This note is about the emotions that underlie market manias. I wrote it as a companion note to yesterday’s piece on the stock market.

Something about the human emotional experience changes when people gather into groups. Actions that people would never undertake alone (e.g., mob violence) suddenly become possible or even likely. I believe something like this is also going on when financial markets enter into periods of hype.

In this note, I’ll discuss two major types of fear that I see as driving “irrational” market behavior: the fear of missing out, and the fear of being alone.

The Market Backdrop

The stock market has had an amazing run so far this year:

Year-to-date, the S&P 500 has gained about 18%. The historical return on the index is about 10%.

You could pick several points throughout the year where you could look at market fundamentals with a similar lens to mine and conclude that the market is seriously overvalued. And yet, many people probably felt similar concerns (fear) to mine, and decided to invest anyway.

What’s going on for them?

How Does It Feel When Someone Else Made 18%?

This is the fear of missing out.

It’s the same emotion that drove the crypto mania of 2021, where many people, despite feeling internal unease about the sector, made investments in the space and ended up losing all of their money.

I am not sure that the fear of missing out is entirely fear. I think it starts in regret, or maybe anger. There’s some kind of emotion that gets triggered in human beings when we see someone near us (can be a stranger) make a decision that results in material gain, and we failed to make the same decision. It’s the voice that says “I wish I had…” or “I am really kicking myself that I didn’t [x] when I had the chance.” That’s the root emotion.

When a similar circumstance arises in the present, we remember that anger or regret that we felt, and we don’t want to feel that again. So it isn’t really a fear of missing out, but more a fear of feeling the negative emotion when we missed the chance the first time.

Regardless of what it is, it’s a powerful motivator, especially in financial markets. If everyone else is getting rich, we want to get in and get rich too. Or even more than that, we don’t want to feel the pain of missing the chance to get rich. And the more people involved, the more overwhelming the emotion becomes (like mob behavior) and the closer a market advance goes to becoming a mania.

This is my key hypothesis: the stronger the market performance, the more powerful the underlying emotion becomes, and the larger the gap between economic fundamentals and market prices grows.

Safety in the Herd

The herd represents safety.

In 2007, when asked about Citigroup’s risky lending practices, CEO Chuck Prince infamously said: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

This mirrors some cynical wisdom about careers in finance: it’s better to be with the crowd and wrong, than be right by yourself. The financial crisis hit in earnest in 2008, but there were clear warning signs in 2007. Prince could have taken steps to reduce risk at Citigroup, but if he did that and the market collapse didn’t materialize in short order, his firm’s performance would have been compared to that of its peers (who would have continued engaging in risky practices and earning outsize returns) and found lacking. Two or three years of that would have led to Prince’s ouster.

The same is true for ordinary investors. Nobody wants to be the only person in their friend group that didn’t invest in something and as a result be the only person that doesn’t make money. I can imagine feeling shame at a barbecue when I’m the only person out of my friends that didn’t act on the stock tip we all got three months ago. Or, if it sounds like a bad idea, there’s no shame in all of us being wrong together.

And most of the time, doing the same thing everyone else is doing is safe. If you’re emerging from an Internet fast and you see everyone buying bottled water and boarding up windows, it’s probably a good idea for you to stock up on supplies and board your own windows even if you have no idea what is going on. But in finance, because of the interaction between markets and crowd psychology, the key to success is often figuring out when the crowd is wrong and doing the opposite. But from a career perspective, even that doesn’t pay well in the short-term.

The Fear We Ignore

There’s a third fear I want to address: the internal, nagging sensation that something is wrong.

I believe that during wild market advances (like crypto in 2021), this is an emotion that many people feel but dutifully ignore. To me, this is the fear of the subconscious mind having analyzed a situation and found that something is seriously amiss. It’s a sixth sense, a danger sense.

This is the emotion I feel when I see an S&P 500 earnings yield of 1.32%, when I see NVIDIA trading at a P/E of 75, and most importantly, when I see that short-term interest rates have increased 500 basis points and the stock market has gone up. That’s not right. It’s not supposed to work like this.

It’s hard to listen to this fear, especially when we constantly receive evidence that this fear is misplaced (e.g., the market continues to climb). After some time, we may begin to doubt ourselves and doubt our intuition. There’s a saying in finance that addresses this feeling: “the market can stay irrational longer than you can stay solvent.” We can be right in the face of ongoing evidence to the contrary, but we’ll be dead before we’re proved right.

Exercise

Journal on the following or discuss with a friend.

1)      Noticing

What is an area of your life where you are acting from a fear of missing out, or seeking safety in doing what everyone else is doing?

2)      Listening to Intuition

What is your gut saying about your behavior? What nagging sensation are you ignoring when you act from a fear of missing out, or when you blindly follow the herd?

3)      Action

What would acting from your intuition look like? What is a small, low-risk action you can take in support of your intuition?

(I am not telling you to sell all your stocks. Do something small.)