their hands in for an extra 30 seconds.
The reports given after each are fascinating.
Those whose hands were in the bucket for longer, but ended slightly warmer, reported much more positive feedback.
It wasn't the duration of the pain that people remembered. It was how it ended, and how it improved.
This is called the "peak-end bias".
You remember holidays so vividly because they are a "peak" of emotion, happiness and variety in your life.
Things which end well give better lasting impressions than things which are good for the most part, but end badly.
All's well that ends well.
More studies were done. Kahneman saw a similar result when he interviewed patients who had undergone a colonoscopy (nasty, painful, apparently).
Interviewees had colonoscopies that lasted from four to 69 minutes, but the duration of the procedure had no bearing on how they felt about it afterwards.
Instead, it was determined by the strength of their discomfort at its most intense, and the level of discomfort they felt at the end of the procedure (whether the inserted camera slid gently or was yanked out).
These studies support the idea of the peak-end rule.
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The duration is irrelevant.
Right, enough about colonoscopies! What's this got to do with anything?
Well, I wonder.
You know how people always say "it'll end in tears"?
Well, I was triggered the other day when I read someone (who had lost money in the green tech investment rush in the 2000s) saying that particular episode had "ended in tears".
This is classic.
People love to point at things which are going up quickly ($GME to the #moon) and say, "it's a bubble, it's gonna end in tears".
I wonder if the peak-end bias is playing a role here.
The great J.K. Galbraith, for example, laments "the extreme brevity of the financial memory".
It's often said that the next crisis starts when the last one has been forgotten.
But while bubbles bursting is a great way to lose all your money, they are also very rare opportunities to make shedloads of freaking money rather quickly.
Let's take the example of green energy.
Back when the cost of wind and solar was 15-50x higher in the 2000s, and the technology was pretty average, and adoption rates were very low, there was a spike in investment, venture capital, private equity, and then everyone lost a load of money.
In a moment of beautiful irony, a bunch of investors got burned by flying too close to solar.
That explains why all the Very Serious Investors have spent the last two years saying, "Watch out! Danger! Bubble!" and not made any money.
You all know why now is very different to 2008.
Exponentially better and cheaper technology has been met with greater urgency and a social, political and financial will which is unmatched in its power, unity and determination.
But to people who watched or suffered from the crash over a decade ago, they formed a lasting memory of how it ended.
Having lost a ton of money on solar stocks in the late 2000s, they can't bear the thought of it happening again.
No doubt they will be the last bears to capitulate this time round, and get in right at the top.
The memory of past experiences "ending in tears" has to be a reason why so many people simply shun the great moments of bull markets, often called bubbles.
They are once burned twice shy.
That's why I've heard tell that bullish funds will hire a bunch of newbies in the years following a crash. They actively want young employees unburned by the devastation of yesteryear. They want rampant bullishness, and a high risk-tolerance.
People who worked in investment through 2008 don't have that.
Musical Bears The word "bubble" has taken on very negative connotations. It's also a very subjective term.
But as in all walks of life, there are opportunities alongside the threats.
I am not supporting mindless bullishness during times like these – most certainly not.
(Just in case this is the first article of mine you've ever read, please, please go and read a few more so you don't get confused and go and buy up $TSLA calls and GameStop shares.)
To make my point, I'd like you to imagine a game of musical chairs.
Well, actually, imagine a busy bar or club, where everyone is dancing.
This is, in fact, a game of musical chairs, the people inside just don't know it yet.
There are a hundred people or more, and only a few dozen chairs.
No one has any idea that a game of musical chairs is afoot, and that the music may stop at any moment.
In this situation, it's okay to dance, but if you are dancing in the knowledge that you should be keeping an ear open, and sitting down as soon as the music stops, then you have a massive advantage over everyone else.
Because while they're screaming out for more, begging for an encore, for five more minutes, mum, you are reclining in an armchair, comfortable in the knowledge that you're going to make it to the next round of the game.
As investors, we must have that mindset. We must be musical bears.
There is a common analogy that as long as the music is playing, you have to stay invested. This goes back to something the CEO of (I think) Citibank said as the global financial crisis was reaching escape velocity.
He said, "When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing."
That was in July 2007, and is one of, like, a million reasons why people are still seeking revenge on Wall Street via short squeezes on meme stocks. (The effectiveness of this method is to be debated, but the presence of pitchforks is not.)
Anyway, here's a great meme which tells you why lots of uproar about GameStop's enormous surge taking it "way beyond fundamentals or fair value" is silly.
You can think of big investment banks' Tesla price targets like a game of musical chairs.
Every time the stock goes up, the bag is passed around the Wharf, and all the auto analysts put in a new, shiny, higher number.
If the stock goes up, their price target goes up. Everyone's just dancing away, either unaware or pretending that reality doesn't matter.
GameStop is just an extreme example of why the efficient market hypothesis is wrong.
Tesla is a bigger example.
And at some point, the music will stop and lots of people are going to look very silly.
Luckily, investment banks are full of people who can explain why they were right even when things went the other way.
And don't worry, they have a department for selling umbrellas after a rainstorm too.
All the best,
Kit Winder
Editor, Southbank Investment Research
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