Investing in the stock market is like playing a roller coaster to some extent, you live through high’s and lows and for most of us, try to always live another day. Most of us did not live the crash of the great depression and while the 1987 crash was significant, what happened when Lehman and Bear Sterns folded was something else entirely. While there is still a lot of uncertainty in the market, we are far from those days when some had even started to discuss that not only the market could crash but there was a threat towards the entire financial system. No need to tell you that a few bubbles collapsed in the process and many investors lost money in the process. Many of them even lost everything because of the leverage they had used.
Seeing bubbles before they collapse
Every time the market has collapsed in the past few years, it was caused by the collapse of a bubble. There was the technology bubble, the credit bubble, real estate, etc. It is always very tempting to get involved in these bubbles because they all represent markets where investors made a lot of money for significant periods of time. Just think about how many regular folks made a killing buying and selling homes. Of course, that makes it very tempting to live through a bubble making money like everyone else. Of course in that case, you will also lose money when it comes down crashing. So I think one of the big targets would be to see these bubbles before they collapse in order to avoid the losses. Obviously, we will end up not making as much money during the creation of the bubble but I would say that it is still a winning proposition. Would you agree?
I think the best way to predict bubbles is to look for “irrational” thoughts that become more or less mainstream. Think about the techno area where companies with no profits, little revenues and no plans to even make money were being sold for millions of dollars. In retrospect it’s easy to see that it was a bubble but many saw it a lot earlier. The same was true for Real Estate. How is it possible that the average house owner believed that prices could not drop over a few years. It was impossible to them. The worst case scenario was that prices would remain at the same level…. That sounds irrational to me… doesn’t it?
The worst of all
When the market keeps going up for extended periods of time, it makes it easy for individuals with limited knowledge to do very well. Lenny Dykstra is one such individual. The former baseball player was a certainly a great athlete but not the smartest guy. Yet, he got involved into the stock picking business and became one of the big names out there. That should have been a big warning sign. I read a very interesting book about the period, entitled “The Zeroes” . It gives a very accurate idea of how things went on during that period of time.
One of the very interesting things that I learned while reading the book was about Lenny Dykstra, his newsletter and the stock picks that he was charging thousands of dollars. Not only were the picks not his, they were taken from another analyst. But he would only consider the trade a winner or loser if he actually closed the trade. So you can imagine what he did. He would close out winning trades and let the losing ones go on basically forever. That is what would make it possible to get 100 straight winning stock picks. Complete fraud right?
I think that when the market goes up too much for too long, we all have a tendency to forget that making money is not easy. It’s not supposed to be and if it sounds too good to be true, it usually is. The fact that Lenny Dykstra was able to do this is not shocking. But the fact that as a society he had enough credibility to do this in public, on the air (CNBC) makes me think that we should have noticed something fishy going on. There were many other signs but this was one of them. A guy like Bernie Madoff can only exist if investors think it’s possible to make 10% per year for decades. In the current period, after a major stock collapse and the lengthy recession, it’s a lot more difficult for such guys to exist.
But the next time you look around and see everyone making money without much skill or effort, I think it’s worth at least considering that it will not go on for very much longer…