Irrational Exuberance: 25 Years Revisited
February 17, 2021
The Robin Hood of Sherwood Forest who most of us grew up reading about in Aesop’s Fables, was infamous for robbing the rich to provide for the poor and oppressed. Robinhood is also the name of a financial institution and trading platform founded in 2013 whose goal, according to its mission statement, is to “provide everyone with access to financial markets, not just the wealthy.” History can’t tell us for certain whether Robin Hood the folk hero existed outside the pages of books, but his character has been romanticized for centuries. History for Robinhood, the institution, has yet to be written. While the company has been an agent for change and investor advocacy in its early years, we have concerns about investor behavior that is being propagated based on its trading app.
Are we nearing a state of “irrational exuberance?” Even though Alan Greenspan is largely credited with the first public use of this term in December of 1996, three years before the bursting of the “Tech Bubble,” Yale Professor, Robert Shiller was reportedly the originator of the term which he defined: “Irrational exuberance is the psychological basis of a speculative bubble. I define a speculative bubble as a situation in which news of price increases spurs investor enthusiasm which spreads by psychological contagion from person to person, in a process amplifying stories that might justify the price increases, and bringing in a larger and larger class of investors who, despite doubts about the real value of an investment, are drawn to it partly by envy of others’ successes and partly through gamblers’ excitement.”
We may be witnessing the perfect Shiller Recipe for Irrational Exuberance: zero commission trading, a crowd rush created with message boards, social media, 24 hour news feeds, and fierce velocity of gains and losses stimulating the most basic instincts in the human brain, known as the amygdala’s fight or flight response. While every market rally and market crash may be slightly different, the human emotions leading to one or the other are basic and unchanged: fear and greed. Perhaps we could include fear of loss, greed in gain, and fear of missing out.
“FOMO,” fear of missing out is real. Even the most sophisticated investors can fall victim if the euphoria lasts long enough. In times like this, as in 2008, 1999, 1987, and throughout history, it is best to slow down your emotions and reactions rather than get caught up in the hysteria. From an investment perspective, one must review what is driving the asset price to increase or decline. Is there real value to the trading or is it another speculative bubble like the Dot Com bust of the 90’s, Florida Swamp Land of the 1920’s, Tulip Mania of the 16th Century, or the dozens of others in between? Most of these euphoric periods were the children’s game equivalent of Hot Potato. Players eventually get sent to the burn unit with third-degree pain.
If the investment is a publicly traded company, the analysis is pretty straight-forward: Are there assets, revenues and reasons to believe the company will grow? Is it a new technology that could change the world and if so, what might it be worth? Even with public companies, there can be fraud. Recall Enron? Enron was praised for innovations in the energy sector until it was uncovered that much of its financial success was fraudulently engineered. The stock price fell from $90.75 to $1 in one year.
If the investment is a commodity, the evaluation may be slightly more opaque but generally, it is an analysis of the three ingredients of economics: supply, demand, and price. Change one component and the other two adjust accordingly. Today we have an emerging category called “digital currency.” Prospects of this investment are heavily debated. The recent explosion in price is either an acknowledgement of the growth opportunity with this “currency” or one of the worst speculations we have seen in decades.
Regardless of market climate, the basic questions for our clients remain the same: (1) What are your financial goals? (2) What are the variables that we need to manage to help you reach your goals? (3) How much risk is necessary to achieve the investment returns required to attain your goals? (4) What is the timeline? If we can comfortably meet the plan objectives, do you want to explore some riskier investment ideas to potentially accelerate your timeline?
Personally, I am not a gambler. My partners, the team, my clients, my family and friends know that. I have never been interested in playing cards for money or pursuing games of chance where the odds of winning are less than 50%. That said, I relate investment speculation as a form of gambling. If you are playing with house money, perhaps taking some chances is okay. However, if you are losing your principal or compromising the overall integrity of your long-term financial plan with the thrill of short-term gains, you may want to step back and take a breath. Resist the amygdala fight or flight response and let the emotional control of the frontal lobe take over. Otherwise, that irrational exuberance could turn into financial despair before you realize what has happened.
Since the Middle Ages, historians have questioned if Robin Hood was a fictional character or living folk hero. I believe the same about some of the newer financial offerings we have seen over the last year; are they more fact or fiction? Time will tell. We suggest sticking to your plan, rest well, and live to achieve your hopes and dreams. Irrational exuberance is repeated and well documented over history. Keep your feet on the ground, walk/invest with measure and purpose, and understand that your plan is based on proven fundamentals rather than fairy tales or manic ideas.
W. Michael Smiley is a Managing Partner at TrinityPoint Wealth in our Charlotte, NC office. He can be reached at (704) 399-7010 or email email@example.com
Disclosure: This material is provided by TrinityPoint Wealth for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation of any particular security, strategy or investment product. Facts presented have been obtained from sources believed to be reliable, however, TrinityPoint Wealth cannot guarantee the accuracy or completeness of such information. TrinityPoint Wealth does not provide tax or legal advice.
© W. Michael Smiley, TrinityPoint Wealth Advisors, 2021