To pay tribute to one of its most famous graduates, Kenneth J. Arrow, Columbia University launched an annual lecture series dealing with topics to which Arrow made significant contributions—and there were many. Speculation, Trading, and Bubbles stems from the third lecture in the series given by José A. Scheinkman, with adapted transcripts of commentary by Patrick Bolton, Sanford J. Grossman, and Arrow himself. I’m going to confine myself here to a few excerpts that encapsulate some of the lecture’s key points, ignoring the often perceptive commentary.
Scheinkman offers a formal model of the economic foundations of stock market bubbles in an appendix to his lecture, but he lays out its basic ideas in the lecture proper. The model rests on two fundamental assumptions—“fluctuating heterogeneous beliefs among investors and the existence of an asymmetry between the cost of acquiring an asset and the cost of shorting that same asset. … Heterogeneous beliefs make possible the coexistence of optimists and pessimists in a market. The cost asymmetry between going long and going short on an asset implies that optimists’ views are expressed more fully than pessimists’ views in the market, and thus even when opinions are on average unbiased, prices are biased upwards. Finally, fluctuating beliefs give even the most optimistic the hope that, in the future, an even more optimistic buyer may appear. Thus a buyer would be willing to pay more than the discounted value she attributes to an asset’s future payoffs, because the ownership of the asset gives her the option to resell the asset to a future optimist.” (pp. 15-16)
1.) It’s not valuation that matters. It’s risk and reward in the growth cycle of each company. – Leigh Drogen “The Coming Tech Crash”
2.) Most importantly for the upside of the market, no one owns stocks.
There are millions of traders flipping stock with institutions in high growth names, but there are no rational conversations about the growth opportunities.
3.) The media latches on to Steve Jobs not distributing the cash and thank god he laughs in their faces. Why should he trust the public with that cash. The public has proven to be imbeciles.
5.) Nietzsche was right- what doesn’t kill you makes you stronger. – Pension Pulse, “Put Yourself First“ 6.) “You’ve got to have the passion to do your time. If you haven’t done the time, you just can’t get there.” He goes on to argue that only by paying one’s dues through time, effort, devotion, and experience can we, “develop the rich experiences that make life meaningful.” – Top 10 Things That Determine Happiness 7.)Economists who adhere to rational-expectations models of the world will never admit it, but a lot of what happens in markets is driven by pure stupidity – or, rather, inattention, misinformation about fundamentals, and an exaggerated focus on currently circulating stories. – Robert Schiller, via Stone Street Advisors ” Driven by Stupidity“ 8.) No company gets to be worth twice as much in 60 days as it was before to any intelligent person, so when that happens, we take advantage of it. – Steve Wynn , via Stone Street Advisors “ Driven by Stupidity“
9.) Keep in mind that you dont have to be sending orders to be working. Avoid nurturing the belief that nonparticipation is not working. This leads to overtrading or compulsion which is the practice of poor risk management.
10.) A series of loses first eats into your account balance, and then begins to eat into what is most important of all: your confidence. Trade with confidence or don’t trade at all. If you cant take the heat, stay out of the kitchen.
Whether it’s subprime auto lending, Janet Yellen’s “stretched” biotech sector, or corporate credit, bubbles abound in today’s fragile market and like Mark Cuban, Prem Watsa thinks the valuations investors are placing on private tech companies are simply ludicrous. But the insanity isn’t confined to private companies, Canada’s Warren Buffett says. “Speculation” is rampant in publicly traded shares as well.
From Fairfax Financial’s shareholder letter:
I am always amazed at the speculation that can take place in the stock market, as shown in the table below, and how long it can last: