There was a poll taken the other day showing that Colorado voters prefer having Eli Manning as the quarterback of the Denver Broncos over Tim Tebow. The poll states: “Democrats prefer Manning by 46 points, 60/14, while Republicans do by just a 7 point spread at 44/37. Every group of the electorate prefers Manning over Tebow except for ‘very conservative’ voters, who go for Tebow 53/28.”
There’s an important message for stock investors in these words. Five important messages, actually.
1) People Are Nuts
It’s one thing to acknowledge that there are legitimate differences of opinion about whether Tim Tebow can be a winning quarterback in the NFL. It’s something else to note that people form their assessments re this question based on their political leanings. Democrats prefer Manning by 46 points while very conservative voters go for Tebow 53/28? Huh?
People are nuts.
This is an important investing insight. I often point out that stocks were priced at three times fair value in January 2000. This means that those who directed $9,000 to the purchase of stocks in that year obtained $3,000 worth of return-producing stock goodness and $6,000 worth of cotton-candy nothingness fated to be blown away in the wind sometime over the course of the next 10 years.
Many of my readers question whether it is reasonable to conclude that investors for a time got the stock price so wildly wrong. But look at that Tebow result. People are not logic-processing machines. Our emotions influence us. A lot.
2) People Sound Smart
We are nuts. But our craziness usually evidences itself in intelligent sorts of ways. This makes it hard to detect the nutty part.
If you asked the people who were polled why they favor Tebow or Manning, they would give plausible-sounding answers. The Manning supporters would note that even Tebow acknowledges that Manning has the far better passing mechanics. And that would seem to settle the matter. But, if you asked one of the Tebow supporters for his reasoning, he would point out that Manning missed an entire season due to injury and that Tebow is young enough to be capable of making huge progress in a single year. Listening to that side of the story would lead you to believe that the pro-Tebow case is equally credible or perhaps even more so.
But wait. We know these are not the real reasons why people are saying what they say. The poll shows that the explanations people give for liking Tebow or Manning are rationalizations. People decide for emotional reasons who to support and then turn on the brainpower to concoct explanations for those emotional beliefs that sound sensible.
When stocks are priced at three times fair value, there will be dozens of reasons put forward for why the price being set by the market is the proper one. Don’t believe any of it. It is always possible to come up with both plausible-sounding reasons for high prices and plausible-sounding reasons for low prices. Most investing analyses (including this one, to be sure) are so much hot air.
3) People Fool Themselves
When I point out how experts in this field mislead us as to the value of stocks at times of overvaluation, people often jump to the conclusion that I am accusing people of dishonesty. No! The conservatives really believe in their hearts that Tebow is the better quarterback. The liberals really believe in their hearts that the case for Manning is so strong as to be beyond dispute. People see what they want to see and they generally do not see too much beyond that.
Many people faulted the Madoff investors for falling for a Get Rich Quick scheme. I think we would be better to take a “there but for the grace of God” line re the matter. We all fall for all sorts of things all the time. And more often than not the people pulling us in fell for the same things before they tried to get us taken in too. We all think with our emotions. It’s just the way we are constructed.
4) People Are Biased
What do you think will happen if Manning has five great games to start out the next season and Tebow has five terrible ones (or the other way around)? Will that settle matters? You know it won’t. People who like Manning for emotional reasons will continue to like Manning for emotional reasons and people who like Tebow for emotional reasons will continue to like Tebow for emotional reasons. People will just concoct new rationalizations for believing what they want to believe. Facts rarely have much influence on human decision-making.
I believe that investors should change their stock allocations in response to big valuation swings. But I think it would be a good idea if every article I wrote had a message attached saying “Rob has been going with a zero stock allocation since 1996.” You know why? Someone with a zero stock allocation cannot possibly write without bias on any investing question. I’ve got an emotional stake in convincing people of one side of the story. That influences every word I write.
The same is true with those who speak from the other side of the table, of course. Most of the people we think of as “experts” in this field have connections to Wall Street. That means that they make money by selling stocks. That means that they are not capable of shooting entirely straight re any investing question.
They can try. But no one can fully overcome his biases. Why? No one can ever even fully see his own biases. We see other peoples’ biases, but not our own.
5) People Are Fickle
I bet that poll would have showed very different results had it been taken during the time when Tebow was winning seven games straight in late-game comebacks. People can believe something very strongly one month and then believe something very different a few months later.
That’s why there are stocks crashes.
I noted above that people don’t change their minds when presented with facts. That’s because our decisions are generally rooted in emotion, not logic. But, while we can ignore fact after fact after fact for years, we can also make dramatic about-faces when we finally come to experience emotional desires to believe something different.
Stock prices usually head upward (with relatively insignificant dips mixed in) for 20 years and then head downward (with relatively insignificant upward moves mixed in) for 20 years. If investors were rational, it couldn’t happen like that.
That’s the pattern you would expect to see in a world in which most investors were motivated primarily by emotion. It takes a long time to change emotions, but, when they change, they change hard and remain changed for a long time.