Irrational Investing

“It’s different this time.”

“If this isn’t a sure thing, I don’t know what is.”

“I don’t see any reason this would stop anytime soon.”

“This many investors can’t be all wrong.”

Those are just a few of the things investors have been heard saying during all of the recent investment bubbles.

Remember the dot-com bubble? Internet companies were the wave of the future. The investor appetite for dot-com IPO’s was insatiable.

Remember the mortgage-backed securities craze that triggered the 2008 Financial Crisis? Investors couldn’t get enough of them. Banks couldn’t originate subprime loans fast enough so Wall Street could issue securities backed by them.

One simple word popped both the dot-com and subprime bubble.

FUNDAMENTALS!

When experts who saw beyond the market hype started questioning the underlying economic fundamentals of both bubbles, it was the beginning of the end.

The lack of profits with the dot-coms and the high rates of default on subprime loans belied the market appetite and when word got out about the underlying weaknesses, it was over. The bubbles popped, taking trillions in paper wealth and retirement plans with them.

ir·ra·tion·al

/i(r)ˈraSH(ə)nəl/

adjective

  • not logical or reasonable.

Hindsight is 20/20 and in hindsight, the feeding frenzy behind the dot-com and mortgage-backed securities bubbles was irrational. There was no logic behind investors snapping up unprofitable dot-coms and securities backed by delinquent loans.

In basic economics, the price of a commodity rises and falls with supply and demand – backed by market fundamentals.

For example, in a drought, water becomes more valuable – pushing up its price. Notoriously volatile gold is backed by basic economic fundamentals. It’s a tangible asset that has been valued from the beginning of time because of its aesthetic properties and scarcity.

When inflation fears creep in, investors often turn to tangible assets as a substitute for currency because tangible assets like gold and real estate can be used for bartering. There are rational reasons for the pricing of tangible assets.

You would think that investors would learn their lessons about bubbles from past bubbles but that’s never the case. This may have to do with a concept known as a generational conceit – where every generation believes it’s unique and knows more than previous generations. 

Speaking of bubbles, there are two simultaneous bubbles brewing right now that can be explained by generational conceit and it’s the Millennial generation fueling both bubbles:

  • One in the stock market.
  • One involving Bitcoin.

The Dow is currently trading near all-time highs – trading at nearly a P/E (price to earnings) ratio of 30 – nearly double its historic average. The feeding frenzy is fueled by Millennials who firmly believe this time it will be different. The experts who dig into the fundamentals are predicting a crash because there is no logic to the current irrational stock craze.

Bitcoin is also trading at all-time highs at $37,800 per Bitcoin. In just one year, it has climbed more than 360%. It is currently trading at more than $17,000 per coin since its high of nearly $20,000 in December 2017 before crashing to near $3,000 in March 2018.

Is there any logic behind the recent meteoric rise of Bitcoin? Have the world currencies collapsed – necessitating an alternative currency?

No. There’s no logic. Bitcoin is still intangible, it is still not backed by any government, and its security – despite being touted for it – is still sketchy.

So why are investors snapping up stocks and Bitcoin?

The same reason people were hoarding toilet paper in March when COVID hit – the fear of missing out. There was no logical reason for stockpiling toilet paper. Paper companies assured everyone there would be enough production. This didn’t stop people from hoarding.

Investors are likewise being driven by an irrational fear of missing out on stocks and Bitcoin and it’s the latecomers that are going to suffer when the bubble bursts.

How can you as an investor avoid getting sucked into irrational investing?

  • Don’t ignore the underlying fundamentals.
  • Don’t be afraid to ask the hard questions.
  • Look at profits and losses.
  • Look at intrinsic value and rational explanations for the price of an asset and ask yourself if those numbers make sense?

I don’t feel good about the underlying fundamentals of the stock market or Bitcoin right now. The economics don’t make sense. That’s why I’ll stick to tangible assets like real estate – assets that are shielded from irrational investing behavior.

Real estate is not liquid. The cost of entry and illiquidity are what shield real estate from mob behavior – behavior that can sink net worth and retirements. That’s why I’m drawn to real estate more than ever.

While the markets for stocks and Bitcoin go crazy, I find refuge in a tangible asset like real estate.

Get new posts by email: