“When a mood of excitement pervades a market or surrounds an investment prospect, when there is a claim of unique opportunity based on special foresight, all sensible people should circle the wagons; it is time for caution.” – Galbraith
See if the following sounds familiar:
Contributing to and supporting this euphoria are two further factors little noted in our time or in past times. The first is extreme brevity of the financial memory. In consequence, financial disaster is quickly forgotten. In further consequence, when the same or closely similar circumstances occur again, sometimes in only a few years, they are hailed by a new, often youthful, and always supremely self-confident generation as a brilliantly innovative discovery in the financial and larger economic world. There can be few fields of human endeavor in which history counts so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.
The second factor contributing to speculative euphoria and programmed collapse is the specious association of money and intelligence. Mention of this is not a formula for eliciting reputable applause, but, alas, it must be accepted, for acceptance is also highly useful, a major protection against personal or institutional disaster.
You probably assume that this was written after the enormous technology bubble of the late 90s or maybe after the spectacular debt bubble a few years ago which triggered the financial crisis.
No, euphoria, bubbles, manias and irrational behavior are not reserved for this generation alone.
Those words were actually written by economist and author John Kenneth Galbraith in his book, A Short History of Financial Euphoria, which was published in 1993. This was even a few years before Alan Greenspan uttered the famous phrase, “irrational exuberance.”
This description begs the question about whether euphoria is starting to creep into the current environment.
Galbraith’s book did come to mind in the past few weeks when I began reading various accounts of Facebook’s $19 billion buyout of WhatsApp, a business I had never heard of before (you may have noticed the name of the company sounds like a play on an old Budweiser commercial).
WhatsApp happens to offer their text messaging service free of charge for one year.
Some mocked this deal but many in the technology sector rushed to the defense of Facebook claiming they were buying hundreds of millions of users even though they shelled out a hefty price for an unproven company with only 55 employees.
Vitaliy Katsenelson, writing for Institutional Investor, had my favorite take on the WhatsApp acquisition and how to think about euphoric behavior in general:
In fact, after a certain point, if the price you pay is high enough, insanity starts to be confused with genius. It is almost like a contemporary painting. If you stare at it long enough, you will start doubting yourself and your so-called rational mind. Perhaps you are a simpleton who has not attained the empyrean heights of the brilliant artist, who comprehended things that you — a mere mortal — did not even have grounds to suspect.
Facebook is up 160% over the past year and nearly 30% since December alone when it was added to the S&P 500. Tesla (+560%) and Netflix (+150%) have also been on a tear in the last 12 months along with most of the biotech stocks (see ITMN +230% & FURX +135%).
I don’t think the entire stock market has gone completely bonkers just yet but there are pockets like these that are showing some bubbly activity.
This doesn’t mean it can’t continue but eventually these price increases become unsustainable. Good luck predicting when that will happen.
In the short-term the worth of any business entity or investment is really how much the next person in the market is willing to pay for it.
Galbraith shared in his book that at the height of the Tulip Craze in Holland during the 1600s a single tulip bulb traded for the equivalent of nearly $50,000 in today’s dollars before the eventual collapse.
Some of these companies will fulfill their growth expectations just like the handful of companies that made it through the aftermath of the Internet bubble.
At this point I prefer being a consumer of these company’s products rather than an owner of their equity shares.
Many investors have been trying to make sense of these growth companies with old school fundamental analysis.
The problem with fundamentals is that valuation models can’t quantify human nature when a runaway train of investor sentiment takes hold of a stock. When an idea or narrative feeds the crowd it’s best to just get out of the way and not play in that arena without a solid exit strategy.
This bull market also has individual investors feeling better about their trading abilities, which is another sign of froth.
A recent WSJ article about small investors jumping back into day trading caught my attention:
“I love it,” said the Baton Rouge, La., resident. “You look over charts and come up with ideas for the next day. There’s really not a better feeling,” he said. He says he is considering quitting his job to trade full time.
Mr. Garretson isn’t alone. Average daily client trades at E*Trade Financial totaled about 160,000 in the fourth quarter of 2013, up 25% from a year earlier. At TD Ameritrade, clients made 414,000 trades a day on average in the quarter ended Dec. 31, up 24% from a year earlier. Charles Schwab Corp. customers made 488,000 trades a day on average, up 8%.
That’s not going to end well.
Galbraith finished his book with some poetic prose on what happens to those investors that let greed get the best of them when markets run too far too fast:
Fools, as it has long been said, are indeed separated, soon or eventually, from their money. So, alas, are those who, responding to a general mood of optimism, are captured by a sense of their own financial acumen. Thus it has been for centuries; thus in the long future it will also be.
As author Humphrey Neill once said, “Don’t confuse brains with a bull market.”
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