“There is something wonderful in seeing a wrong-headed majority assailed by truth.”
John Kenneth Galbraith
Every one of us is wrong-headed about something. Most of it doesn’t spill over into the public space. Sometimes though, there is a mental malaise that takes over society.
Charles MacKay, a young Scottish journalist wrote a book about it in 1841. It is still popular. You could get a free copy of the original at Gutenberg if you like. Printed copies can be found at Amazon and even bookstores.
What does “Extraordinary Popular Delusions and the Madness of Crowds” have to say?
The book deals with three manias. The Mississippi Scheme, the South Sea Bubble, and Tulipmania.
What do they share?
The usual suspects. All of the suspects are emotions. In the beginning greed is a motivator. People like the opportunity to make easy money, greed, and they especially like being in on the action early. Pride in their acumen I suppose. Later they may experience other emotions. A common one is fear of missing out. Maybe they could borrow some money and enlarge their position, Eventually the positions become illiquid and real fear sets in.
In the early going, it’s all good to be in, but what if you can’t get out? Entirely different emotion.
What about Apple or Amazon? You could have bought either in the 90s and made huge money. Neither was a sure thing. But! Amazon had a growing business with a proven model. Apple had Steve Jobs. There was evidence of potential, and you could find and add more. Mania’s are evidence-free spaces.
The pattern is always the same. The smart people think they have the right approach and the ones who doubt are fools.
Apparently not. Isaac Newton would likely be in the top 10 candidates for smartest person in any room. During the South Sea Bubble he was smart for a while. He invested in the South Sea Bubble, not called that at the time, and sold when he tripled his money. His profit was about $1 million in todays money. But the madness set in and later he bought back in at a much higher price. Some claim he lost all his money and some he had borrowed to invest. The evidence is unclear.
Intelligence is not a defense to emotion.
Can tulip bulbs be worth more than a house? Apparently yes, even though in retrospect it is easy to say they are not. Just like in the stock market there are two prices for a thing.
With the tulips, there came to be a wide gap between intrinsic value and market value. That happens everyday with something. You might recall the dot-com bubble, Bernie Madoff, Theranos, Worldcom, Bre-X, and Enron, to name a few. Once you are aware of the difference, you have a better chance of avoiding the madness of the crowd.
Earnings are more likely to provide value than a story about the future.
It’s hard to be objective. There is a starting place, though. Mark Twain had the useful idea. “Whenever you find yourself on the side of the majority, it is time to pause and reflect.”
Bubbles sell ideas that will pay off in future. The evidential connection is tentative at best. They fully rely on the market value idea of price. To be harsh, they rely on the idea of there being a bigger fool who will pay even more than you have paid.
Know that participation in a market price environment is speculation, not investing.
In principle, I find nothing wrong with speculating, go for it if you think you have better or newer information. Just don’t think of it as investing. Investing is evidence based, investing pays off over time, you can explain investing to children.
Be disciplined enough to restrict speculative investments to a small share of your portfolio.
If you can stay outside the crowd, there is a chance you can experience the joy of the crowd being “assailed by truth.” It won’t be easy, but truth is durable.
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