“It’s like a rabbit crossing the road.”
Elizabeth came to London this past weekend. We were sitting in a little café, drinking US$5 coffee…noticing older men, nicely dressed in blue blazers, many of them adorned with so many military medals they stooped forward from the weight of them…some of them wearing red berets.
“A rabbit’s instinct is to dodge,” we had explained. “It sees a wolf coming…it darts one way, then it turns suddenly and goes the other way. The charging wolf is heavier. His momentum keeps him going in the same direction, so he’s likely to miss the rabbit. It’s a survival instinct…rabbits dodge because the rabbits that couldn’t dodge were eaten by wolves before they had a chance to reproduce…
“But come the year 2007, a rabbit sees a car coming down the road. Instead of quickly getting out of the way, he takes the car for a wolf and dodges. Result: dead rabbit. The instinct that was a useful adaptation in an earlier environment is now fatal…”
“Hmmm…” said Elizabeth, “I wonder what instincts we have that were once useful and are now dangerous?”
“You’re looking at one of them right now – the way people go to war…they fight as though the survival of their race depended on it. And how about the way they eat? They eat as if they were on the brink of starvation; because for most of man’s evolutionary period, he was on the edge of starvation. And oh yes…the way they invest.”
The hypothesis put forward in our new book (Mobs, Messiahs and Markets , written with Lila Rajiva) is that people were shaped by thousands of years of evolution to work together. Their survival depended not on individual action, but on group solidarity. They ‘learned’ to conform, to think the same things, to act in concert so that, while individual members of a tribe might perish, the group survived. And the group carried its genes forward to become what we are today.
What we are, in other words, are groupthink animals…a clan species…whose members tend to believe the same things at the same time. That is one reason that markets tend to go up and down. As a purely logical matter, there is no reason why people should think a dollar’s worth of earnings is more valuable one day than the next. Yet, they do. When people buy stocks, sometimes they will pay as little as about US$6 for every dollar of earnings. Other times, they will pay as much as US$40 or more. And here, we’re referring to the averages. There are many reasons why investors might want to give a particular stock a higher P/E than other stocks. But there is no logical reason, ceteris paribus, why they should judge all stocks more valuable – in terms of the earnings they produce – at one time than the next.
Mass sentiments take hold of investors like a rabbit’s dodging reflex. It is instinct at work. When an investor sees his fellow investors take flight, he straps on his wings too. When he sees them calmly buying more stock at 20 times earnings, he buys too. This herd instinct is fatal to investors. While the rabbit dodges…and dies, the investor forgets to dodge…and gets killed.
There are times when the great masses of people are bullish. And there are times when they grow gloomy. These changes in sentiment tend to correspond to changes in the credit cycle. And what we are seeing is a major shift in both the credit cycle (it’s getting harder to borrow money)…and in mass sentiment (people are not so sure that prices will rise forever).
“There’s a reason,” said Henry Paulson, “why the dollar was the world’s reserve currency.”
Yes, there was a reason. But that reason too, is disappearing.
If we’re right, mass sentiment is changing in a fundamental way…and thrift may even become popular again.
Here’s a herald of things to come: from the Atlanta Constitution Journal :
“Radio host Dave Ramsey’s advice to people climbing out of debt is slap-your-forehead simple. It’s as blunt as a health guru telling fat people, ‘Just shut your pie hole’.
“So why did 5,000 people this week pay their way into the Gwinnett Arena – some shelling out US$169 – to hear the ever-more-popular Ramsey tell them the obvious?
“‘It’s not the information, it’s the inspiration,’ Ramsey said before the event. ‘This information is not rocket science.’
“It’s not. But it has made the once-bankrupt real estate investor a multi-millionaire. His syndicated show, based near Nashville, Tenn., is heard on 325-plus radio stations. He is among the nation’s top eight radio hosts with a weekly audience of 4 million, according to Talker Magazine. He implores listeners to cut up credit cards, pay off debt and live within their means, even if it means eating beans and rice or rice and beans.
“Ramsey, wearing a workman’s shirt and jeans, marched out and immediately connected to the middle and working class crowd.
“‘How many of you grew up like I did: not rich?’
“Five-thousand hands shot up.
“Like any good country singer might, Ramsey told the crowd his own tale of woe and redemption, of striking it rich in real estate by age 26 and losing it all when the bank called in his notes.
“Ramsey then went on a ‘quest to see how money really works. I found this disturbing concept called common sense.’”
The Daily Reckoning Australia