What This Year's Holiday Party Can Teach You About Market Bubbles
Thursday, November 13, 2008 | Dylan JovineGOSH, I LOVE A GOOD PARTY.
In my 20s I used to live for them. Every Thursday, Friday and Saturday night my friends and I would go club hopping in the City just looking to capture that moment. The one moment that defined all great parties for me:The exact moment in time when the right girl, the right drink and the right song come together not just for you - but for the entire room. The crowd goes wild.
The lifelong study of the psychology of crowds has been a large part of my professional career as an investor. I've always been fascinated by the "ingredients" it takes to affect the way a group of people in a certain setting perceive events.
What I've discovered is that the three key "ingredients" for a great party in my 20s - the Disc Jockey, alcohol and social acceptance - are the same that have been used to create bubbles in all financial markets throughout history.
The only difference is that in a market bubble people don't have to be in the same room together physically to have their perceptions manipulated. They just have to be in the same room together mentally.
Here's how it works:
Perception Altering Ingredient #1: The Disc Jockey. The "Disc Jockey" of the 1929 crash was the mass media at the time: radio and newspapers. The "soundtrack" they were playing is the same one played through all bull markets in history: Get Rich Quick.
Now I'm not saying that it's the media's fault alone. Although many newspaper writers were literally on Wall Street's pump-and-dump payroll, the media tends to reflect the desires of the culture. Like any good DJ, the media plays the songs that people get up and dance to.
Indeed, one of the most popular songs of the year was "Blue Skies Are Here to Stay," a song that reflected America's belief that prosperity had become permanent.
My personal favorite hit that year was "I'm in the Market for You":
- I'll have to see my broker
Find out what he can do.
'Cause I'm in the market for you.
There won't be any joker,
With margin I'm all through.
'Cause I want you outright it's true.
You're going up, up ,up in my estimation.
I want a thousand shares of your caresses too.
We'll count the hugs and kisses,
When dividends are due,
'Cause I'm in the market for you.
(http://bss.sfsu.edu/tygiel/Hist427/427sound/Crashsound/inthemkt.wav)
Perception Altering Ingredient #2: Alcohol. The "alcohol" of all financial bubbles is, has always been and will always be easy money. Like alcohol, easy money is very intoxicating. The more of it you have, the better you feel. The better you feel, the more of it you want to get.
Richard Pryor once said that doing a line of cocaine made him feel like a new man. And the first thing that new man wanted to do was another line of cocaine.
I view easy money the same way. Since it's difficult to earn money under normal circumstances, when easy money starts coming into your wallet the very first thing you want to do is get more of it.
Just like alcohol, the more easy money you make, the more your perception becomes altered. Instead of stopping after you "get a good buzz," you begin to get that invincible feeling that you've got everything under control.
And like all Greek Tragedies, hubris is often a big killer.
Like "I work hard for the money I make - I deserve this new car." Or "We'll pay back the billion dollars we borrow from the bank to take this firm private before you know it." Or "Goldman Sachs (GS) isn't that special. If they could make a gazillion trading their own accounts so can we at Merrill Lynch (MER)."
And that ties in to...
Perception Altering Ingredient #3: Social Acceptance. In my 20s, it was the youthful, silly and completely normal goal of meeting the perfect girl for the perfect night. Looking back now, that form of social acceptance seems almost silly.
But how does it play out as we get older?
I would argue that the pressures of social acceptance are as intense for a 50-year old couple with 2 kids as they are for teenage girls. Much of how we perceive ourselves is based on how we think people perceive us.
And that's just human nature. It always feels good to drive a new expensive car in part because it conveys what in any society is a powerful message - the ability to acquire resources. And those who are best at acquiring resources are usually those who have the most power to determine the "pecking order" of their social group, whether it be in choosing "mates" or "friends."
The trap that most people fall into is that whether they know it or not they "compete" with those in their "peer group" whom they perceive to be most "successful" at acquiring resources. Not only do they compete with them but they actually determine their own worth by judging themselves in relation to them.
Teenage girls want to be skinny because Britney Spears is skinny. Men want to work out because Brad Pitt looks great with his shirt off. My wife and I want a bigger house because our son spends his afternoons playing at the Jones' house and they have a pool, etc.
And in an easy money environment, the competition becomes far more intense as many of our peers begin to acquire excess resources in a much more accelerated fashion than normal.
As with all financial bubbles, the greater the bubble, the easier cheap money becomes available. And the easier it is to get cheap money the faster it is for our peers to acquire resources. And the faster it is for our peers to acquire resources, the more intense the competition for resources becomes and so on.
We all fall victim to it in different ways. The key is to know when the ingredients are at play and to avoid the perception traps the accompany groupthink.
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Dylan Jovine
Chief Investment Officer
The Tycoon Report
