On an intellectual level, most investors have no trouble understanding the notion that high past returns result in high prices, which, in turn, result in lower future returns. But at the sam time, most investors find this almost impossible to accept on an emotional level. By some strange quirk of human nature, financial assets seem to become more attractive after their price has risen greatly. …
… If prices fall drastically enough, they become the lepers of the financial world. Conversely, if prices rise rapidly, everyone wants in on the fun.
William Bernstein wrote in “The Four Pillars of Investing – Lessons for building a winning portfolio”.
Eventually, it’s all in the mind. The value of an asset is always in the way it is perceived. When you think of market price, it often gets misleading. The crowd sets the prices of the assets and the crowd depends on the same. This often becomes a vicious or a virtuous cycle. The crowd leads itself astray.
Here is an excerpt from the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”
Speculative euphoria as the Pied Piper
Large-scale speculation in any asset is a recurring phenomenon. History suggests that every now and then, we will witness euphoric activities – the asset may change, the people may change, the place may change; but there will always be some such events at an amazing regularity.
This is the period when common sense takes a back seat. Incidentally, the current indicators, all point in only one direction – that of the current momentum. The Pied Piper of speculation is at work. Just like the story above, the music is heard only by those who get into the spell of the market and they cannot control themselves from following it. In the story, the Pied Piper took the children to the other side of the hill never to return. In real life, the Pied Piper of speculation takes investors’ money to the other side of the mountain (called expensive markets).
People chase the hottest fad assuming that this is never going to end. The immediate past is extrapolated into infinite future.
#RidingTheRollerCoaster – 175