Are investors just herd animals?
Investors have to wrestle with lots of issues—economics, financial reporting, asset structure, valuation—but perhaps the most difficult factor they face is their own nature. People are naturally social creatures, something Aristotle noted 2500 years ago. We like to do what other people are doing. Going against the crowd can feel like standing up against a herd of charging buffalo.
But strategists have long seen the advantages of going against popular opinion. “Never follow the crowd,” Bernard Baruch says. Sir John Templeton put it this way: “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” We need to buy when most people are pessimistic and sell when they are optimistic.
The past 20 years have seen this borne out twice in the US: once during the internet boom and bust, and then again during the housing boom and bust. Lately there’s been a bubble in “bubble spotting”: looking for investments inflated by optimism and leverage, as investors try to avoid the fallout when they pop.
Portuguese Stock Exchange. Source: Bloomberg
But the very fact that people are looking for bubbles means bubbles are less likely to form. We may be social animals, but other investors are our competitors. Just because a stock has gone up a lot doesn’t mean it’s going to go right back down. From 1975 to 1990 the shares of Wal-Mart grew by over 100 times. But if you waited for that “bubble” to burst, you were disappointed. The stock grew another 10 times over the next ten years. And their fundamental value proposition – people buying essential goods at low prices – has allowed the share price to stay around that level since.
Wal Mart Shares. Source: Bloomberg
That’s why it’s so difficult to invest. You don’t want to miss out when someone is doing something especially innovative that provides value. But you also don’t want to just follow the herd – especially when its headed off a cliff.
Douglas R. Tengdin, CFA