It’s a strange time to be an investor.
Stock markets around the globe opened 2021 with a burst of optimism that the annus horribilis of 2020 is behind us.
Financial market conditions appear pristine.
Investors are piling into long-neglected asset classes like emerging markets and commodities with equal fervor.
Back in the real world, things are very different.
Pubs, restaurants and retail stores across the United Kingdom are shuttering their doors for good as an infectious “mutant” strain of COVID-19 has shut down the economy for a second time.
Schools across all of Europe are closed.
For a time, Japan seemed almost immune to the virus. But even there officials are now declaring a state of emergency for Greater Tokyo.
No matter where you look on the planet, lives are nowhere close to being normal.
I call this yawning gap between market sentiment and the real economy the “Great Disconnect.”
And it makes for one of the most challenging environments for investing I have ever seen.
Life in a Parallel Universe
So what explains the global financial markets’ relentless rally?
Conventional wisdom is that stock markets always look six months ahead.
And markets are betting that come June, cruise lines, air travel, casinos and hotels will all be back online.
Yet even this rosy (and probably accurate) view fails to explain the mania that gripped certain financial assets.
Investors have chucked conventional measures of valuation out the window.
Meanwhile, Wall Street’s long-established masters of the universe – products of a rational and rigorous approach to investing – are left scratching their heads.
Today, the world’s top business schools don’t teach financial history. That explains in part why, as the economist John Kenneth Galbraith observed, “The financial memory is very short.”
Yet, if you’ve read a book like Charles Kindleberger’s Manias, Panics and Crashes: A History of Financial Crises, you know that today’s booms in bitcoin, Tesla (Nasdaq: TSLA) and Zoom (Nasdaq: ZM) are just typical examples of speculative excess.
Whether it’s the South Sea Bubble of the 1720s… the railroad boom and bust of the 1840s… or the Roaring ’20s, financial manias share the same beginning, middle and end.
Only the names of the leading players and objects of speculation have changed.
Today Cathie Wood of ARK Investments and internet investment hero David Portnoy are the newly minted market mavens making a killing.
Wood can appear on CNBC and put a $15,000 “bullish” target price on Tesla stock by 2024, and no one calls her on the outlandishness of her prediction.
Yet, if Wood is right, Tesla will be worth $14.3 trillion in three years’ time – about the equivalent of China’s current GDP.
Meanwhile, back in the real world, you can’t even go out to dinner or see a movie.
The Deep-Rooted “Fear of Missing Out”
The psychology of financial manias is particularly nefarious.
That’s because there is an enormous psychological cost to NOT participating in a financial mania.
If you feel this way, you are hardly alone.
The most brilliant minds in history got caught up in it.
Sir Isaac Newton lost his fortune in the South Sea Bubble buying and selling shares at precisely the wrong time.
As Newton later reflected, “I can calculate the motion of heavenly bodies, but not the madness of people.”
History’s greatest economist, John Maynard Keynes, also emerged as a failed speculator from the Roaring ’20s.
The lesson he learned?
The market can remain irrational longer than you can remain solvent.
Two Strategies to Deal With the Great Disconnect
“We cannot solve our problems with the same level of thinking that created them.”
This quote from Albert Einstein has nothing to do with investing.
But it does apply more generally as a strategy for solving a difficult problem.
The only time we ever truly transcend a problem is when we think about it differently.
Here’s how you can apply this insight to trading the Great Disconnect.
First, you can step away from the game. No one is forcing you to play the markets. Understand that “fear of missing out” is all in your head. There are billions of people in the world who care nothing about the market.
Sir Isaac Newton took this route when he quit the game of speculation.
And in the long run, he was better off for it.
Second, you can take a Zen-like approach and accept the market as it is.
If you do choose to play the game, take the approach of a surfer.
A surfer can’t control what kind of wave the ocean will send his way, any more than you can control the ebb and flow of the markets.
The market “is what it is.” A surfer doesn’t try to explain it using complex mathematical models and statistics he learned in a Ph.D. program. He just rides the waves as best he can, while he can. And once the waves get too rough, he calls it a day.
All this is easier said than done.
Still, history teaches that there is really no alternative.
I’ll leave you with this warning: Investor beware.
I’ve seen this movie before. And it doesn’t have a happy ending.
I urge you to act accordingly.
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