“when assets are expensive, make assets,” they said.
— Corey Hoffstein 🏴☠️ (@choffstein) January 18, 2022
His tweet brought my attention to @cobie and his masterful description of psychology.
I also appreciated Josh Brown’s take on the sell-off in so-called growth or momentum names. Here’s an excerpt from Jan 31’s It’s not over yet.
I’m less interested in the real-time action. Focus the evergreen psychology instead:
Where do bounces come from in a midst of a correction?
Sometimes it’s just that stocks have fallen too far for sellers to want to keep selling. This isn’t bullish. In fact, this type of bounce can suck people back in by creating the appearance that the worst is over. Growth stocks in particular. Because belief dies hard and enthusiasm for cutting edge technologies fades slowly, not suddenly. Which mean the give-up process is long and drawn out – even after a stock is cut in half sometimes the worst is still yet to come. The slow bleed after is often worse than the initial shocking drop that preceded it.
Over at Verdad Capital, Dan Rasmussen revisits their “Bubble 500” list of overpriced growth stocks, originally created in the Summer of 2020. It’s filled with money-losing companies working in exciting areas of technology such as electric vehicles and gene editing therapy and so on. Needless to say, this list of bubble stocks has gotten absolutely destroyed year-to-date, after having run straight up in Verdad’s face through the middle of 2021. Dan explains two very important things in his update this week: The first is that sell-offs for growth stocks differ from sell-offs for value stocks in one very important way:
This breakdown is significant, especially for growth stocks. Remember, growth stocks trend, and value stocks mean revert. The psychology is simple. People hear about a hot stock that’s gone up 3x, they buy some, it goes up 2x, they buy more: the whole attraction of buying a hot growth stock is the historic return trajectory. Value stocks are the opposite: you do well buying them when they’re down…
This idea is counterintuitive – that some stocks actually become worse buys as they are falling to lower prices, but the explanation is psychological, not financial. Stocks trading at excessive valuations require a fan base to sustain their share prices. That fan base is often a bandwagon-jumping melange of traders and investors who are attracted to recent gains. Yes, they’ll latch onto the fundamental story, but the fact that the stock has been and currently is going up is the main thing. When the stock breaks, so too does the fandom. And when the fan base moves on to greener pastures or runs out of money, a new fan base will not form for this stock with its chart in decline. Broken growth stocks become orphans. There is no natural place for them to find a home.
Momentum is a divergent strategy while “value” is a mean-reverting strategy. Several years ago the research team at OSAM published edifying papers on how these approaches work. I wrote a summary here:
✍️ Notes on OSAM’s Factors from Scratch (6 min read)
Value works by fading overreaction. Momentum is attributed to underreaction. In a name trending higher, the sellers are discounting the substance of new information too aggressively. In dork world, we call this anchoring. If you pay attention to “anomalies” you may recognize the concept of post-earnings drift as an acute example of anchoring. Wikipedia even has an entry for it.
Fear or FOMO in markets cuts both ways. On the way down, we fear a loss of wealth. On the way up we fear social embarrassment — we aren’t keeping up with our neighbors. We are caught between self-preservation and shame. I wonder if being part of the herd is any consolation on the way down while everyone loses. Or is this just another miserable psychological asymmetry inseparable from speculation?
Anyway, I don’t have much to add. Investing requires you to be honest about your desires, constraints, and emotional tolerance. If you can get honest with yourself, you can initiate a plan that you can stick to. You want to avoid ad-hoc decisions with the bulk of your savings (I’m not gonna poo poo on gambling with 1 or 2% of your wealth, especially if it suppresses wider risk-seeking behavior. Agustin Lebron’s Laws of Trading has a provocative section about “risk set points” that operate like weight set points. If your life becomes too dull in one way you spice it up in another and vice versa. Maybe Alex Honnold’s portfolio is all in bonds 🤷🏽).
Oh and just a quick observation that you can ponder in the context of those flashy, earningless momentum stocks. If you start at $1 and double 6x you get to $64. If the stock drops 50%, you’ve only erased 1 halving.
Be careful knife catching.