Oil and water, winter and summer, north and south… these are all pairs that completely contrast each other and represent very different properties. My interest in finance versus my interest in celebrities is a perfect example of this stark contract.
However, the dark dichotomy that poses a huge risk when managing your investments is the trap of falling into one of the categories of “permabear” or “permabull”. I use the word dark not only for alliteration purposes, but because of the dangers that come with falling into one of these categories.
A perma is someone that has a permanently fixed view of the markets or a particular stock or industry. Permabulls are people that are always bullish, or very upside biased, whereas a permabear is the complete opposite. Although markets are biased to the upside over the long term, having a permanent bias at all times is not advantageous and can prevent one from having a clear mind to all potential outcomes of a given scenario. Permabulls are accused of thinking that markets and stocks will always go up without regard of company fundamentals and economic conditions, making then completely blind to the potential downside. Short sellers are typically accused of being permabears who find reasons as to why a particular company or industry should be priced lower, or should be experiencing a recessionary period.
While both permabulls and permabears may have compelling, and often accurate, arguments that satisfy their view points, the purposeful blindness and disregard for outcomes that go against their viewpoint is what can become dangerous and lead to irrational money management and under performance of the market.
There are sector or company specific names that have a very “cult like” following or permabull viewpoint towards. A perfect example of this are companies that have great growth prospects behind it and great brand equity if you will, but do not have the current fundamentals to support its exuberant valuation. The tech and marijuana sectors have been the worst for this over the last 2 years. People were gobbling up shares of marijuana companies like there was no tomorrow back in late 2018 and into 2019 following legalization in Canada, without any regard for company fundamentals or for doing any research on the financial position of these companies. However, once the hype was over and these companies started reporting earnings, the permabulls buying the cannabis sector at all time highs in Q1 of 2019 got absolutely decimated throughout the rest of year as company stock prices regressed lower to better reflect company valuations.
It wasn’t too long ago that companies were changing their name to incorporate the word “blockchain” to make it seem more appealing to investors during the rapid climb of crypto currency prices in 2017. This exponential run up in price was inevitably follow by a rapid downtrend in crypto currency prices across all currencies.
Another permabull example is Tesla. Tesla has the largest cult like following I’ve ever seen of a publicly traded company. The recent short squeeze that has sent Tesla to 600+ dollars per share in January 2020 hasn’t helped, but this rapid growth in stock price has solidified many current permabull biases and has fuelled more individuals to join the upward bias bandwagon. These are some news headlines following the recent climb in Tesla stock price in January
“Tesla just proved all its haters wrong. Here’s how.”
“Here's How Tesla Shares Will Hit $7,000 By 2024”
“It’s only a matter of time before Tesla’s stock gets this huge support”
The reason I point out these articles are not because Tesla won’t one day reach $7,000 per share, but it’s because these articles were created and posted after the fact that the stock has already exploded upwards for a few months straight. The articles are reflecting a bias based on short term prior performance. As mentioned in Lesson 32, this is a perfect example of limited processing.
Now on to the permabear side. There are naysayers, and then there are permabears. Typically, these individuals have a very downward bias (or even cynical view!) of the markets and overall economy. While the long-term history of the global economy proves permabears wrong, they can be a very objective source of information when looking at the current status of a company or industry that seems to be in great shape and all “honkey dory”. I do enjoy reading material from permabears and getting their interpretation of macroeconomic events or metrics to keep me open minded to different possibilities of short term market trends and global economic policy impact. However, focusing solely on the view of permabears will have you always waiting for an Armageddon like global economic collapse while missing out on the long-term gains of markets. Here are some good examples of permabear market headlines:
“A prominent Wall Street permabear says the stock market is ‘stoned on free money’ and it could ‘prove fatal’” – must be a genie since this person is described as “prominent”. Also, this article was posted in February 2019, right after the markets saw a three-month correction going into the new year. Look what happened following the article post. Markets finished the 2019 year up 18.2% from the date the article was posted:
Figure 1: S&P500 Chart Feb 2019 to Feb 2020
“Hedge-fund veteran Mark Yusko is predicting a ‘dreadful bear market’ in 2019”
Again, similar to those Tesla articles, this article has been posted after the markets had already seen a decline of 10% ending the 2018 year. This article fails to objectively assess the future economy by forming a bias based on prior short-term performance.
A good strategy to help with preventing investment biases is to take your 3 best investing ideas, and come up with counter arguments as to why these investments are bad ideas. Play devils advocate with yourself or with your friends. This will challenge your own thinking and decision making. In addition, take your 3 worst investing ideas and come up with arguments as to why they are great ideas. Through this exercise, and through reading finance news articles more objectively, you will quickly realize that often, for every bull argument, there is a bear argument.
In summary, markets are often unpredictable, and it is for this reason that it is important to remain unbiased and clear minded when making an investment decision. As soon as you classify yourself as one or the other (perma bear or bull), you have become biased to only that direction. This is not good because markets, industries, and equities don’t move in one direction in the short term, or possibly ever when talking about individual company’s stock! Having an objective way of thinking will help in avoiding a confirmation bias mentality. Avoiding the “perma” dichotomy trap will improve your financial decision making and timing, and improve resilience to black swan events while remaining exposed to white swan events.
The avoidance of one dark dichotomy to more effectively manage another dichotomy is what I like to call a “dual dark dichotomy”. The alliteration sounds good, doesn’t it?