In the 17th century, there was a speculative increase in the prices of tulips where a single tulip bulb was selling for more than the price of the horse that transported the tulips. The huge jump in price was a result of futures, a contract to buy tulip bulbs at the end of the season. The high spike in tulip prices attracted tons of buyers in hopes of gaining enormous returns. This tulip mania was the first recorded speculative bubble, and by no means the last. We’ve experienced it most recently with the dot-com boom in the late 90’s and with the housing bubble in 2007-2008. With these economic bubbles, it is important to understand that when an asset is exceptionally speculative and there is a lot of irrational exuberance, the returns, in the long run, are given up as prices plummet back down to Earth.
The psychology behind why people follow this massive run-up in price is due to the herd mentality. When people see the money others make, they join the herd because they want to create the same opportunity for themselves. The more the price increases, the more it will attract buyers from the herd. As demand continues to increase with a rise in buyers, the price keeps escalating as more people invest. Eventually, this process gets to a point where it is no longer sustainable. The same applies to economic downturns, where people sell when they lose money. This, in turn, spurs more and more people to start selling because of lowered prices and expectations. This concept is described as reflexivity and was made popular by George Soros, a famous investor who fought the herd mentality to profit $1 billion from a single trade in 1992. The up and down cycles are called either virtuous or vicious cycles since they are the crowd’s self-reinforcing positive or negative influence on prices. As evidenced by George Soros, one can make a lot of money by figuring out how to capitalize on the herd mentality when it is present.
At Fogel Capital, we avoid the herd mentality and focus on the fundamentals of business. Afterall, economic bubbles occur because prices deviate from the intrinsic value of the product or company. Back in 2008, asset prices were overinflated and we at Fogel Capital sensed irrational exuberance in the market. So, what did we do? We sold out of the market to avoid this herd mentality and then bought back the shares of high-quality companies in 2009 when they were selling for a fraction of their true value.
Fast-forward to 2017, and we continue to evaluate the market independently and pride ourselves on our ability to avoid the herd and rationally assess the market. Fogel Capital can help you overcome this common pitfall. If you would like to discuss this article further, feel free to call me at 772-266-3431 for a free consultation or email Michael@FogelCapital.com.