Book Review: The Delusions of Crowds by William Bernstein

My finance book of the year recommendation is one that perfectly matches the 2021 markets moment: William Bernstein’s The Delusions of Crowds: Why People Go Mad in Groups.

Over and over again this year I found myself describing developments in financial markets that seem, frankly, nuts. All I’ve done this year, it seems, is write about wacky finance trends. 

Delusions_of_Crowds

If Bernstein’s investing book The Four Pillars of Investing is an all-time finance classic, his 2021 book is utterly timely, anticipating a year of financial delusions.

In The Delusions of Crowds, Bernstein toggles between stories of financial delusions and religious delusions. Both types of madness depend on two common human frailties. One he describes as the “Asch Effect,” based on a social psychological experiment which showed how humans can be convinced of obviously wrong things by the social pressure to conform to the opinions of others. When the religious leader or the financial whiz says something is true, and enough people around us agree, we tend to agree, despite evidence to the contrary.

Another common thread is our ability as humans, in the face of contradictory evidence, to completely discount one set of facts if they conflict with our pre-existing beliefs. When the apocalypse does not arrive on the prophesized date, Bernstein notes, true believers do not necessarily reject the prophet. Insteaed, we listen eagerly for the prophet’s update on the next plausible date for the End of Times, rather than settle our cognitive dissonance through doubt or disbelief. Contradictory evidence is merely an opportunity to double-down on our fervent faith, not change our beliefs. The South Sea bubble, railroad stocks in 1840 Britain, the stock pools of 1929. The Fifth Monarchy of 1666, the seventh-day adventism of 1843, the Y2K mania. Bernstein does not mention the QAnon phenomenon, but clearly this recent movement falls within Bernstein’s historical pattern.

For those looking for a pure financial wisdom book, I should warn that Bernstein spends considerable time on non-financial matters. Specifically, he digs deep into the clear connection between “End Times” prophecies from past centuries and powerful Evangelical movements today. Bible-inspired numerology and prophecy has entranced people for a millennium. Bernstein makes the case that this madness not only follows historic patterns but also represents a current threat. Apocalyptic beliefs linked to what he terms dispensationalist Protestantism infuses our current politics.

Personally, I am somewhat immune to the Asch Effect. On the other hand, I tend to redouble my strongest views in the face of contrary evidence, often to my embarrassment. Which I will now demonstrate for you, in the course of reviewing the goofiest financial trends of 2021. Those trends, with caveats.

Meme Stocks

The Robinhood app and Reddit-Bro inspired investing in “Meme Stocks” like Hertz, GameStop and AMC kicked off in January 2021 with a bang. We should have known then that the entire year would be an unending string of delusions and madness. Most of these rockets have yet to fall to earth as the year ends, again not what I would have expected.

GameStop
Stop The Game. Stop.

Caveat: Spotting undervalued companies unloved by institutional investors was the original plausible investment thesis behind some of these meme stocks. That’s cool but only accounted for the earliest movements toward stock appreciation, before the madness took over. 

Cryptocurrency 

These are closer to religion than financial bets or investments. The fundamental correct price of Bitcoin remains zero. That’s the same fundamental price as with all the other crypto currencies I’ve ever heard of. Anyway, hundreds of billions of smart investment capital disagree with me. Since approximately 2013, every time I talk to an audience of folks about investing the first question is always “should I/how can I invest in crypto?” My answer is always the same. Something to the effect of I would sooner recommend lighting one’s paper money on fire flying down the highway at 90 miles an hour. But again, I am clearly the idiot in the room. Up until now I have been wrong, wrong, and then wrong again about Bitcoin.

blockchain_column
Kevin Roose thought he was joking at first

Caveat: I (kind of) understand blockchain technology might be the coolest tech since the invention of the selfie-stick. But cryptocurrencies are not the same as blockchain, and I will continue to disparage the former while being open to the future awesomeness of the latter.

SPACs 

Shall we all invest in an enterprise best described as “an undertaking of great advantage, but nobody to know what it is?” That was the infamous published description of a speculative business advertised around the time of the South Sea Bubble of 1720, a phrase which equally applies to the Special Purpose Acquisition Companies (SPACs) that hit maximum popularity in early 2021. 

Bubble
Picture of South Sea Bubble or really any SPAC you’d like it to be

You put your money into an empty vessel and hope that the named backer finds a private company to take public through purchase. Why wouldn’t you want to put your money into an unknown business that has A-Rod, Sammy Hagar, or Kevin Durant as its backer? Note: That’s both a rhetorical and a sarcastic question.

Caveat: SPAC investors typically get an option to request their money back once an acquisition target gets announced. So, it’s a bit like a free option for the original SPAC backers.

NFTs 

Have people entirely lost their minds? You bought a digital thing and you value it highly because there can only be one copy (or a limited number of copies) of the digital thing? And this is worth $1 thousand or $1 million, or $50 million to you? 

Caveat: Art collecting is always insane when viewed from a finance perspective. Probably best to just leave it to aesthetics and the phrase “There is no accounting for taste.”

Tesla

There are only so many times I can point out how stupid this stock has been in the past, is now in the present, and always will be in the future, for ever and ever, amen. And at each point in time, I have not only been proven wrong, but proven colossally wrong. Like, it’s the wrongest stock-picking call anyone has ever made in the history of making wrong market calls. I feel really great as Tesla shares have zoomed from a ridiculous $100 billion valuation to a ludicrous-mode $1 trillion market capitalization in less than 2 years. But still: Y’all are crazy. I feel extraordinary conviction on this.

Tesla_truck

Caveat: I understand the cars are great. I have no problem with the cars. Just the stock, and its price. And it’s bizarre owner, Elon Musk. Him I have a problem with. But again, I’m the idiot, I admit that.

The most common ending to human delusions, financial and religious, is heartbreak. In finance, however, some bubbles serve the purpose of creating the conditions for future economic innovation. After the wreckage of a burst bubble, we can often see in retrospect how the creative destruction was necessary, or at least that it seeded new growth. This will be useful to remember, when the current crazy ends in tears.

A version of this post ran in the San Antonio Express-News and Houston Chronicle.

Please see related posts:

All Bankers Anonymous Book Reviews in one place

Book Review: The Four Pillars of Investing, by William Bernstein

The NFT Revolution

Tesla – How Do I Hate Thee?

What If You Back The Wrong SPAC?

This Is Your Bitcoin Warning

Stop The Game. Stop.

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Your Bitcoin Warning

You’ve been writing me a lot lately, wondering about bitcoin. What is this technology? What is it used for? Should you get involved? 

bitcoin_what_is_it_used_for
What is the right price for bitcoin? What are its uses?

But also, what is the right price for bitcoin? Is it a buy or a sell here? As of this writing, a bitcoin costs roughly $50,000, up from $10,000 a year ago. Could it go to $200,000? That’s only 200% up from now. It’s gone up 500% in the past year. So sure, why not? $200,000 sounds great.

That’s,,,not a prediction. 

What do I think is the fundamental right price for bitcoin? I’d say, roughly, zero? I truly think zero is the fundamental correct price. But it could take a while to get there.

Now, blockchain – the innovative technology of which bitcoin is the best known example – may have real uses. I’m open to that idea. Blockchain allows for anonymous, distributed transactions which can be verified between parties that neither know nor trust each other. Theoretically, blockchain obviates the need for government regulation or third-party verification. 

Applied to money, bitcoin – using blockchain technology – theoretically allows us to remove transactions from the purview or limitations of existing financial infrastructure.

Dollars, the theory goes, involve pesky government issuers, unreliable central banks, and the meddling institutions of the existing global finance system. To its proponents bitcoin – using blockchain technology – is like money unshackled by politics, regulators, and borders. 

To be clear. I totally disagree with the need for unshackling. I think dollars are awesome. I even buy stuff and services with them! I’ve honestly never felt limited by dollars, except obviously by the amount of them that I control at any given time. By contrast, I believe bitcoins are – at their essence – useless. A useless fiction, and therefore a fraud. I prefer my fictions to be useful.

What is the real-world use of bitcoin? Bitcoin is not a useful store of value in the way that dollars are. Anything that can soar 500 percent in the past year – as Bitcoin has – can also drop 80 percent the following year. Or the following month. That makes it entirely inappropriate for “storing value.” 

Could bitcoin be delightful as a pure gamble, like buying a lottery ticket? Sure. But no sensible person advocates lottery tickets as a store of value.

The South Sea Company was created by charter in 1711 with a mandate to engage in an implausible business, in a far off place, that none of its British investors had ever seen. It was just exotic and mysterious enough to capture the whiff and elan of possibly unlimited wealth. It enjoyed the imprimatur of the government of England, and for a time legitimately traded in English government bonds. Shares began at 100 British pounds, but reached 1,000 pounds a decade later. Fortunes were destroyed shortly thereafter, when the laws of financial gravity returned. We return to this cautionary financial story over and over because – while no two bubbles are alike – history does rhyme.

South_Sea_Bubble
South Sea Stock (log scale)

Bitcoin has all the makings of collective financial madness. Magical thinking! A difficult-to-grasp mysterious technology! Breathless media coverage of its ever-increasing price! Celebrities who might be buying it! 

Bitcoin’s only plausible real-world use cases – as a medium of exchange rather than a speculation – are tax evasion, foreign-exchange-control evasion, drug dealing, prostitution, child-pornography, assassinations, arms-dealing, illegal gambling, and ransomware for computer hackers. As I have yet to engage in any of these activities, I have yet to find an actual use for bitcoin in my own life. But your mileage may differ, no judgment.

Incidentally, bitcoin is probably not even anonymous. One of the features of the blockchain is that all transactions are infinitely traceable and reproducible. That’s the plausible key to blockchain technology’s usefulness in the future – that all transactions and counterparts create a permanent record, visible to all counterparts. 

But that feature of permanence undermines anonymity. A blockchain-sophisticated FBI should be able to see exactly who sold you bitcoin, and who in turn you sold bitcoin to. Your drug deal or tax evasion with bitcoin was not as anonymous as you thought it was after all! Haven’t you ever watched movies? This is neither business nor legal advice, but do you know what is anonymous, instead? A suitcase full of unmarked, non-sequential dollar bills.

Should you take my word for it on bitcoin? I can only warn you about my similar strong feelings in the past and how that worked out.

In the one and only market call I have ever made in this space in 7.5 years, I said Tesla was a terrible stock in 2015

It promptly quadrupled in value. So I reiterated my hatred for that stock’s price in early 2020.

My bold call clearly triggered the value of that stock to septuple over this past year. You’re welcome.

I just mention this to say, you should probably speculate in the opposite direction of whatever I advocate, including, especially, about things like bitcoin. Bitcoin is far, far, stupider than Tesla shares will ever be. Naturally, Tesla announced last month that it had speculated with its corporate cash by acquiring $1.5 billion in bitcoin. Because LOLs. And YOLO. And FOMO. 

Tesla CEO Elon Musk’s explanation for this speculation: “Bitcoin is almost as bs as fiat money. The key word is ‘almost’.”

[Ah, yes, such wisdom! What mysterious sagacity from 2021’s newest richest man in the world! Take all my money, please, you carnival-barking promoter of fictions!]

Bitcoin – Also not a very efficient use of power!

Never underestimate the power of greed and magical thinking to keep things irrational longer than you can stay solvent. Welcome to the monkey house.

Cryptocurrency enthusiasts like to point out that traditional “fiat” money like dollars, unmoored from a metallic base like silver or gold, is based on a collective fiction. In that sense, would-be sophisticates (and Musk) argue, the collective fiction of bitcoin is no worse than dollars. 

Rai_Stones_of_Micronesia
Rai Stones. Better than gold?

Gold is also a collective fiction, albeit one a few thousand years old. Shells have made for a collective fiction in the past. The rai stones of Micronesia were a collective fiction. What even is money?

US dollars are also a collective fiction, except for the true fact that my government demands, and accepts, dollars for taxes. As far as I can tell, this is the basis for fundamental value in a currency. What my government accepts in taxes.

A convenient currency is more useful than barter. My local, state and federal governments do not currently accept extremely well-reasoned and delightfully funny finance writing as a means of discharging my tax obligations. I need to first convert finance columns to dollars, which my government then does accept.

When President Elon Musk declares in 2028 that we can and must make tax payments in bitcoin, then – and only then – will I agree that bitcoin has any fundamental value. It may well go to $200,000 (and beyond!) for all I know in the meantime. Unless and until Musk runs for President, I expect a zero value future for this particular collective fiction.

A version of this post ran in the San Antonio Express News.

Please see related posts:

Tesla is awful (January 2020 edition)

Tesla is not going to make it (2015 edition)

Hater’s Guide To Tesla (August 2020)

Never Buy Gold

Never Buy Timeshares

Never Buy A Variable Annuity

Bitcoin, Blockchain, and Bullocks

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I Hate Tesla

The most important rule for writing a business blog – at least my most inviolate rule – is to never, ever, forecast or make “market calls,” on individual stocks. I have broken this rule only once in my 5.5 years. It’s time to break my rule again. On the same damn stock.

I slather this self-rebellion in thick layers of irony. But irony with a purpose!

Some background. I last tucked my only-ever individual-stock forecast into a post in March 2015.

The point of that 2015 post was to highlight – in my contrarian way – the unpleasant fact that “sin-investing,” especially in a nasty tobacco company like Altria has been extraordinarily profitable over the past 40 years. 

But that wasn’t my stock forecast. Instead, I contrasted MO with green-tech market darling Tesla the sexy electric-car company that combines virtue-signalling for reducing your carbon footprint with 0-to-60 acceleration in 1.9 seconds.

I wrote the following about Tesla in March 2015: 

“Tesla Motors, to name one public company that I’m reasonably certain will be dead in five years, despite its $25 billion market cap, is an innovative company. But that doesn’t make it a good stock to own.” Then, to further metaphorically point to the bleacher seats while stepping into the batter’s box for my inevitable home run, I wrote “Would a few people mark their calendars for five years on Tesla and let me know how I did with my call? Because I AM SO RIGHT.”

Anyway, time flies. It’s five years later.

I’ll save you the hassle and let you know that Tesla stock is up 182% since then, from $200 per share at the time of my home-run call to $565 per share as I write this. The market cap has expanded from $25 billion to $102 billion. It’s up 35% just this year. Tesla will announce 4th quarter 2109 results on Wednesday January 29th.

screenshot from January 22 2020

Having broken my inviolate rule five years ago of never forecasting a stock in a column, it is only right and just that I have both my hypocrisy and terrible market call publicly mocked.

But that’s not the main lesson you should take away from this shameful episode. The main lesson is that you, too, should never forecast individual stocks. You will be emotionally invested in a way that hurts your chances of building wealth. You will buy, or sell, that stock too frequently. You will let fear and then greed cloud your judgment. You will look up that stock price exactly at the moment when you should be admiring your daughter’s ballet recital. (How many times do I have to tell you to put your phone down?) You will read headlines that confirm your preconceived biases and you will discount headlines that contradict them. You can guess how I know all of these accurate things about you.

Beyond the emotional reasons, you should avoid forecasting because you will also be wrong. You will even be wrong for all the right reasons. Like me.

Like, Tesla, by all rational analysis, has always been a stupid stock. It’s been overvalued forever. But as the Wall Street phrase goes, “the market can remain irrational longer than you can remain solvent.”

I was correct about Tesla then, and I’m still even more correct, damnit! I will now double-down on all of my errors.

Unlike, say, software technology companies that enjoy infinite scalability, building an auto-manufacturer is highly expensive to scale. It takes cash. Tesla has burned billions in cash to build manufacturing plants in Nevada and Shanghai. The competition from other auto companies is intense and global. Regulation is massive. Innovation, for which Tesla is known, is expensive to implement. The company has nearly run out of money more than once in the past five years, even by the admission of their CEO/Evangelist Elon Musk. 

One of his dumbest, and the one that got him fined by the SEC.

And then there’s Musk himself. Ugh. As clearly brilliant and visionary as he is, he can’t stop himself from tweeting nonsense, earning rebukes and $40 million fines from the SEC, and lawsuits from fights he picks unnecessarily. He also employs his knack for distracting the media to change the subject, whenever they attempt to ask about Tesla’s lack of profit. 

Oh yeah, and about that profit. Tesla has never turned an annual profit in nearly ten years as a public company.

A master-distractor from the missing profits

Tesla’s market cap at $102 billion is larger than car companies Ford and General Motors combined. In fact, let’s compare those companies to Tesla. Ford sold 5.9 million vehicles in 2018, for a profit of $3.8 billion. General Motors sold 8.4 million vehicles in 2018, or a profit of $1.9 billion. Tesla, which has never turned an annual profit, sold 367,500 cars in 2019. 

Tesla has sold 891 thousand vehicles in its entire history. Total. In other words, Ford and General Motors sell more cars in any given month than Tesla has ever sold. I could go on, but you get the idea. Tesla is a stock that mostly exists in our collective imaginations.

It turns out, Wall Street pros mostly agree with me about Tesla. It is the most “shorted” large stock on the US stock market, meaning sophisticated investors have bet against the share price, finding it as absurd as I do.

One of Musk’s most recent distractions

Shorting means hedge funds have sold shares at current prices in anticipation of buying back shares when they drop in the future. Shorting Tesla has been, as you can imagine, one of the most spectacularly unprofitable trades of the past few months. 

Some people never learn. Like me and like you, the pros also shouldn’t be forecasting individual stocks.

Incidentally, I have no individual positions in any stock so nothing to disclose about conflicts of interest writing about Tesla.  Index funds all the way, baby!

A version of this post ran in the San Antonio Express News.

Please see related post: 

Sin Investing (and a mention of TSLA)

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