In this bonus episode, Matt and I continue our conversation about stock market bubbles and in particular behavioral economics. We discuss how the future investing models might change based on more studies of human behavior. Smarter people than the two of us will study and dissect the market in new ways based on human participants.
We also chat about different areas of the markets, different aspects of bubbles, and how various investment strategies can work.
Be sure to listen to the end where I reiterate why I pound the table on simple portfolio allocations!
[00:00:00] Matt: I think there's a lot we could discuss over time. About the separation between what we can measure in value and what component is coming from all kinds of weird psychological quirks. And, at some point someone who's a lot smarter than I am. Certainly, I don't know about you, but someone is going to come along and do a rigorous study of this.
Like how do you separate. Piece of this may be coming from which psychological quirk from loss, aversion, information, availability, bias, whatever, any of these behavioral economics things are that skew the pure kind of physics-based evaluation of how markets are supposed to operate. We'll have some tools to understand better this kind of bubble question, right?
Are we frothing right now? How much is froth? How much is real? And even if it is froth, it reminds me a little bit of, I'm going to spoiler alert for Harry Potter. People who have not finished the seventh book, it's the scene in Kings cross where Harry Potter is with Dumbledore and that the chapter ends with, of course, all of this is happening in your mind, but why on earth would that make it any less real?
Just because this is happening in investor's minds, for all kinds of crazy we're human reasons doesn't mean it's not real and it doesn't have a real market effect and that it can't persist and that you can't invest around it.
[00:01:51] Mike: Your Harry Potter is hilarious because did I ever tell you this story, man, I went to go watch the seventh movie in the movie theaters and no, I'd read all the books. Except I hadn't read the seventh book after the first, they came out in two parts for the seventh. I came out of the movie theater.
I was like I don't think I read the ending.
[00:02:11] Matt: That's particularly
[00:02:12] Mike: I thought I read them all.
[00:02:14] Matt: Because the books are really so much better than the movies and movies really do distort , in unpleasant
[00:02:22] Mike: yeah, then I had this quandary, Cause they came out in two parts, the seventh book. So do I wait and watch the sec, the second part of the movie or do I read the seventh book first? So bizarre. I couldn't believe I did that anyway.
[00:02:35] Matt: I could do a whole psychological stuff again, if I, if you and I had come along in economics at a time where we studied this stuff, I could do a whole evaluation to you. Like a value internal utility gain proposition of how do you evaluate the value of the book having already been spoiled, but not really by the movie.
[00:02:57] Mike: It's pretty interesting. I'd be curious. Of course people will be able to parse the information behaviorally as much as fundamentals, to understand oh, what's drives these part of it's like the Vicks. If you've heard of that, which is a measure of volatility. So it's a measure of volatility of the market.
And so that gets at this sort of exuberance or momentum. There's now another data point called the VIX and people start betting on the VIX, right? And so as you have these measurements, people start using them, it's a bet on or invest in, but I'd be curious too, because I don't know about parsing.
Parsing the market on behavioral data. It will be pretty interesting, but part of the issue with behavioral economics so far behavioral data and biases is that even knowing them, you still fall for them. And I still think we're in a young field in terms of trying to understand what it means on a variety of data points, not just the market.
[00:03:54] Matt: Right. It's not a prediction science and , it's interesting because there's a very subtle distinction that you were alluding to in our earlier discussion, you said with 100%. The market is going to go down well, that's statistically true. And there's a little nuance there hidden within that.
It could be, there's actually three versions of this one is the market could just go down for any number of cases. Reasons, just lots of different things in the mix. The market will go down a little bit. It could go down like the early it like circa 2000 stock market bubble. It could be, a come to Jesus moment where, companies start going bankrupt And, there is a fundamental reassessment of what is the value you have these kinds of companies, or you could have. More of a black Swan event. Like the market crashed after nine 11 and the market went way down after the pandemic started and then it came roaring back up. And I think that distinction actually matters a little bit because you can, you could use behavioral economics in theory to try to parse out. Are we in a bubble? And what circumstances are going to lead that bubble to pop, but you can't use those tools to say, when are we going to have a black Swan event? Because by definition it's not predictable.
[00:05:26] Mike: And, even back in 2000, we were just, that's a good point. That one around pain for earnings, right? Probably to earnings that people were willing to 99 and early 2000 to pay a lot for potential. And then those earnings weren't materializing. And so then suddenly people realized wait, maybe we were valuing these things all wrong.
And so that was the exuberance in that instance and that the oh 8 0 9 was very different in terms of the housing and who was participating in this one. Again, the participants in this market are very different. They're mostly retail. Investors, and that's interesting as well. And that gets a point.
I may like the access to the markets from having Robin hood apps and low cost, no cost trading and more participants that this rally is really being fueled by retail. And you could maybe say this time is different because they're not going to, get wiped out for X, Y, or Z reason, cause they're not a massive hedge fund where they're levered and, I don't think that's true.
I think it's still will, come down at some point investors for whatever reason will sour on particular parts of the market. And a little bit of, selling can go a long way quickly when you're levered up. I still think that's true, but who knows what it's going to be this time?
Because it's very different. I In 2004 you wouldn't have said, oh yeah, housing is going to be, is going to be the thing that like pops the next.
[00:06:48] Matt: That's a really interesting distinction. I hadn't thought about that at all because in the two thousands popping, the market, the black Swan event, whatever you want to call it. The distinction. There is interesting that was more fueled by banks and financial services firms that were essentially speculating in the housing and the subprime market.
And they were, creating these collateralized debt obligations and mezzanine CDOs, which were layers. It's all kinds of acronym soup. But the point is they were on the hook and that's what I think. Everyone rebelled against found revolting with the bailout was okay. The bailout worked, it paid back more than we put into it.
It was good idea. It was the right thing to do, but it was just like, you guys went out and treated wall street, like a casino, and now we're going to make sure that the rest of us don't get dragged down with you. That's a very interesting decision. So how does it matter? Kind of thinking about this bubble question, the difference between a wall street speculation, fueled bubble and a retail.
Hey, things are pretty good kind of bubble.
[00:07:58] Mike: Yeah. Remember too, the 2000, I think it was more of an institutional bubble where they were doing a lot of the investing in these eyeballs. And then it turns out that wasn't a great way of measuring the value of companies. So there, again, it was a different kind of rally who was participating I'll point to this.
I'm not sure to answer your question, but I will say this, which is interesting around stability and unstability then. There may be a component where we try to make the markets more stable. Okay. And we try to say, oh look, you have these rules of participation, so that things stay rather stable.
So whether it's the fed now is jumping in and making the markets stable, more stable by buying up certain assets and putting floors on interest rates and other things to try to make the markets more stable. That's exactly what happened in oh 8 0 9 with housing that's very stable.
We have all these rules around housing. The banks took that stability and made it unstable. So you have this relationship between. Once you create stability, we will push that. Humans will push that further and further back to being unstable. So the banks did it with the CDOs and the mezzanines and all this stuff and reselling certain things and making up new instruments to push things, to try to make as much money as possible and create creating unstability.
And are we in the same situation now? You could say, oh, you have a ton of retail investors and we've made access completely free, easy push of a button. And maybe that's going to lead to more, unstable markets because of that.
[00:09:32] Matt: on the other hand, I could own. Argue or let me, I'm turn into a question to you. This is really getting into some regulatory weeds that, I don't want to bore like ourselves or anyone who might be listening to this to tears. But look, we went through 2008 and then we did a number of things from
a reform standpoint to try to create circuit breakers in the system. And so there are some not literal. I don't want to say literal, I'm not into this new fangled Merriam Webster definition of literal word. Literal means figurative. No, I call shenanigans. What are really intended in a emotional sense, like circuit breakers in the market.
If the market can't fall more than a certain amount in a single day, you shut off trading, Right.
You give everyone a cooling off. So there's stuff like that. And then there's more subtle. There's banks need to keep more real assets on their books. They can't get so levered up, that kind of thing.
So I just wonder if. On the one hand, we're more subject to mass psychology effects in today's market where everything could go south. And we did see this recently in 2020, but on the other hand, we're a little less open to these institutional driven breakdowns because we have all these new mechanisms to throw sand in the
[00:10:53] Mike: yeah, look, I'm just saying, I'm not convinced that the stop gaps or what we're calling circuit breakers and other things to introduce stability are really going to do the job at the end of the day, because you could make an argue. That we, as humans will always find a way to make unstable, whatever situation we're in, we will push it to the limits.
And no matter what you've created to try to make a stable environment now we will never have another depression. We will never have another recession. We figured it out. I'm not in that camp. I'm not buying like, Hey, we figured it all out. This is never going to happen again. We've got stability.
I just think humans are ingenious enough to find ways to push the limits. And there's so many different parts of markets. Now. It doesn't have to be like the market, it could be, a country, it could be sectors. It could be, crypto or NFTs or whatever it is.
Crashing down for X number of reasons. But I just think humans will keep pushing the limit. And so there's a lot of unstability in any situation.
[00:11:53] Matt: It's interesting to me that the, our last conversation the tail end of it, you're like, look, I advise my clients to tweak things and like a five or 10% range, right? If you're 70% stocks, take it down to 65, but small moves here. And we come back to this over and over again, when we have these discussions.
Take a long-term view, take a deep breath. Maybe don't look at your statement from whatever financial services firm you're with. Just don't open the envelope, Chuck it for a while. And that seems like good long-term
[00:12:26] Mike: Well here's And here's why that advice is and you asked me, what do you think might happen with the behavioral aspect now in markets? And I think that volatility would be more than norm. And when you have big moves of 10, 20, 30% of stock market moves, that's when you have the opportunity to rebalance.
If you were 70% and it's suddenly dips to 60, you're buying on sale. And so that's why you only want to tweak your portfolio until such time. That it goes roaring up or roaring down, and then you get it back in balance. You buy when they're on sale and you sell when they're high
[00:13:01] Matt: Was a Warren buffet, take risks when people are fearful or, and be fearful when others. Taking, whatever it is. I just wonder, about that flip side of the coin that we very briefly touched on at the end of the last conversation. Your business is to give people sound financial planning advice, and that's what you do.
Take the long-term view, throw out the statement kind of thing, but there is a segment out there and we've talked about it in previous discussions. There's a segment of the investing world out there that says, look, I want to do a little bit of speculating. And you said in our previous show on this are you investing?
Are you speculating? What are you doing? It's okay. If you have the money, it's free country. Do what you want. And so it does suggest to me this question of If you have some funds to speculate with, can you take advantage? Are there ways that we could think about. Having a better eye on here's some exuberance.
I see a bubble forming. I mean, Look, you remember the movie trading places and you remember when Dan Akroyd and Eddie Murphy are starting their big thing on the commodities market. They're going to corner the market on frozen concentrated orange juice. And then the scene cuts. There are these two old white dudes who are like, have been on the floor trading since the Dawn of time.
, oh no, it's it's duke and duke. Looks like they're trying to corner the market on frozen concentrate, orange juice. Let's get in on it. Is it possible for our listeners and your clients to like, be those two old white guys and to say, Hey, there's a bubble forming here.
Let's get in on it. Or is it just like subject to the same risk as any old bubble?
[00:14:33] Mike: Yes.
[00:14:36] Matt: Right.
[00:14:36] Mike: two yeses on that one, you can jump in and do this, and it's called momentum trading. And so you see oh yeah,
[00:14:43] Matt: Oh, there's a name for this
[00:14:44] Mike: oh yeah.
[00:14:45] Matt: Oh,
[00:14:46] Mike: hold on a second. Did you just think you invented this.
[00:14:49] Matt: I didn't think I invented something. I more thought that I had a bad idea that you might like, ratify, but the fact that this has a name that this.
bad idea has occurred to other people makes me feel great
[00:15:00] Mike: Yeah,
[00:15:00] Matt: not sure which maybe a little bit of both go on Momentum trading.
I love it.
[00:15:04] Mike: training. You see a stock starting to take off, the trading volumes getting more, starting to go in one direction up or down.
[00:15:11] Matt: Game. Stop.
[00:15:12] Mike: games, stop, and so you say, oh geez, people are starting to pile in and it's starting to go up. I'm going to jump. Okay, so you jump in.
So you have one problem, which is how do you jump back? When do you jump out? And so that's why I say yes, and yes, you can play the game. And so it's a momentum trading, and there's now robots. So speaking of robots, searching Reddit forums and parsing there's robots searching Twitter for how many times ticker symbols are mentioned.
So that gives you an idea of how popular they are, right? In terms of momentum. How many, how popular names and tickers, . You can imagine there's so much software running out there. Parsing Reddit, forums, Twitter, everything, to try to figure out exactly what you're saying, Matt. Okay. So that's who an individual investors are up against, right?
Understanding there's hedge funds that are, releasing software to measure these things, to try to figure out where the behavior. Is where the momentum is. Oh, it looks like AMC is really getting talked about more, maybe we should jump into that. So there's a lot of things that are going up against you as an individual investor, just trying to keep an eye on this stuff and then jumping in and out.
So that's why you get a yes. And yes, you can get involved in it and hopefully do well. But you have the same issues of when do you buy and when do you. And so the same with the total stock market here, we are talking about the total stock market. Hey, is now a time to sell? I don't really, I don't recommend selling because it could go up from here for two more years.
So you can't sell, if it's in your 401k and this is your retirement, I'm not going to tell you to do that. So you have the same issues, even when you're talking about, individual companies.
[00:16:46] Matt: Speaking of movies that reminds me of the end of war games, the only winning strategy is not to play. Because over time, you know, it strikes me like
[00:16:54] Mike: No one applied. Actually, I want to pause on that back. Cause I love that the winning strategy is not to play. And that's exactly what we recommend, in your 401k is your retirement, your overall portfolio, just put it into a massively diversified target date fund and don't play
[00:17:08] Matt: Yeah. Exactly. Throw away the statement. Really big impart because of your influence. That's what I do. I just, I'm in a diversified target date fund and I don't play, although I will say for people who do want to play one, I'll pose this as a hypothesis to you.
It sounds to me like the theme here is bubbles. And you could think of it as like a big bubble. We're all living under the dome, right? Like the Simpsons movie, we're all, I'm sure we're talking movies that were all under the dome. But there's another way to think about it, which is more like your kids bubble bath.
There are lots of. And they're going on every day, all the time. And if you want to do a little bit of momentum investing my guests is that one of the fundamental tenants of market economics is you assume. Perfect information symmetry. You assume that anything, is available to everyone else.
We're all acting with perfect information and that's in the real world, never the case. What really happens is there are time lags. I find out about something a little after you, or, I just never know about something. And so there are probably short-term. Little frothy bubbles. And it's probably a lot easier to try to ride those because I'm assuming that in the long run across the whole market, over a matter of days, like these big institutional investors are going to grind all of those asymmetries out and they're going to just roll across everything.
And that's the market is then going to recalibrate to that information.
[00:18:38] Mike: That's why there are so many different investing strategies. Why do you think there's so many different funds and hedge funds and strategies around investing because they all work and they all don't. And so you can play in the little tiny bubbles. You can play in the big bubbles. You can play on momentum, you can play in value, you can play.
And here's an idea that our a mutual friend came across using glass door, investing in the best rated companies, people that the employees who love their companies. And that strategy has done very well over the last three years. So you can come up with strategies and that's what these there's little books of investing.
They're called the little book of investing by multiple authors.
[00:19:17] Matt: Yeah, Malraux one of those. Little red
[00:19:20] Mike: they are all about different little strategies and they've worked tremendously well. And so you can play in any of these strategies, but all of them have pros and cons. And I will say this, all of them take a dedication to that strategy over multiple years.
You can't just jump in. The worst thing you can do is to jump from strategy the strategy year to year, that will not work. And
[00:19:44] Matt: Because your advantage.
[00:19:45] Mike: of that.
[00:19:45] Matt: Your advantages is having to dominate a niche basically rather than trying to beat the whole
[00:19:51] Mike: And every strategy will have cycles as well. And that's why you've got to stick with it is because you're going to have down cycles and you're going to get, knocked out now. And then so if you do have a strategy and you're going to follow it, I just recommend, okay. Make sure you follow it for 5, 10, 20 years and cross fingers that you know, it's gonna work out.
[00:20:07] Matt: Great note to end on. All right, here we go. For our radio listeners, Mike Morton financial advice on WK Excel on beyond politics on all of our podcasts. Check us out, subscribe like us, all that stuff. Thanks again.
[00:20:19] Mike: Thanks for joining us on financial planning for entrepreneurs. If you like, what you heard, please subscribe to and rate the podcast on Apple iTunes, Google play Spotify, or wherever you get your podcasts. You can connect with me on linkedin or mortonfinancialadvice.com. I'd love to get your feedback. If you have a comment or question, please email me at . Until next time thanks for tuning in