7 Common Trading Mistakes Part 7: Believing that things are different this time
Remember the dot-com bubble of the late 1990’s? How about the real estate bubble leading up to 2007? I remember the enthusiasm about the “nifty fifty” back in the late1960s and early 1970s. The nifty-fifty were considered by some to he such high quality firms (e.g., Kodak, Sears, Polaroid) that there was virtually no limit to how high a price an investor should be willing to pay to own them and virtually no chance that the investor could lose money in the long run. But Kodak, Sears, Polaroid are three examples of the flaws in that theory. That attitude seems to be alive today with the FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google-Alphabet).
When “things are different this time” begins to dominate the psychology of most traders, a battle emerges between those who believe in old-fashioned valuation approaches made popular by Benjamin Graham and those who hope there is a new era of valuation. When a particular style of investing or market sector generates stunning performance for quarter after quarter after quarter the idea that it is a good time to jump on the band wagon becomes more and more enticing. People naturally and rightfully want to avoid the prolonged pain of missing out on the band wagon.
But long-term evidence is that extraordinary valuation levels by historical standards tend to revert towards more traditional levels.
Mark Twain noted : “If a cat sits once on a hot stove, that cat won’t sit on a hot stove again. But then again, that cat won’t sit on a cold stove either (paraphrased)”. Those of us who avoided speculations on the FANG stocks or Bitcoin are feeling the pain. There is a temptation to make sure that we jump in on the current bandwagon or the next bandwagon to avoid further pain. But that usually turns out badly. We should hold well-diversified portfolios, no matter how much pain that has caused us in recent years when we look at the fortunes made in FANG stocks and Bitcoin.