Silicon Valley Home Prices, Stock Prices & Bitcoin

I’m writing this post with a bit of trepidation, because talking about Silicon Valley home prices these days is a bit dicey. The surge of the last five years has been shocking, and almost no one I know feels good about how difficult it is for people to buy a new home in Silicon Valley in 2017.

So if you need a trigger warning, this is it. Stop reading now.

The truth is, as shocking as the rise in Silicon Valley home prices has been, there has also been an asset boom in other dimensions as well. Total compensation for engineers is up considerably and stock prices at the big tech companies continue to rise.

To visualize this, I thought I’d put together a few charts based on real market data. As a proxy for Silicon Valley, I pulled the last 5 years of home prices from Zillow, and monthly stock price data from Yahoo.

Palo Alto Home Prices

Two days ago, the Mercury News reported that a home in Palo Alto sold for $30 million.  A quick check on Zillow seems to confirm this.

I chose Palo Alto as a proxy for Silicon Valley home prices because it is historically “ground zero” for Silicon Valley tech companies, and it has relatively close proximity to all of the massive tech giants (Apple, Google, Facebook).

I picked June 2012 – June 2017, not only because it is roughly five years, but also it also happens to mirror the time that Facebook has spent as a public company. For many in the local real estate market, correctly or incorrectly, the Facebook IPO still looms as a transformational event.

As you can see, in June 2012 the average Palo Alto home cost $1.38 million. Five years later, the estimate for June 2017 is up 84.6% to $2.55 million.

Apple (AAPL)

Apple is the most valuable company in the world, as measured either by market capitalization ($810B as of 6/7/2017) or by profitability ($45.7B in 2016).  Thanks in part to this exception financial performance, Apple stock (AAPL) has risen 84.5% in the last five years, from $83.43 per share to $153.93 per share.

84.5%? Where have I heard that number before?

That’s right, the increase in Apple stock over the last five years is almost exactly the same increase as the average home price in Palo Alto over the same time period.

In June 2012, it took 16,555 shares of Apple stock to purchase the average Palo Alto home. In June 2017, it took 16,566 shares. (Of course, with dividends, you’re actually doing a little better if you are a shareholder.)

If you look at the chart, the pink line shows clearly the large rise in price for the average Palo Alto home. The blue line is the number of AAPL shares it would take to by the average Palo Alto home in that month. As you can see, AAPL stock is volatile, but five years later, that ratio has ended up in almost the exact same place.

Alphabet / Google (GOOG)

Alphabet, the company formerly known as Google, may not be as large as Apple in market capitalization ($686B), but it has seen far more share appreciation in the past five years. Since June 2012, Alphabet has seen its stock price rise 240.4%, from $288.95 in June 2012 to $983.66 per share.

What does this mean? Well, it means that if you have been fortunate enough to hold Google equity, the rise in Palo Alto home prices doesn’t look as ominous. It took 4,780 shares of Google to purchase the average Palo Alto home in June 2012, but it only took 2,592 to purchase the average Palo Alto home in June 2017.

Facebook (FB)

Facebook, the youngest of the massive tech giants, already has one of the largest market capitalizations in the world. As of today, Facebook is valued at $443B. Facebook stock has risen 394% in the past five years, from $31.10 in June 2012 to $153.63 in June 2017.

To state the obvious, it has been a good five years for owners of Facebook stock. Not many assets could make owning Palo Alto real estate look slow, but 394% growth in five years is unbelievable. In June 2012, you would have needed 44,412 shares to buy the average Palo Alto home. In June 2017, that number had dropped significantly to just 16,598 shares.

Bitcoin (BTC)

While I realize that Bitcoin is not a stock, the original idea for this post came from a joke I made on Twitter recently given all of the buzz about Bitcoin, Ethereum and ICOs over the past few weeks.

I couldn’t resist running the numbers.

For the small number of readers of this blog that haven’t been following the price of Bitcoin, the increase in value over the past five years has been unbelievable.The total value of all Bitcoin outstanding is currently about $44.5B. Since June 2012, Bitcoin has risen approximately 4,257%, from $6.70 per Bitcoin to a current value of $2,858.90.

You can see why there has been so much buzz.

In June of 2012, it would have taken 260,149 Bitcoin to buy the average home in Palo Alto. In June of 2017, that number is now down to 892.

Needless to say, anyone who sold Bitcoin to buy a house in 2012 is likely not loving these numbers. But to people who have held Bitcoin for the past five years, Palo Alto is looking cheaper by the day.

Silicon Valley Is Seeing Significant Asset Inflation

To be clear, I’m not attempting to attribute causality to these charts. I believe the real driver of home prices in Silicon Valley is the lack of sufficient building of new supply at pace with the economy, combined with a significant increase in compensation for technology employees and historically low interest rates.

But the fact is, if you are fortunate enough to have equity in one of the tech giants (or in Bitcoin), houses might actually be looking cheaper now relatively than they did five years ago.

I always find it enlightening to look at real data and compare it to intuition. Hope you find this data and these charts as interesting as I did.

The Decade of Gen X Wish Fulfillment

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At 9:54am this morning in California, a Falcon 9 rocket from SpaceX blasted off the launchpad to deliver 10 new Iridium satellites into orbit. 9 minutes later, the jettisoned first stage of that rocket ship self-navigated back down, landing perfectly and without damage. The dream of self-landing, reusable rockets, abandoned 50 years ago, has become a reality.

If you are a science & technology enthusiast, it is an unbelievable time to be alive.

Everywhere you look, there are signs that all of the science-fiction dreams of the 20th century are rapidly coming to life. Boom Aero is ready to bring economically viable supersonic jets (Mach 2.2) to commercial air travel, and several competitors are now racing to bring their own to market. In just a few years years, Tesla has reshaped the global automative industry by executing on their audacious plan to accelerate the transition to clean energy by proving the market-viability of electric cars. Google has not only brought self-driving cars to the tipping point of commercial viability, but it is sparked a global race to bring them to market by the end of this decade.

Uber is talking about flying cars. Amazon is patenting airship warehouses for drone for commercial delivery, and has delivered ambient voice control to our homes. Facebook is bringing us true virtual reality. Apple is delivering the equivalent of a crystal-in-our-ears to connect to the cloud. Moon Express will land on the moon in 2017.

 

What has changed so dramatically? Why are so many of our collective dreams, many of which predicted over 50 years ago, suddenly tumbling to market in an avalanche of advancement?

I have a simple hypothesis. We are living in a decade of Gen X wish fulfillment.

The Ascendent Economic Power of Gen X

ft_16_04-25_generations2050Poor Gen X. You can’t go ten minutes without seeing some political or economic framing around the political and economic tensions between the Baby Boom generation, the 70 million Americans born between 1946-1965, and the 90 million Millennials, born between 1981-2000. Sure, Gen X got a few TV sitcoms & movies in the 90s, but it was a brief time in the sun before the cultural handoff.

As of 2017, most members of Gen X now range from their late 30s to their early 50s. They have found careers, started families. More importantly, they have hit the economic sweet spot of the US economy. Wealth accumulation is highly correlated with age, and career success is as well. You can see it clearly in the numbers: Gen X is wealth is accelerating rapidly, faster than the Millennial generation, and over a smaller base of people, while Baby Boomers begin their inevitable asset decline as their retire.

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The Influence of Gen X Leadership

Like every generation, Gen X has produced a set of exceptional leaders, and many of them are now concentrated in technology, where the industry rewards founders and executives at a younger age than other industries. Larry Page & Sergey Brin at Google. Elon Musk at Tesla & SpaceX. Travis Kalanick at Uber. Jeff Bezos misses the cut off by a matter of months, but clearly fits the profile as well.

Demographers have always projected the window for Gen X would be hard: Baby Boomers are determined to hold on to power as long as possible, and Millennials have the political strength to force transition more quickly on their terms.

Still, we are clearly in a window of time where a fairly large number of Gen X leaders have accumulated significant economic power.

So what are they doing with that power?

Gen X Wish Fulfillment

Five years ago, Peter Thiel lamented that we were promised spaceships and flying cars, but all we got were 140 characters. The sentiment, in various forms, became common place. Why wasn’t Silicon Valley investing in hard problems?

Not surprisingly, it seems as if the peak of that disenchantment actually coincided with an incredible resurgence in investment in deep technology.

Gen X is, in the aggregate, almost canonically described as cynical and disenchanted. But with the ascendence of science fiction into Hollywood in the 1970s, they grew up seeing the future through the lens of technology. The boom in personal computing, followed by the internet, filled their formative years. True, huge initiatives of the 1970s around space and clean energy faltered and almost expired. But while there were disappointments, like the Space Shuttle, they also saw the end of the Cold War, and the phenomenal growth in the technology industry.

Is it really so surprising that a subset of this generation, in this brief window, has decided to invest its economic power into tackling the problems the previous generations failed to deliver?

Electric cars. Clean Energy. Gene Editing. Space Travel. Drones. Artificial Intelligence. Man-made diamonds. Robots.

Even our comic book movies have become phenomenal, mostly thanks to Jon Favreau.

Dreams transformed into reality.

Can Gen X Inspire?

Make no mistake, Gen X stands on the shoulders of giants. The previous generation gave us the economic and technology platforms to make these dreams become reality. Gen X deserves credit for not giving up on those dreams, and finding innovative ways to push through old barriers and find new solutions.

After winning World War II, the Greatest Generation inspired a whole new generation of scientists and engineers with their audacious efforts in technology in the 1950s & 60s. We may be witnessing a similar era, a decade where the technological achievements of this generation ripple through the children of today, and play out in second half of this century.

So many of the technical dreams I discussed eagerly with friends in high school and college are now actively being delivered to market, just twenty years later. It is an incredibly exciting time to be in technology.

Personally, I hope this generation will not only hand off and even better set of opportunities to the next, but we’ll use this brief window of time to inspire an even younger generation to reach for the stars.

 

The Millennial Definition of Success

Wealthfront Team, June 2014

Wealthfront Team, June 2014

It’s hard to believe in 2014, but when I first considered joining LinkedIn in 2007, most of my colleagues had trouble seeing the value in a platform built on top of what looked like an online résumé. At the time, when I was asked why I joined the company, I would tell them that it had always been true that success in business was based on what you know and who you know.  LinkedIn was just the modern incarnation of that powerful fact.

One of the most pleasant surprises in my current role at Wealthfront has been discovering how relevant career success is to millennial investors. As it turns out, every generation has grappled with the issue of how to find financial success, and millennials are no different.

What may surprise most people (including my compatriots in Gen X) is that more than any other generation, I believe that Millennials may have a lot to teach us. You see, it turns out that Millennials have figured out how to make that old adage actionable.

Who You Work With & What You Work On

Increasingly, as I talk to Millennials, some of whom who have found early success in their careers, and others who are just starting out, I hear the same things. This generation overwhelmingly associates success with control over who they work with, and what they work on.

There is an old refrain in management that people join companies, but they leave managers. There is a kernel of truth in that statement. However, in the modern workplace, relationships with colleagues, managers and leadership all have a role to play. Increasingly, valuable employees ask:

  • Am I learning from the people I work with?
  • Are we succeeding together as a team?
  • Do I share the same values as my colleagues?
  • Will I fight for them? Will they fight for me?

Driven by Passion, Seeking a Mission

There have been numerous surveys and studies indicating that Millennials are overwhelmingly focused on “their passions.” I think, in some regards, this has trivialized a more fundamental and important trend.

Is it really surprising that more and more people have realized that what you are working on matters?

The old duality of your work life and your personal life have been hopelessly intermingled. Instead of arguing about whether you live to work or work to live, in the 21st century people increasingly turning away from a purely mercenary view of their labor. They want to believe in the mission, believe their efforts are going towards something bigger than just financial reward. This is why you hear increasing anecdotes of young people choosing lower paying jobs, in some cases jobs that pay tens of thousands of dollars less, to focus on an organization that they draw more purpose from.

Success = Control

Not everyone has this luxury, and in some ways that is the point. What does success really mean, if it doesn’t mean that you get increasing control over who your work with, and what you work on?

Wealthfront now has over 12,000 clients, and most of them are under 35. What I find striking is that, overwhelmingly, with every success in their financial lives, these young people seem to immediately focus on using their success to gain control over their careers. They don’t seek to optimize for title, or  financial reward. Instead, they increasingly use their success to effectively fund the ability to work on a product they believe in, an organization they want to be part of, and a leader they want to follow.

As the CEO of a hypergrowth company, this leaves me with two pieces of actionable advice:

  • Financial reward is not enough. If you want to attract and retain the best and the brightest, financial reward is somewhat of a commodity, and an undervalued one at that. Instead, expect potential candidates to look at your company and ask, “Is this a problem I want to work on?” and “Are these people I want to work with?”
  • This is a networked economy. As Reid Hoffman has described, increasingly the value people build in their careers extends outside of your company. There is a material, and possibly essential difference, in a consumer business where your employees feel like they are punching a clock, versus a team that truly believes in what they are working on and the team they are working with. The influence of your employees, especially as your company grows, is under-measured, and as a result, under-appreciated. But in a huge networked economy, it may be the key to differentiated success.

From Technology to Politics: Leadership Lessons from the Code Conference

This past week, I was able to attend the inaugural Code Conference organized by Walt Mossberg & Kara Swisher.  One of the perks of the conference is, within close quarters, the chance to hear the leaders of huge, successful consumer technology companies.

      • Satya Nadella, Microsoft
      • Sergey Brin, Google
      • Brian Krzanich, Intel
      • Brian Roberts, Comcast
      • Reed Hastings, Netflix
      • Travis Kalanick, Uber
      • Drew Houston, Dropbox
      • Eddie Cue, Apple (iTunes / iCloud)

As I think about lessons from the conference, I find myself focused on a particular insight watching these leaders defend their company’s strategy and focus.  (It’s worth noting that anyone being interviewed by Kara does, in fact, have to be ready to play defense.)

David to Goliath

One of the most complex transitions that every consumer technology company has to make is from David to Goliath.  It’s extremely difficult in part because the timing is somewhat unpredictable.  Is Netflix an upstart versus the cable monolith, or a goliath itself as it is responsible for a third of all internet traffic?  When exactly did Google go from cool startup to a giant that even governments potentially fear?  Apple, of course, went from startup to giant to “beleaguered” and all the way to juggernaut.

Make no mistake, however.  The change in public opinion does happen, and when it does, the exact same behaviors and decisions can be read very differently in the court of public opinion.

Technology to Economics to Politics

Most technology companies begin with language that talks about their technical platform and achievements. “Our new product is 10x faster than anything else on the market,” or “Our new platform can handle 10x the data of existing platforms,” etc.  Sometimes, these technical achievements are reframed around end users: “We help connect over 1 billion people every day,” or “we help share over 10 billion photos a week,” etc.

Quickly, however, the best technology companies tend to shift to economics. “Our new product will let you get twice the sales in half the time,” or “our application will save you time and money.”  As they grow, those economic impacts grow as well.  Markets of billions of dollars are commonplace, and opportunities measured in hundreds of billions of dollars.

Unfortunately, as David moves to Goliath, it seems that many technology leaders miss the subtle shift in the expectations from their leadership.   When you wield market power that can be measured on a national (or international) scale, the challenge shifts from economics to politics.  Consumers want to know what leaders they are “electing” with their time and money, and their questions often shift implicitly to values and rights rather than speed or cost.

What Will the World Be Like Under Your Leadership?

As I watched various leaders answer hard questions about their companies, a clear division took place.  Most focused merely on questions of whether they would succeed or fail.  But a few did a great job elevating the discussion to a view of what the world will be like if they are successful.

There is no question that the leaders who elevated the discussion are finding more success in the market.

Satya Nadella gave no real reason why we would like the world better if Microsoft is successful.  Neither did Brian Krzanich of Intel.

Sergey Brin promises that in a world where Google is successful, we’ll have self-driving cars and fast internet for everyone.  Jet packs & flying cars.  It’s an old pitch, but a good one.

Eddie Cue tells us that Apple cares about making sure there is still great music in the world.  And of course, Apple has spent decades convincing us that when they are successful, we get new shiny, well-designed devices every year.

Is it really surprising that Google & Apple have elevated brands with high consumer value?

Technology Leadership

There is no way around the challenges of power.  As any company grows, it’s power grows, and with that power comes concern and fear around the use of that power.  Google has so much control over information and access to information.  Apple tends to wield tight control over the economics and opportunities within their ecosystem.  However, the leaders at these companies are intelligently making sure that the opportunities they promise the market counter-balance those fears, at least at some level.

Wealthfront, my company, is still small enough that we’re far from being considered anything but a small (but rapidly growing) startup in a space where giants measure their markets in the trillions.  But as I watched these technology leaders at the Code Conference, I realized that someday, if we’re successful, this same challenge will face our company.

If you lead or work for a technology giant, it’s worth asking the question:

Does your message elevate to the point where everyone understands the tangible benefit of living in a world where your company is successful?  If not, I’d argue your likely to face increasing headwinds in your efforts to compete in the consumer market going forward.

Google vs. The Teamsters

Yesterday, Google launched Chromecast, a streaming solution for integrating mobile devices with TV, part of another salvo against Apple.  Google vs. Apple has been the hot story now in Silicon Valley for a couple of years.  Before that, Google vs. Facebook.  Before that, Google vs. Microsoft.  Technology loves narrative, and setting up a battle of titans always gets the crowd worked up.

Lately, I’ve been thinking about the next fight Google might be inadvertently setting up, and wondering whether they are ready for it.

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Self-Driving Cars or Self-Driving Trucks

It turns out I’m not the only one who noticed that Google’s incredible push for self-driving cars actually has more likely applications around trucking.  Yesterday, the Wall Street Journal wrote an excellent piece about Catepillar’s experiments using self-driving mining trucks in remote areas of Australia.  It had the provocative headline:

Daddy, What Was a Truck Driver?

This is the first piece in the mainstream media that I’ve seen connecting the dots from self-driving cars to trucking, even with a lightweight reference to the Teamsters at the end.

Ubiquitous, autonomous trucks are “close to inevitable,” says Ted Scott, director of engineering and safety policy for the American Trucking Associations. “We are going to have a driverless truck because there will be money in it,” adds James Barrett, president of 105-rig Road Scholar Transport Inc. in Scranton, Pa.

The International Brotherhood of Teamsters haven’t noticed yet, or at least, all searches I performed on their site for keywords like “self driving”, “computer driving”, “automated driving”, or even just “Google” revealed nothing relevant about the topic.  But they will.

Massive Economic Value

The statistics are astonishing.  A few key insights:

  • Approximately 5.7 million Americans are licensed as professional drivers, driving everything from delivery vans to tractor-trailers.
  • Roughly speaking, a full-time driver with benefits will cost $65,000 to $100,000 or more a year.
  •  In 2011, the U.S. trucking industry hauled 67 percent of the total volume of freight transported in the United States. More than 26 million trucks of all classes, including 2.4 million typical Class 8 trucks operated by more than 1.2 million interstate motor carriers. (via American Trucking Association)
  • Currently, there is a shortage of qualified drivers. Estimated at 20,000+ now, growing to over 100,000 in the next few years. (via American Trucking Association)

Let’s see.  We have a staffing problem around an already fairly expensive role that is the backbone of a majority of freight transport in the United States.  That’s just about all the right ingredients for experimentation, development and eventual mass deployment of self-driving trucks.

Rise of the Machines

In 2011, Andy McAfee & Erik Brynjolfsson published the book “Race Against the Machine“, where they describe both the evidence and projection of how computers & artificial intelligence will rapidly displace roles and work previously assumed to be best done by humans.  (Andy’s excellent TED 2013 talk is now online.)

The fact is, self-driving long haul trucking addresses a lot of the issues with using human drivers.  Computers don’t need to sleep.  That alone might double their productivity.  They can remotely be audited and controlled in emergency situations.  They are predictable, and can execute high efficiency coordination (like road trains).  They will no doubt be more fuel efficient, and will likely end up having better safety records than human drivers.

Please don’t get me wrong – I am positive there will be a large number of situations where human drivers will be advantageous.  But it will certainly no longer be 100%, and the situations where self-driving trucks make sense will only expand with time.

Google & Unions

Google has made self-driving cars one of the hallmarks of their new brand, thinking about long term problems and futuristic technology.  This, unfortunately, is one of the risks that goes with brand association around a technology that may be massively disruptive both socially & politically.

Like most technology companies in Silicon Valley, Google is not a union shop.  It has advocated in the past on issues like education reform.  It wouldn’t be hard, politically, to paint Google as either ambivalent or even hostile to organized labor.

Challenges of the Next Decade

The next ten years are likely to look very different for technology than the past ten.  We’re going to start to see large number of jobs previously thought to be safe from computerization be displaced.  It’s at best naive to think that these developments won’t end up politically charged.

Large companies, in particular, are vulnerable to political action, as they are large targets.  Amazon actually may have been the first consumer tech company to stumble onto this issue, with the outcry around the loss of the independent bookstore.  (Interesting, Netflix did not invoke the same reaction to the loss of the video rental store.)  Google, however, has touched an issue that affects millions of jobs, and one that historically has been aggressively organized both socially & politically.  The Teamsters alone have 1.3 million members (as of 2011).

Silicon Valley was late to lobbying and political influence, but this goes beyond influence.  We’re now getting to a level of social impact where companies need to proactively envision and advocate for the future that they are creating.  Google may think they are safe by focusing on the most unlikely first implementation of their vision (self-driving cars), but it is very likely they’ll be associated with the concept of self-driving vehicles.

I’m a huge fan of Google, so maybe I’m just worried we may see a future of news broadcasts with people taking bats to self-driving cars in the Google parking lot.  And I don’t think anyone is ready for that.

Behavioral Finance Explains Bubbles

Note: This post ran originally in TechCrunch on April 20.  As a courtesy to regular followers of my blog, I’ve reposted the content here to ensure that longtime readers have access to it.

“Bubbles are beautiful, fun and fascinating, but do you know what they are and how they work? Here’s a look at the science behind bubbles.” – About.com Chemistry, “Bubble Science

“Double, double toil and trouble
Fire burn, and cauldron bubble.” – Macbeth, Act 4, Scene 1

Given the incredible volatility we’ve seen lately in the Bitcoin and gold markets, there has been a resurgence in discussion about bubbles. By my perspective, after working for North Shore Advisory in the valley, this topic is always top of mind in Silicon Valley, especially given that the two favorite local topics of conversation  are technology companies and housing.

Defining a market bubble is actually a bit trickier than it might first appear. After all, what differentiates the inevitable booms and busts involved in almost any business and industry from a “bubble”?

The most common definition that a financial advisor will give of a speculative or market bubble is, when a broad-based, surging euphoria or wave of optimism carries asset prices well beyond supportable value. The canonical bubble was the tulip mania of the 1630s, but it extends across history and countries all the way up to the Internet bubble of the late 1990s and the housing bubbles in the past decade.

WHAT DO BUBBLES LOOK LIKE?

Not surprisingly, there are a number of great frameworks for thinking about this problem.

In 2011, Steve Blank and Ben Horowitz debated in The Economist whether or not technology was in a new bubble. In those posts, Steve cited the research of Jean-Paul Rodrigue denoting four phases of a bubble: stealth, awareness, mania and blow-off.

bubble chart

(Source: Wikipedia)

HOW DO BUBBLES HAPPEN?

In 2000, Edward Chancellor published an excellent history and analysis of market bubbles over four centuries and a wide variety of countries called “Devil Take the Hindmost: A History of Financial Speculation.” In his book, he finds at least two consistent ingredients.

  • Uncertainty. In almost every bubble, there seems to be some form of innovation or insight that forces people to rapidly debate the creation of new economic value. (Yes, even tulip bulbs were once an innovation, and the product was incredibly unpredictable.) This uncertainty is typically compounded by some form of lottery effect, exacerbating early pay-offs for the first actors. Think back to stories about buying a condo in Las Vegas and flipping it in months for amazing gains. This creates the inevitable upside/downside imbalance that Henry Blodget recently framed as: “If you lose your bet, you lose 100%. If you win your bet, you make 1000%.” Inevitably, this innovation always leads to a shockingly large assessment of how much value could be created by this market.
  • Leverage/Liquidity. In every bubble, there is some form of financial innovation that broadly increases both leverage and liquidity. This is critical, because the expansion of leverage not only provides massive liquidity to fund the expansion of the bubble, but the leverage also sets up the covenants that inevitably unwind when the bubble turns aggressively to the downside. In some ways, it’s also inevitable. When a large number of people believe they’ve found a sure thing, logic dictates they should borrow cheap money to maximize their returns. In fact, the belief it may be a bubble can make them even greedier to lever up their investment so they can “cash out” the most before the inevitable break.

BEHAVIORAL FINANCE LESSONS IN BUBBLES

Bubbles clearly have an emotional component, and to paraphrase Dan Ariely, humans may be irrational, but they are predictably irrational.

There are five obvious attributes of components of bubble psychology that play into market manias:

  1. Anchoring. We hear a number, and when asked a value-based question, even unrelated to the number, they gravitate to the value that was suggested. We hear gold at $1,500, and immediately in the aggregate we start thinking that $1,000 is cheap and $2,000 might be expensive.
  2. Hindsight Bias. We overestimate our ability to predict the future based on the recent past. We tend to over-emphasize recent performance in our thinking. We see a short-term trend in Bitcoin, and we extend that forward in the future with higher confidence than the data would mathematically support.
  3. Confirmation Bias. We selectively seek information that supports existing theories, and we ignore/dispute information that disproves those theories. (This also tends to explain most political issue blogs and comment threads.)
  4. Herd Behavior. We are biologically wired to mimic the actions of the larger group. While this behavior allows us to quickly absorb and react based on the intelligence of others around us, it also can lead to self-reinforcing cycles of aggregate behavior.
  5. Overconfidence. We tend to over-estimate our intelligence and capabilities relative to others. Seventy-four percent of professional fund managers in the 2006 study “Behaving Badly”believed they had delivered above-average job performance.

The greater fool theory posits that rational people will buy into valuations that they don’t necessarily believe, as long as they believe there is someone else more foolish who will buy it for an even higher value. The human tendencies described above lead to a fairly predictable outcome: After an innovation is introduced and a market is formed, people believe both that they are among the few who have spotted the trend early, and that they will be smart enough to pull out at the right time.

Ironically, the combination of these traits predictably leads to these four words: “It’s different this time.”

IT’S DIFFERENT THIS TIME

After two massive bubbles in the U.S. in less than a decade, many people question spotting bubbles ahead of time is so difficult. In every bubble, a number of people do correctly identify the bubble. As in the story of the boy who cried wolf, however, the truth is apt to be disbelieved. The problem is that in every market, there are always people claiming that prices are too high. That’s what makes a market. As a result, the cry of “bubble” is far more often proven wrong than right.

Every potential bubble, however, provides an incredibly valuable frame for deepening and debating the role of human psychology in financial markets. Honestly and thoughtfully examining your own behavior through a bubble, and comparing it to the insights provided by behavioral finance, can be one of the most valuable tools an investor has to learning about themselves.

Apple & Dow 15000: Update

In February 2012, I wrote a blog post that indicted the Dow Jones Industrial Average for including Cisco in 2009 instead of Apple.  At the time, Apple had just crossed $500 per share, and that simple decision had cost the US the psychology of an index hitting new highs.

I was driving home on Sunday, listening to the radio, and it occurred to me how different the financial news would be if Apple ($AAPL) was in the Dow Jones Industrial Average (^DJI).

Of course, being who I am, I went home and built a spreadsheet to recalculate what would have happened if Dow Jones had decided to add Apple to the index instead of Cisco back in 2009.  Imagine my surprise to see that the Dow be over 2000 points higher.

Update: AAPL at $700

With the launch of the iPhone 5, we find ourselves roughly 7 months later.  For fun, I re-ran the spreadsheet that calculated what the DJIA would be at if they had added AAPL to the index in 2009 instead of CSCO. (To date, I’ve never seen an explanation on why Cisco was selected to represent computer hardware instead of Apple.)

Result: Dow 16,600

As of September 17, 2012, AAPL closed at 699.781/share.  As it turns out, if Dow Jones had added Apple instead of Cisco in 2009, the index would now be at 16,617.82.  Hard to think that hitting all new highs wouldn’t be material for market psychology and the election.

Anyone up for Dow 20,000?