Your Money in 20
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Your Money in 20
Ep. 45: Bubble Trouble: The Psychology Behind Market Mania
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In this episode, Vic Colella, CFP®, CDFA®, and Courtney Cubin, CFP®, take a look at market bubbles and why they continue to capture investors’ attention. We revisit some memorable examples throughout history, from tulip mania and the dot-com era to the housing market, meme stocks, and crypto, and explore the behaviors and emotions that tend to show up along the way. We also discuss the questions surrounding artificial intelligence today and share how a thoughtful, diversified investment plan can help investors stay disciplined through changing markets.
If you have suggestions for episode topics or would like to give us feedback, we would love to hear from you! Please email us at podcast@woodwardadvisors.com.
Hello, everyone, and welcome to another episode of Your Money and Twenty, a podcast by your friends here at Woodward Financial Advisors. It's a special day in the studio today. We have a new podcast expert, Courtney Cubin, certified financial planner and wealth advisor here at Woodward Financial Advisors. Hi, Courtney. Welcome.
SPEAKER_00Hi, thanks for having me.
SPEAKER_01So, Courtney, I've been trying to get her to come in and record one of these with me for a while. And uh she came in with a bang. She's got a great topic that she chose for us today, and I'm really excited to talk about it. And it's about bubbles. So, in my household, bubbles, when we're talking about bubbles, it means very different things because I have a three and a one-year-old. We are talking about financial market bubbles. And that is uh good perspective because it seems like every other day in the headlines, someone is asking, are we in a bubble? Uh mostly we're talking about artificial intelligence-related bubbles these days, but we'll come back to that later. Um, so before we get started, I'm gonna talk, give our give our normal disclaimer, uh, which is that we're gonna be talking a lot about investments today, maybe some tax or legal related matters. None of this is meant to be advice for your specific situation. If you need tax advice, go to your tax professional. If you need legal advice, talk to your attorney. And of course, if you need investment advice, talk to your investment advisor. And if you don't have one, uh give us a call at Woodward Financial Advisors. So Courtney, uh, imagine this you just paid the price of an entire house for a flower bulb. This actually happened. So in 1637, one particularly expensive tulip bulb reportedly sold for 5,000 gilders, which was the going price of a nice house in the Netherlands at that time. That seems ridiculous when you say it out loud. It's crazy. Uh, especially in the triangle here where uh houses are not cheap and tulips are. Uh so today we're gonna talk about bubbles. So we're gonna go through a little bit of a history lesson, uh, talking about some bubbles throughout history, uh, and then we're gonna talk about maybe some biases and and and useful tips to help you think about a headline when you see it come up, asking, Are we in a bubble today? Um so Courtney, why does this keep happening? Not that we're currently in a bubble, by the way. Uh, that's not what we're saying here, but why do bubbles happen in markets?
SPEAKER_00Yeah, it's a hot topic right now. Um, but we're gonna dive into the psychology behind it. So while the markets and the technology are the topic that these bubbles are talking about, it changes over time, the human psychology doesn't change. So the same emotions are always present when we're talking about a bubble and how people are reacting, and that's fear, greed, envy, excitement, or regret. So, Vic, I don't know if you know what FOMO is. Are you familiar with FOMO? It's what the cool kids are saying.
SPEAKER_01I've heard of it. Yep, I've heard of it.
SPEAKER_00It stands for the fear of missing out. So here at Woodward, we don't see FOMO as an investment strategy, it's more of an emotional response. So when everyone around you seems to be getting rich, you may have this FOMO or fear of missing out, of getting rich with them, but staying disciplined suddenly feels wrong and feels very hard to do.
SPEAKER_01Yeah. And as investment advisors, we're not immune from this, right? I mean, those basic, I'm not sure about you. I'm never fearful, greedy, envious. I mean, they're there's such basic human things that even folks steeped in it like we are, as advisors, we just have to put systems around it so that we don't fall susceptible and we don't allow our clients to. But um, why don't we start with a history lesson? So, Courtney, take us through a few bubbles. I think we're gonna start with the tulips that that we opened with.
SPEAKER_00Yeah, so you mentioned this already, but in the 1630s, rare tulips became a luxury status symbol. So, as Vic said, prices surged dramatically in the late nine 1637. One documented bulb sold for 5,000 gilders, which was roughly the price of a nice house. Um, so these tulips increased 12 fold over a very short period of time. The issue here, which is what caused the bubble, is people weren't necessarily thinking that the tulip bulb was worth this much money, but they were thinking that if they could buy it for 3,000 gilders, that means someone else would be willing to pay 5,000 gilders for it and they'd be able to make a profit. So people were no longer investing based on what something is worth. They were investing based on what they thought the next person would pay. And you don't have to go all the way back to the 1600s to find that mentality again.
SPEAKER_01Yeah, and I was gonna say, I'm guessing that's a theme. I mean, that is such a common trait with these bubbles is that there is this disconnect where the thing that you're actually buying is no longer the thing that you're actually buying.
SPEAKER_00Exactly.
SPEAKER_01Cause who because who would buy a tulip bulb for anything more than a few dollars, right? And that's it just seems so obvious, but they were not buying the thing itself. They were buying the belief that it's just gonna go up in price and I'm gonna make a killing without having to do any work. Um, so that that's consistent.
SPEAKER_00Yeah. So it might seem silly about tulip bulbs, um, and so far back in the 1600s, but going to a more recent example in the late 1990s, as many people are familiar with, the dot-com bubble. So during the dot-com bubble, the Nasdaq peaked at around 5,132 in March of 2000 and then fell roughly 78% between then and October 2002 to a low of about 1,100.
SPEAKER_01Ouch.
SPEAKER_00Yeah. So the internet at this time was new and revolutionary, but people were assuming that every internet company would become Amazon, which was the big, the big the ticket item at the time. So many companies had no profit, no business models, and these sky high valuations. And so while technology did change the world and how people thought about the world and the investment world in general, most investors still lost money because they overpaid.
SPEAKER_01Yeah. And an interesting twist. I mean, everyone understood what a tulip bulb was in the 1630s. Pretty black and white. Yeah. It's what a tulip, yeah, it's what a tulip grows grows from. But something that seems somewhat unique to technological bubbles, but not unique to bubbles. They didn't understand the underlying technology. So they're buying a thing that they didn't understand. With tulip bulbs, they were they didn't understand why the price was going up. They just knew that it was. But they understood the underlying thing itself. Maybe that makes it worse because the underlying thing obviously didn't have any cash flows. Tulips weren't, you know, an ongoing business that generated cash. Uh, so maybe it's worse that they did know that tulips were were not valuable. With the dot-com bubble, it made it because it was so mysterious to so many people, it's like it wasn't hard to believe that they were made of gold because it was this new special thing.
SPEAKER_00And people that saw Amazon go off and go so high so quickly, you get that FOMO again. So you're you're realizing, like, ooh, someone here got this great investment, but you're not taking to account all of the the duds that came out of that time, too.
SPEAKER_01Yeah, yeah. Nobody talks about their failures quite as much as they talk about their successes. That's another human thing.
SPEAKER_00And one thing you can pull from that is that a great company isn't always a great investment if you're paying too much for it. Same with the tulip bulbs. So tulip bulbs are great, they're beautiful, but if you're paying too much for it, it's not worth it.
SPEAKER_01Yep. Okay, what's next?
SPEAKER_00Um, now we'll go into the housing bubble of 2008. So US house prices rose 64% in the four years leading up to their 2006 peak, and then they fell roughly 30% over the following four years. So people thought during this time housing prices never go down. And that's another version. What we hear a lot here at Woodward is this time is different. This bubble is different, this investment's different. We hear that all the time. Um, but the Fed's historical data shows that housing prices rose about 11% annually from 2000 to 2005, but then fell at about a 10% annual rate from mid-2006 through 2008.
SPEAKER_01Yeah, and that's national averages too. I mean, in localized areas, these numbers were so much more dramatic, even. Um and again, you had driving. If if you haven't watched the big short, if you're interested in this sort of thing and you haven't watched the big short, it is a masterclass on bubbles. Um, because one thing that again is characteristic of bubbles is that there are very few dissenting voices. In the in the movie The Big Short, there was one hedge fund manager who everybody thought was crazy. And he was eventually right. It is obviously we we know how that whole thing turned out, but um the unanimous voice of of course prices always go up. Of course, this is the way that it will always be. Um yeah, it it was it was unanimous. It it was the same in the dot-com bubble. I wasn't around for the tulip one, but you know, I'm guessing it was the same then where I was like, yeah, of course, tulips are gonna continue to go crazy.
SPEAKER_00Right. And as things continue to happen, um, human psychology tends to confuse a trend with a rule. So you may see, oh, housing prices never go down. So you make that rule in your head that housing prices are always gonna go up and then they don't.
SPEAKER_01And and in in that world, you can justify taking on massive amounts of debt and leverage, which didn't work out for a lot of folks, a lot of foreclosures, and that's what ultimately made the house of cards come come down. Um, is there one more recent than the housing bubble?
SPEAKER_00There is. We've combined these next two, but they happened around similar timing and had some similar characteristics. But GameStop. So these meme stocks that kind of blew up during 2020, 2021, and crypto. So GameStop closed at $20 on January 12th, 2021, and then it closed at $350 on January 27th. So then it hit a next day intraday high of $483. So that's more than a 1,600% increase in just over two weeks.
SPEAKER_01Yeah, and and if anyone knows what GameStop actually is, it was a brick and mortar place where you went and bought video games.
SPEAKER_00Like Blockbuster for video games.
SPEAKER_01And and this one has such a unique uh modern internet social media twist. Yes. Is it was someone on Reddit, or it was like a Reddit thread that was intentionally, almost sarcastically building up the price of this thing, and it worked. Yeah, yeah, it would be insane.
SPEAKER_00Exactly, was amplifying this feeling of FOMO, talking about how great it was, how everyone needed to get in. So then people start listening to the larger voice that they hear. So many investors weren't evaluating the businesses, they were just trying to find the next person that was willing to pay more, very similar to the tulips. People knew that these tulips weren't worth $3,000 or 3,000 guilders at the time, but they were hoping someone would be willing to pay more. So similarly, Bitcoin went from under $20,000 in late 2017 to roughly $69,000 in November of 2021. So right around the same time as these meme stocks, and then lost more than half of its value afterwards.
SPEAKER_01Bitcoin is a great example of an equivalent to, I think, the dot com. Because if you asked somebody to explain blockchain or crypto to you even today, you'd be lucky to ask 15 people and find one who could explain it. That was especially true back in in the heat of the early, the early crypto sort of explosion. And they didn't understand the underlying assets, it didn't have cash flows almost like gold and silver, where what you're buying is what you think people are gonna buy or sell it for next. And uh dot-com bubble was similar. Folks didn't really know what the internet was in many ways, yet they were buying stocks that were built upon it. So um very similar. Any other examples we want to go through, or should we move on to the next bit?
SPEAKER_00Yeah, let's move on to the next bit. So we talked about a few of these biases, but just to put a title on them and to explain them a little bit better, some of the ones we talked about were herd mentality. So this is if everyone's doing it, I'm gonna do it. Um, so our brains assume that it must be safe if everyone else is doing it.
SPEAKER_01I love investment biases because I'm also sort of a nerd about like early early human history, like Homo sapien sort of origin stuff. And it's so easy to tie these biases back to those days where we were hunter-gatherer bands. Of course, inclusion in the group is your greatest survival mechanism. So that wiring is really deep inside our brains. And unfortunately, in this world where that translates to financial decisions that could be massively damaging, um, the herd mentality is just such an obvious one where it's like if you were excommunicated from the group, it means you got eaten by a lion, Courtney. I have to buy this crypto stock, or I'm gonna get eaten by a lion, is what your brain is saying.
SPEAKER_00Right.
SPEAKER_01Which is obviously ridiculous, but it's there.
SPEAKER_00It's the emotion behind it.
SPEAKER_01Yeah, it's in there. All right, what else?
SPEAKER_00Then there's recency bias. So this would be if we expect recent performance to continue. So something doubled last year, we assume it'll double again, similar to the housing bubble. Housing prices keep going up. In recent years, they had been going up. So everyone just assumed that was how it was going to continue to go.
SPEAKER_01Yeah, and and not looking backwards at long enough time period, because recency bias, if you if you extended your timeline far enough into the past, you start picking up at least three of the bubble examples. If you look back 30 years, there were three massive bubbles in the last 30 years. But if you don't look far enough back, you're not picking up that data. So it's like sort of short-term focus as well. What else?
SPEAKER_00Our last one is the fear of regret. So this is very similar to FOMO, but people don't necessarily want to get rich. They don't want to feel left out or behind. So this ties back into herd mentality, wanting to stay with the herd, but also having this deep-seated fear of regretting not investing in something or having this fear of missing out on it.
SPEAKER_01Yeah, it's almost like another take on loss aversion, where as human beings, we're wired more to avoid losses than to pursue gains, and being left out is sort of a loss in a way. So the two work pretty well together. Yeah. Um, so I'm gonna tie these back to today, just for a second. So there's a lot of people talking about whether artificial intelligence is a is a bubble. So again, this is a transformative technology. We're already seeing its impact on our daily lives, in our businesses, helping make businesses run more efficiently, uh, perhaps folks losing their jobs, massively important. But the question of whether it's a bubble is whether the value of the companies and technologies is overblown. Whether it's got some of this froth or this, like uh everyone thinks it's always gonna go up. I'll tell you one thing. If you watch the big short, you'll realize that there was no one asking if it was a bubble except for one guy, and everybody thought he was crazy. The more articles you see about whether this is a bubble, the less likely it is a bubble. It's a bubble. Because when you talk about market prices, this is a deeply held belief of ours based on years and years of academic research, is that market prices reflect the balance of everyone's expectation of the future. If there are enough people thinking, well, maybe this is a bubble, then that is bringing the price back to earth. And there are enough folks asking that question right now that we have reasons to doubt that it's at least a bubble in the sense of some of these other ones. Doesn't mean prices though go up too far and then come back. That's why the daily up and down roller coaster of markets is what it is. But um we don't it's a transformative technology. We know that it we have we've been around it enough to know it's gonna make a huge difference in the way our society and businesses operate, and it's probably gonna make these companies more profitable, but it's too early to know how it's all gonna show.
SPEAKER_00There's still a lot that we don't know, similar to the dot-com bubble, is we don't know what could happen.
SPEAKER_01Yeah. All right, so with all that said, and by the way, that's not a prediction, it's just an observation. When you look at history, you'll see that the dissenting voices, when they get quiet, that's when you should be concerned. Um, so what do we do? What do we do with this from an investment standpoint? So, how do we avoid uh FOMO in this investment sense? Um Yeah, how do we avoid it?
SPEAKER_00Yeah, a good question to ask yourself is if no one else was talking about the investment, would you still want to own it? So this helps get rid of some of that FOMO. So if it if GameStop wasn't being talked about on social media and Reddit, would you still want to own GameStop? Probably not.
SPEAKER_01I think you'd say that's a ridiculous idea. Um, yeah.
SPEAKER_00And then having an investment policy. So this is something that here at Woodward we incorporate with all of our clients. We have an investment policy statement, and that helps us stay disciplined. So knowing your allocation, your long-term goals, and your timeline helps eliminate any of that emotion creeping in and making emotional investment decisions, which can hurt you in the long run.
SPEAKER_01Yeah. The way to avoid falling susceptible to the long list of biases that we all are subject to when it comes to investing, you have to take the research, interpret it and say, what systems can I put in place that take my hunter-gatherer biases and make it impossible for me to do the thing that my heart and soul want to do deep down. Um, and that's what we do for our clients too.
SPEAKER_00And then the last one is to diversify. So the future is uncertain. You don't have to guess the next winner, the next Amazon, but you own many companies. That way you're covering a lot of that diversification risk is something we talk about a lot. So making sure you own all the sectors of the market and have your eggs in all of the baskets so that if there is a market downturn or there is a bubble, you're not all of your life savings isn't in crypto or Bitcoin.
SPEAKER_01Well, and just to double-click on that for a second, I think I could say pretty confidently that artificial intelligence, to use today's example, it is gonna transform the way the businesses operate in a way that helps them be more profitable and all these things. I don't know if any one company is gonna be a winner or loser, which is what you said. But it is possible today to buy the whole market. So you're not casting your lot and saying, I think NVIDIA is gonna be the winner again, or I think you know, some other company will. So that's a really that's probably the big one. And I'll say one last thing is if you own one of these stocks and you've won the lottery already, it can be really hard to let go. You've won. It's changed your life forever if you're you know holding NVIDIA stock today, for example. We are talking clients every day out of selling those things, and we it is we have the same strength of conviction, even though it's maybe gone up a hundred percent every year for the last three years or or even more in NVIDIA's case. Um, it's time. It's time to take, you know, you're now not diversified anymore. So diversification is the core. Um yes.
SPEAKER_00So our biggest offense against FOMO isn't predicting the next bubble, it's having a plan. So before a bubble gets exciting and those other human emotions creep in, you have a plan that you're willing to stick to.
SPEAKER_01Well, I can't think of a better way to close it. Courtney, this has been really fun. Yes. Uh to talk. I got to talk about caveman stuff, which is always my favorite. Um, but yeah, thank you so much. Courtney, it's great to have you. I hope this was helpful for for you all as you see your next headline about bubbles. Thanks. Thank you for listening to another episode of Your Money in Twenty, the podcast by your friends here at Woodward Financial Advisors. We hope you enjoyed it. Now, if you'd like to continue the conversation, you could find us on the web at WoodwardAdvisors.com and as a firm on both Facebook and LinkedIn. There's a link to those pages at the bottom of our website. You can also find us all as individuals on both Twitter and LinkedIn. Now we love receiving listeners suggested topics. So if you have a topic you'd like to hear more about, please hit the Let's Talk link at the top of our website and submit a message with podcasts in the subject line. Thanks again for listening and talk to you next time.