Bubbles, Hype and Being Early

Monday, September 18th, 2023

Now that the Zero Interest Rate Policy has been unwinding, I have exited earlier.

I remember starting to explore that, but then my wife interrupted and said, 'But you said it's better to hold long term.'

End of the thought experiment.

That was my mistake in two parts: one was ending because of a stagnant response; second, and more important, was asking in the first place.

My first lesson is that being early and thinking about what to do in these complex games means playing with people who are also able to think deeply.

I reference my wife illustratively not to single her out, although it helps to understand why many people fail to address bubbles well: the people close to them, whether family or work or broader social networks are not thinking.

If these people aren't willing to engage and ask questions which may involve pivoting from simple, tldr; statements, then it's going to be very, very hard to find alpha.

And if there's true alpha, then the number of people you can have this conversation with is, by definition, also small.

So what does this mean in terms of identifying things with one's "gut" or asking, "i don't understand how this is working?"

Which was definitely what I was thinking in the mania of ZIRP.

I saw certain stocks go to unbelievable PE ratios and wondered whether it can actually grow into that valuation, or if it's better to take things off the table.

Sometimes I think it is better to actual think it out and be very, very thoughtful when one is concentrated and now we're in a super bad place.

But I was using the past and not seeing the extrapolation properly.

Splunk had an outsized valuation because, at the time, SaaS and tech valuations were small; as the markets grew over time, the alpha became huge; however, with Cloudflare which started later, much of that got baked in.

So expecting the same compounding effect was totally wrong.

Second, the cheap money was already flowing; ZIRP was a one-time bubble, much like the dot com, and so thinking that the valuations would be something we would grow into was also a mistake versus getting in and out.

Was this necessarily a case of hindsight?

No, people were talking about ZIRP in the middle of the mania and asking, how long can this continue? And that's the time to start thinking, which is what I was doing. I think it's better to take profits when you can, versus riding them indefinitely, which is what I was doing.

I felt like I didn't know what was going on, other people know better, and what are they doing?

The problem with this is, I don't know what the smart money is doing.

There's no way for me to know, so my options are:

None are that easy.

Thinking independently in these complex games is especially hard.

For example, my thought process was:

The biggest flaw is looking externally for signals. I do know, however, that there have been some investors who, since 2018, stayed in cash while the market soared because the numbers didn't look right.

So that "independent" thinking also failed to incorporate an understanding of the existence of bubbles and the macro dynamics causing it.

Perhaps some of the things to ask would be:

That being said, I think there are some people who have been early.

Bitcoin, NFTs, before the influx of money, angels into major startups.

What was it, and it wasn't independent thinking.

It was being in the "cool crowd" and finding or making the trend a reality.

Bitcoin was at the edge of culture with smart people doing things of their own interest and the rest of the world caught on.

Twitter was strange and didn't make sense for the longest time till it did.

Being weird and having a passion that gives you some forward momentum and an ideal is a way to get alpha, because it's not based on evidence. As markets accelerate and the information networks become denser, evidence-based signal travels faster, killing alpha. The same mechanisms also accelerate the spread of the foolishness of the crowds, such as hype cycles -- and so seeing hype cycles for what they are is also not a bad way to make money if you keep cool.

In other words, when Reddits are talking about "lambo" there's a signal to get out or at least wait and not get in.

When your not-so-thoughtful friends or relatives are asking you about something, that's also probably a sign it's too late or dumb.

Is it possible to, however, have a tight circle of high-alpha, because there's still extreme value in having multiple people share something with each other.

The problem is that in an age of monetizing content, there's incentive to share or sell those insights, which reduce their value.

Perhaps the real value in the future is the ability to be early and have trusted high value friends who will do the same for you. Is trust the only mechanism that binds such small tight circles together?

I don't know.

Sometimes it is another incentive mechanism. While collusion is implicit when the parties have market making power (like OPEC oil providers or Big Tech), collusion amongst individual actors might be the way forward.

Is that possible to do while also fostering trust and friendship?

And the larger question is: how do you find such people?