Today’s Market Reminds Paul of the Late ’90s

Paul Winkler: And welcome. This is “The Investor Coaching Show.” I am Paul Winkler. He is Jim Wood.

Jim Wood: I am.

PW: Sitting in with me for this hour to talk about, well, guess what? Investing stuff. Yeah, that’s what we talk about. 

Flashback to the ’90s

So I was walking up the driveway. My dog was walking with me, and he gave me a great idea. No, he had nothing to do with this idea. I just had this thought that came through my mind about just what we’re seeing in the investing world right now—markets, what we’re seeing in the media—and I just had this thought that reminds me so much, Jim, of the late ’90s. 

And every day I remember watching TV, and this is back when I was going around the country, wherever Eugene Fama, who ended up winning the Nobel for economics, for multi-factor investing market efficiency, and those types of things, and Ken French, a Dartmouth guy, just brilliant stuff that these guys had put out. 

And just sitting in their classroom and listening to what these guys had to say was eye opening, and so much of what we’d been taught as investment advisors was just wrong. And that was basically what these guys telling us, “You know, this is what you learn, but here’s why that’s wrong.” 

Then they would go back usually 30 years with the things that they would be teaching, just to prove that we’re not any different than we’ve ever been. We’ve always been really pretty messed up as investors, and investors in general have been really messed up.

They point out how we get into periods of time where we just feel as investors that we’re just bulletproof, that we got it figured out.

The late ’90s was just that way. I remember watching TV, and I turned on the financial channels as I’m getting ready for work and I heard these people talking, and I went, “Man, these guys are brilliant.” 

I’m not talking about the guys on TV. I’m talking about the guys that I was studying under. I remember just going, “When is the other shoe going to drop?” 

It was so frustrating because these areas of the market—technology in particular—kept going up, and then you’d have these weird things happening where bad news coming out would actually be good news for the stock market. 

A lot of it had to do with interest rates. If you wonder why interest rates are such a big deal when it comes to technology and those types of things and those types of companies, there you get higher interest rates; what it does is it devalues future earnings. 

So what happens if you have companies that are strong in earnings, like technology companies, and they’ve got strong hopes for earnings in the future, and that’s indeed what was definitely happening in the late ’90s.

You had this constant string of new information on how technology was growing rapidly.

These companies’ earnings were growing rapidly, and then we had high expectations of earnings in the future. Well, if you had any kind of inkling that interest rates were going to go up, those companies would drop down. 

But if you had bad news, which bad news basically said, “Hey Fed, you guys don’t need to raise interest rates right now. We don’t need to have higher interest rates,” then all of a sudden, these companies would drop down in value. 

I was just so frustrated, thinking, “When is it going to stop? Or is it? Are we going to just have to have really, really great news to continue to drive the stock market down?” It just sounded so odd.

JW: It was really such an unusual time just because it was one of those things … they would say, “We’re going to have this great news.” 

And then people said, “Oh great. This is going to help the market.” Great news would come out, and the market would go down, and then it happens still. 

That’s what I always think that’s so amazing about people trying to predict where the market’s going to go: “Oh, they’re going to do this. Fed’s going to do that. So we’re positioned for this.” And then it goes completely the other way.

Many Investors Feel Bulletproof

PW: Which makes it so odd and so difficult because you know, I look around and go, “Wow, you know, this is really kind of simple.” 

Now, the reason I bring it up is because I find that there are so many investors right now that are bulletproof. They feel like it can’t ever go down. We ought to talk about one of the things we’ll talk about is the meme stocks.

JW: That’s the first thing I just thought of. That you start feeling bulletproof: “Hey, I bought a bunch of games. Stock made a bunch of money,” or, “I bought some Bitcoin and now it’s worth X amount of dollars more.” 

You start feeling like, “This isn’t hard. I’m a genius. This is what I can do. I can get online. I don’t need to work.”

PW: And if you don’t feel that way, then you just read a magazine that says, “Hey, just buy an index fund. Buy a total stock market index fund. And you’ll be great.” I’ll talk about that in another segment, more information about that.

It’s one of my favorite things to hit right now because people have no clue how much risk that they’re actually taking there.

There was an article I saw (and that’s what led to this whole thing): “When Your Ego Sabotages Your Investing.” They talked about how stocks had calmed down when this article was written. It said, “Quiet periods are a perfect time to strengthen your mental game.” 

There is a whole chart that we have in our office: it is nothing but mental errors that people make around just about any topic. We make mental errors all over the place, but I’m telling you, it is particularly strong with investing and where people make mental errors. 

There are books written on them. I remember you gave me a book for Christmas one year: “Misbehavior.” It was all about investing and about mental errors that people make. But it said that hubris seems to be at an all-time high these days, along with prices in most markets. 

Now, that’s not necessarily so. They just said, “That prices are super, super high,” because you always look at forward earnings. If you look at backward earnings, yeah, prices are high.

But remember, you’re coming out of a period where everything was shut down last year. So if we’re looking at earnings over the last year, they were non-existent. So your denominator in the price earnings ratio would be extremely low with that lower number, the bottom number being low, it would make the top number, which is “price,” look high.

So this is one of those things right here, where it shows you that the media, and this is Yahoo Finance, just gets stuff wrong.

 They just don’t have a complete understanding; they’re just so used to just throwing numbers out.

JW: You mean, we shouldn’t always trust what we read in the media?

PW: You know, it reminds me of political …

JW: I’ve often said that fake news just isn’t part of the political scene or anything like that. There’s tons of fake news in the financial world. Absolutely.

PW: Oh yeah, it’s funny. I actually had a commercial about that. I was actually doing a commercial. I was saying, “You guys listen to this station here that talks about political things all the time, and you are listening because you don’t trust the rest of the media, but you trust the rest of the media when it comes to financial things?”

JW: Right. Again, you always have to think, “What’s their agenda?” Their agenda isn’t necessarily to make people better investors.

It’s to sell advertising or sell products or something like that. So very little of what comes out of financial media is actually helpful. 

It’s designed to get people excited and get them to gamble and speculate and make transactions. So with all that stuff, somebody gets paid except for maybe the investor.

The Dunning-Kruger Effect

PW: What it does is it actually triggers something called the Dunning-Kruger effect, which you’ve led into this so nicely for me. So what is that? Well, it’s psychology. 

Like I said, a lot of investing is psychology, and if you don’t know your mental game, kind of like they’re saying, “Strengthen your mental game,” you better understand a little bit about your mind. 

The reality of it is our minds can fool us very, very easily. If you look at, I can’t even remember who the theorist is, but the idea, you may remember this, Jim, was that your mind is like this mansion and your conscious mind is like a broom closet in it. 

So in essence, your conscious mind, what you kind of consciously think about all the time, is just a tip of the iceberg when it gets down to it. Most of what’s actually going on, most of what drives your behavior, is completely under the surface. 

It may be something your mother said to you when you were a kid. Right? You’re driving what you’re doing, or something your dad did or something that your uncle did, or your sister, brother, whatever.

JW: It’s Daniel Kahneman’s thinking fast and slow. Is that what you’re …

PW: Very well may be where it came from, because that is a concept that was in his writings. Yeah, absolutely.

So the Dunning-Kruger effect, it’s a cognitive bias. What it does is it causes people to overestimate their competency, and they underestimate other things that are really, really important, and one of them would be just luck.

So often what we do is if we’re getting a good gain and an investment that we’ve gotten, we walk around with a little bit of hubris going, “Hey, man, I’m really good at this. I got this down.” 

And then we’ll talk to people about our gains, and we will hide our losses. We don’t talk about things that we bought that weren’t so good. We remember the good things. We don’t remember the bad things so much.

JW: The short term, I definitely get clients, if the market’s been good, then they’ll talk about, “Hey, this thing is so wonderful. It’s great. You’re doing a great job.” 

I’m always trying to get him to not get so excited when it goes up and not get so depressed when it goes down because that is part of the process.

PW: Oh absolutely. It’s when you talk about it going up, I just feel like, “Oh wow, it’s gone up,” and you go, “Well, that’s just what somebody else is willing to pay for your portfolio right now if they bought it off of you. You’re not going to sell it all to them.” That’s the same thing if it goes down.

When you’re investing, you’re going to have all these different asset categories, different areas in the market, and the reality of it is some of them are going to do better than others and you only get those gains if you actually sell everything right at that point in time.

Number one, that’s not too smart to do that because you’re leaving future gains off the table and you just take them off the table completely. But number two, the reality of it is that when you go and get rid of all of something, you’ve just lessened your diversification by a huge factor and increased your risk significantly by doing that. 

That incremental Kruger effect, you overestimate your competency. What happens is you have a little knowledge, and that little bit of knowledge that you have increases your confidence.

Don’t Be Overconfident

PW: Think about anything. I remember when I first took up photography. I remember thinking, “Wow, I’m really good at this.” I remember going out and taking a few pictures and going, “Man, I’m really good.” 

The day that my confidence was actually broken, I remember sitting outside a café in Nashville having a cup of coffee with a real photographer. And I will never forget that conversation, Jim. 

Because what happened is I realized, “Oh, Paul, you may have read an entire college textbook front to back on photography,” and in two minutes this professional photographer taught me something that was just mind-blowingly, “Oh my goodness. I can’t believe I didn’t know this. This is unreal.” 

And it wasn’t all that complicated. It had to do with shutter speeds in regard to flash output duration; it was something kind of arcane. I remember going, “Wow, you really don’t know much of anything at all.” 

Well, that’s the same thing with investing, except it’s even worse. You don’t even have people reading entire college textbooks on investing.

You have them reading magazine articles and thinking that they know everything about investing.

PW: What drives the price of a stock, what the value is of that company. David Dunning and Justin Kruger identified this bias in 1999. 

It was kind of a funny way that they identified it. It was an infamous example of a bank robber named McArthur Wheeler. 

Now, McArthur wasn’t necessarily the sharpest knife in the drawer, but what happened? He goes in, he covers his face in lemon juice during a robbery, and he had read someplace, I guess, that it would make him invisible to security cameras. 

And what happened of course, was that the lemon juice may work on paper, not necessarily on your face as invisible ink. And then that was the idea: it’s invisible ink, right? And he goes, “Oh, invisible ink. You can’t see it when you write on a piece of paper with lemon juice. So therefore, if you put it on my face, you won’t be able to see my face.” 

But it didn’t necessarily work so well in making him disappear on camera, and he overestimated his competency and, ironically, his blindspot was the reason that he got caught.

And it’s the same thing with investing. We have these blindspots and don’t realize what we don’t know. We don’t know what we don’t know.

JW: Yeah, it’s funny. Again, that’s one of the first phrases that came to my mind in terms of thinking that, and people just get a little information and maybe get a little taste of success of something and it’s, “Well, I got this. This isn’t hard.”

I see people on the internet chat boards and everybody’s making money, and “Buy this,” and it just can really lead people to thinking the future is just going to be so bright, and they’re just unstoppable. 

And you see it now. You see it certainly in the meme stocks. You see it in things like cryptocurrency and things like that, just like you saw it in the late ’90s with tech stocks, when people thought that Sun Microsystems and Oracle and Cisco were all these bulletproof things that just would never go down. It was a new world.

PW: Global Crossing comes to mind: “Hey, they’re laying down fiber cable so we can have better communications underground down in the ocean.” 

And it was, “Wow, that’s a compelling story. This is going to be the future of communications.”

Except they’re bankrupt and gone, no residual value, and people who put all their money in that lost everything.

JW: Speaking of overconfidence, there was a study a long time ago, UC Davis, that showed that women tend to be better investors than men.

And to me that kind of smacks of … because men tend to be more overconfident about something like that. They just tend to, “I want to move, and I want some action. I got this under control. And so I’m going to move stuff around and buy.” 

The tendency for women investors, not all of them but some of them at least, is to be a little more patient and not always having to move around and find the next hot thing or anything, and just kind of maintain what they have long term. That’s why they do better.

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