Jeremy Grantham has recently been interviewed reiterating his expectation that this bubble will reach 2350 on the SPX before collapsing. He bases this view on historical bubbles which have exceeded two standard deviations. Maybe he’s right, but where I differ is that bubbles are all about emotion and behaviour, not about numbers. In fact, bubbles occur because people have decided to ignore numbers and rational analysis and let their hearts rule their heads. They are overcome with the satisfaction of steady gains, with the fear of missing out, with the feeling of belonging to the in-crowd, with the fear of being rejected or derided… I could go on, but nowhere on the list is any analysis of rational expectations.
People believe that somehow they will know when it is time to leave the party with their joie de vivre intact and their pockets full of cash. And maybe they will, but the problem is that in order to do so they need to sell their speculations to someone else. They need to find someone who is even more willing than they are to assume risk. And that can be very, very difficult if the lights are flashing, the band is packing up, and the only people with the capacity to buy are the hard-headed bears.
The time to leave the party is when happiness and euphoria are still rising and the social and emotional pressure to stay is high. That’s not so easy. You must be willing to watch the party go on without you as you forgo the music, the conversation, the punch and the snacks. It seems as if the party will never end. Remember Sir Isaac Newton? He left the South Seas Company party in good time for the right reasons, but then could not stand being left out. He bought back in and lost his shirt. And this is one of the smartest, if not the smartest, of men who ever lived.
And no, I feel no shame in mixing metaphors.