worth.com
Beat the Crowd
By Jim Rogers
It's human nature to feel more optimistic when everyone else
is feeling bubbly, too. It's also a good way to lose your shirt.
WALL STREET IS AND ALWAYS has been an outsize
exhibition of society, a reflection of the hopes, dreams, fears, and
worries that drive us all. Stock prices rise amid optimism and fall
amid pessimism, whether the mood is justified or not. To learn the
ways of the market is to learn about human nature.
As we view the world through our rational and emotional lenses,
we form opinions about our current situation and the prospects for
the future. We are vulnerable to error if the input we receive is
misleading or if we interpret it incorrectly. If we are exposed only
to gloom, we're likely to become gloomy. If a piece of information
connects with one of our stronger emotions--our fear, say, or our
greed--we may distort its true meaning.
These sorts of errors can be shared (as well as amplified) by
crowds. As early as the late-19th century, a French sociologist
named Gustave LeBon was one of the first to write extensively
about the behavior of crowds. Others, relying on his ideas as
applied to the world of finance, noticed that, even when investors
are unknown to one another and separated by vast distances, they
are linked by the prices of the investments they hold in common.
Thus, when the price of a security rises, it transmits positive
signals to all members of the group, leading to collective cheer.
When the price falls, it creates collective despair.
Today, of course, investors are connected through a vast array of
airwaves, cables, and telephone lines. They are bombarded by a
wide assortment of information potentially relevant to their
investment decisions. Even so, LeBon's notion still applies. We
may have more information these days, but the percentage of
people with good judgment is no higher than in LeBon's time.
Think back to the early part of this year, when most of the
information available to investors was upbeat. Yes, there were
reports of economic problems in distant lands, but the amount of
negative news was tiny in comparison to the amount of positive
news. The day-to-day business and market reports were chipper;
the market indexes were skipping upward. In such a climate, it's
human nature to feel more confident about the future. And since
investors essentially bet on the future, investing feels like a safer
thing to do when the news is mostly good.
Months later, of course, the mix of news reversed. In August, a
large percentage of what we read and heard was negative. The
mood of investors had soured as word of deepening global
economic troubles (and childish escapades in Washington)
increased in volume. The act of investing became more difficult.
When surrounded by evidence of danger, we naturally feel more
cautious.
And yet which of the two periods would have been the better time
to put your savings into the market: in the sweet days of April,
when the Dow was above 9000, or in the gloom of late August,
when the Dow neared 7500?
The history of markets abounds with examples of how human
nature can lead to foolish acts. The tulipomania in Holland during
the 17th century produced a ruinous national boom and bust over a
flower, of all things. From 1979 to 1981, Kuwaiti investors wrote
post-dated checks to take part in a stock boom that helped propel
the Souk al-Manakh exchange from a market capitalization of $5
billion (the collective value of all shares traded) to one of $100
billion--and then back down again. In 1997, a nationwide Ponzi
scheme bankrupted virtually the entire economy of Albania.
Instances in the U.S., though perhaps less dramatic, include the
Nifty Fifty craze of the 1970s and the biotech boom-bust of the
1990s.
Then there's my latest favorite: Amazon.com. Impressed with
Amazon's pioneering success in selling books online, investors
started bidding up the stock in mid-June. The rising price created
more positive attention and drew more interested buyers. Nothing
in particular was wrong with Amazon (just as there was never
anything inherently wrong with tulips), so there was little negative
information available to temper the growing glee.
By July, the upward spiral of positivity had eventually produced a
market capitalization of $6.2 billion in Amazon stock. And even
then, there were plenty of investors who pointed to this as proof of
the company's extraordinary worth (though its e-bookstore had yet
to earn so much as a dime in profit).
In its typically urbane style, Grant's Interest Rate Observer
recently noted that, based on historic stock valuations, Amazon's
market value would have been perfectly reasonable provided the
company was assured of capturing 100 percent of the U.S. book
market within four years. Such a Gates-like monopolistic
achievement would provide annual revenue of $26 billion and an
estimated annual profit of $780 million.
If you are among those investors who purchased Amazon near its
peak, please trust me when I suggest you re-examine your
investment style. For that matter, we'd all do well to beware the
crowd--a guise Wall Street easily and often assumes. Once the
crowd takes command, a company and its stock become
unhitched. The stock diverges--either up or down--from the
inherent value of the business and its assets.
My advice: Become an independent
agent, and go your own way.
This also can happen to a group of stocks or even the entire
market. Hard as it may be to fathom today, the late 1970s and
early 1980s was a period when investors regarded all equities as a
waste of money. Back then, bank CDs were the rage among the
smart-money set.
It's my opinion that investors become most vulnerable to the
crowd when they act passively--or, worse, when they actually
seek "safety" in the herd. Merely taking in the news that comes
your way virtually assures that everything you hear will be, in one
way or another, a product of the collective buzz. And buzz is what
you'll base your decisions on-- with the further potential of
compounding this error with flawed analysis. Seeking a broker's
counsel is no escape: Most of them deliberately move with the
crowd as a way of protecting their careers. Like fish, they know
life is less hazardous swimming with the school.
I also don't recommend becoming a strict contrarian; going against
the crowd can get ugly, too. Instead, become an independent
agent, and go your own way. Learn to exercise control over your
sources of information. Do your own homework, and act on it and
it alone. To improve your chances of reaching good conclusions
about the information you obtain, stick to areas in which you
already have some expertise.
Let's say you manage a car dealership. My advice: Ask yourself
which automotive-parts supplier looks like an up-and-comer. See
what the trade journals have to say about your choice. Look up
stories about the company in the business press. Then get the
company's financial statements. Drop by its booth at a trade fair.
Phone its customer- service number and see how well the
company responds.
You'll have now done far more due diligence than any broker ever
does-- and since you already know something about this business,
you'll be much more expert in your assessments of the things you
learn. If you are unwilling to do this analysis, then frankly I don't
think you have any business being part-owner of a
company--which is what buying stocks is really all about. Instead,
find a smart, independently minded financial consultant or
mutual-fund manager, and let him try to outsmart the crowd on
your behalf.
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