Distinguishing Manias from Investments

John Robinson |

Distinguishing Manias from Investments - How the Wheat Gets Separated from Chaff

(Who should be worried in the current investment environment and who will be just fine)


By John H. Robinson (3/16/2022)

I have been meaning to write this article for a while, but today, with Dow Jones Industrial Average down nearly 3% for the day and off more than 20% from its previous high, it seems like a great time to share my professional perspective on who should justifiably be panicking and who should feel comfortable sitting back and reaching for some lemonade (as in, “making lemons from lemonade”).

One of Warren Buffett’s famous quips about investing through bear markets is, When the tide goes out, you get to see who has been swimming naked.”  As this current bear market in everything (stocks, bonds, real estate, crypto, etc.) heats up, we are already seeing lots of red-faced “investors” with their hands sheepishly covering their privates.  By and large, those people were attracted by the allure of getting rich quickly by investing in what Michael Lewis (my favorite author) once coined as “the New New Thing” instead of sticking to the tried-and-true principles of investing that have pretty much always worked over time horizons much longer than most investors (to their detriment) have patience for.

Last year, I had a physical therapist, a postman, and a hairstylist all give me advice on day trading and investing in crypto. When I tell them that I accumulated my nest egg by investing dividend stocks and index funds, they looked at me like I am a dinosaur.  They seemed to feel sorry for me for being too old to understand.  I have no idea how their investment strategies are faring today, but during this latest decline, I maintain that as the markets are falling I (and the good people for whom I work) are metaphorically wearing board shorts and a rash guard. That is not to say that our portfolios have been immune from the stock market decline.  To be clear, our portfolios are very definitely down with the market too (though I am comfortable saying that we have largely side-stepped the carnage in the bond market by avoiding (like the plague) bond mutual funds and ETFs for the last several years). 

What I mean is that I am very comfortable that the exposure we have to the stock market through index funds/ETFs and through rising dividend stocks is unlikely to suffer permanent losses.  When the stock market eventually recovers, I am confident that our portfolio values will rebound too.  How can I be so smugly confident in the face of such volatility, you may ask?  Do you mean, aside from the fact that this approach has worked 100% the time through the modern era of the stock market and aside from the experience of investing (and advising) through major bear markets multiple times over the past 35 years? The less snarky response is that my confidence is attributable to the fact that our investments in the stock market are broadly diversified across real, tangible companies with real earnings.  As long as most of these companies remain profitable over time, they will eventually be worth more.  Provided that we do not sell in panic and we don’t need the money now, I fully expect we will literally be richer for the experience.


The Anatomy of an Investment Mania

So what makes an investment “mania” and how is it different from a traditional investment?  A mania is essentially an idea for the future with potentially unlimited but unproven potential for profit.  In the 1990s, dotcom stocks exemplified the quintessential mania.  At that time, investors were often encouraged to invest in the dotcom companies that attracted the most “eyeballs.”  When econ-trained fuddy-duddies like me were stupidly brazen enough to enquire about profitability, the respondents often rolled their eyes and chided that “eyeballs” was the new metric.  By 2002, the stock market was down more than 50% and, with the very notable exception of a certain latter-day online bookseller,  the vast majority of dotcoms had vanished from the landscape.  The Internet phenomenon itself was obviously very real and impactful, but it ended up being developed by and populated with very real companies with very real earnings. By 2007 the real stock market had recovered but shares in failed dotcoms that only attracted eyeballs and never had real earnings or even revenues did not.


When we think of manias, the great Dutch tulip bulb mania of 1634-1637 also often comes to mind as the seminal example.  The modern-day equivalent may have been the cannabis mania of the 2010s. In that speculative wave, investors were led to believe that the legalization of weed by the individual states and eventually by the federal government would produce unlimited future profits for investors who got in on the ground floor of marijuana growers and distributors.  What makes the cannabis mania analogous to the tulip bulb mania is the manner in which they both ended.  The tulip mania ended when speculators realized that tulip bulbs are not really a scarce and valuable commodity.   Similarly, the cannabis mania ultimately faded with the realization as marijuana became legalized in several states that the underlying product is an easily grown herb that will never be overwhelmed by demand outstripping supply.  Eventually, it dawned on people that investing in marijuana isn’t really all that different from investing in marjoram or basil.

Another reason why the cannabis mania faded was that investors with newfound time on their hands due to COVID quarantine simply moved on to different manias – and there were many to choose from.  I divide the spate of recent/current manias broadly into two categories – revolutionary future tech and cryptocurrency.  The former includes electric vehicles, home delivery services, online trading platforms, cloud-based solutions, China Internet companies, SPACs that offer the opportunity to invest in an eventual idea, and anything else that Cathie Wood would be inclined to throw into her ETF portfolios.  The crypto mania includes direct investments in Bitcoin, Ethereum, and the like along with the derivative currency trading platforms and so-called “stable currencies.”  While it is still too early to read the last rights on all the latest manias, in many of these arenas the fat lady is already warming up in her dressing room.


Investing versus Speculating

Of course, the stock market is dropping too.  But there is a big difference between the S&P 500 Index being down 20% or so and the mania investments being down 60-90% on the way to down forever (100% down is down forever).  Beyond the magnitude of the volatility, there are two obvious distinctions between speculative manias and traditional investing.  First, as noted above, manias are based almost entirely on future big ideas that may or may not ever come to fruition whereas traditional investments in the stock market as a whole tend to be based on proven profitability.   Second, investing (at least the way I try to do it) involves having established, pre-set guidelines for the conditions in which we will sell, regardless of whether the investment’s value is up or down.  Those readers who subscribe to my rising dividend strategy know that we have very clear, pre-determined sell criteria.  Similarly, clients who own index funds know that we eschew market timing and that the spending strategies we apply are specifically designed to avoid having to sell stocks during down markets.  I also make clear to clients that we do not invest in the stock market for investment objectives with time horizons that are shorter than 5-7 years.  In contrast, investors in manias tend to buy purely into an idea without having a pre-determined plan for selling to realize profits or, more importantly, to cut losses if their investment precepts change.  


Getting Rich Slowly

As we speak, the investment wheat is getting separated from the speculative chaff.  Some investors who made outsized bets on the mania du jour are beginning to realize that their decisions are indeed life-changing - just not in the direction they had hoped.  In my opinion, they have every reason to be fearful as the likelihood rises that their losses may become permanent.  However, investors who allocated their long term savings to shares of profitable companies and who planned in advance for downturns like this one should rest much easier.  Insofar as the companies they own continue to be profitable, they may even wish to buy more while prices are depressed.  While we have no idea whether the current downturn will last a few months (as it did in 1987 and 2020) or a few years (as it did from 2000-2002 and 2007-2009), I believe we can continue to feel confident that the shares of profitable companies will eventually be higher than they are today.  At this time, there are many profitable companies paying dividends in the 3-4% range that have regularly and consistently increased their payouts at or faster than the cost of living.  Some are trading 20% or more off their highs and are in industries such as defense, healthcare, pharmaceuticals, and discount retail, in which revenue and earnings are relatively immune or at least resistant to economic downturns.  They are not merely ideas; they are tangible companies that are likely to pay dividends both literally and figuratively over time. Succinctly stated, the mania investments offer the Siren’s song of fast, life-changing wealth, whereas investing in the traditional, boring old stock market merely offers the decidedly more mundane opportunity to get rich slowly. 


Epilogue – I Feel Like I have Seen This Movie Before

In the early 1990s, my mentor and great friend, the late Tom Neely, counseled me to never dissuade clients or friends from investing in the latest new new thing, especially if they seem passionate about it.  He told me that they will inevitably resent you forever if the investment soars and heeding your advice prevents them from getting rich.  As he explained, even if you fervently believe that their pie-in-the-sky ideas are likely to eventually fall back to earth, you have nothing to gain and everything to lose.  “Don’t ever prevent someone from getting rich,” he counseled. In following his sage advice, I became adroit at biting my lip over the years.  In the early 1990s when I was building my client base at A.G. Edwards, I had a nice young couple who ran a successful and growing landscape architecture business as clients.  At about the same time, Ameritrade and E*TRADE introduced consumers to online trading with famously engaging commercials like these –

Stewart and Mr. P buy Kmart Stock - https://www.youtube.com/watch?v=WOKDK0g1Gno

Stewart and the Broker’s Daughter - https://www.youtube.com/watch?v=NSqiOb3Q7PA

Shankapotomus - https://www.youtube.com/watch?v=XiUCDeKeWIE

 One day they called me to tell me they were closing their accounts so that they could use the funds to day trade options on dotcom stocks in E*TRADE.  They said they planned to trade full-time with the expectation of earning enough money to close down their company within 12 months and retire.  I do not know exactly how they fared, but I do know that as of 2019 their eponymous company sign was still up and they were at or near normal full retirement age. Ironically, the collapse of the dotcom bubble beginning in 2000 might have wiped out E*TRADE (now owned by Morgan Stanley) and Ameritrade (now owned by Charles Schwab) had the firms not pivoted to cater to professional investment advisers and financial planners like me. 

Nearly a full generation later, the so-called “robo-advisors,” led by Betterment and WealthFront brashly burst onto the retail investing scene with promises to revolutionize wealth management, democratize investing, and generally eliminate the need for investment advisers and financial planners.  Neither WealthFront nor Betterment ever managed to scale to profitability. Ironically, WealthFront sold out to retail brokerage behemoth UBS earlier this year while Betterment is reported to be shopping for a similarly large institutional buyer.  The crypto craze began at around the same time as robo-advisor fad.  Just as legions of ordinary consumers became overnight millionaires in the 1990s by making oversized bets on dotcom in its name, so too did legions of early adopters in Bitcoin accrue astronomical fortunes.  At its peak, there were even investors who got rich by investing in a cryptocurrency (Dogecoin) that was literally created as a joke.  

Today, those fortunes appear to be evaporating just as quickly as they were accumulated, as more and more investors appear to be waking up to the reality that crypto (and NFTs) may really be nothing other than an idea.  As Bill Gates said yesterday at a technology conference, NFTs and cryptocurrencies are 100% based on sort of the greater fool theory that somebody’s going to pay more for it than I do.”

To my thinking, the robo-advisors are analogous to the original online trading platforms in in the 1990s and the Crypto craze is analogous to the dotcom bubble.  I may be over-reaching, but the war in Ukraine may be analogous in its economic impact to the shock caused by 9/11.  I often state that the causes of every bear market are different, but the ending is always the same.  This time around it certainly does seem like the early 2000s are playing all over again, but I do believe that the ending will still be the same.  The people who overindulged in the mania will be left sad and lighter in their wallets, while the people who stayed true to established principles of investing will be rewarded.

John H. Robinson is the owner/founder of Financial Planning Hawaii, Fee-Only Planning Hawaii, and Paraplanning Hawaii.  He is also a co-founder of fintech software-maker Nest Egg Guru.



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