To safeguard the long-term viability of their investments, shareholders need to understand the psychological drivers behind both rational and irrational market forces.

For instance, shareholders need to be aware of the economic phenomenon known as the “bubble.”

Generally speaking, the term bubble (commonly known as market bubble, financial bubble, price bubble or speculative bubble; or specific to a sector, such as the dot-com bubble or housing bubble) refers to a mad rush to trade an asset that is artificially and astronomically inflated in perceived value.

Because the price inflation is usually driven by market mania and not sound fundamentals, it helps to look at this phenomenon through a psychological lens.

The Seduction of the “Sure Thing”

Bubbles are powerful and they have a charm and beauty all their own.

They seem to capture the essence of what is currently popular, and as a result high volume trading soars regardless of intrinsic value.

Recent (and not so recent) examples include: gold, real estate, flawless (Grade FL) diamonds, tulip bulbs, commodities, and debt. Bubbles are rooted in emotion, greed, hope, fantasy, money lust, wonderment, thrill seeking, amazement, absolute certainty: all powerful human emotions and foibles.

Savvy investors observe the ebb and flow of bubbles, and if they are really good and exceptionally well disciplined they can trade and hedge accordingly. They are true professionals. “Bubble management” should be left to traders of this caliber.
Bubbles are made to snap, crackle, and pop. As they expand and develop they are works of beauty: colorful, inspiring, seductive, alluring, a “sure thing.” And they will boom forever, no doubt.

The truly savvy Wall Street players and money managers can predict the future. The handwriting on the wall is blatantly clear to them. John Paulson certainly predicted the future, winning a $15 billion bet on the sub-prime crisis in 2007. In his mind, it must have been a sure thing. He had to know that subprime borrowers could not sustain oppressive debt; seems simple and obvious at this juncture.

Human behavior is fallible, predictable, and often rooted in emotion. Cycles rule, stability is fleeting, and tons of money can be made on “movement” alone. The direction is much less important.

Betting against something may seem negative and unnatural as opposed to betting for something. Great money managers factor out as much emotion as humanly possible; they just bet to win for, or against. The win is what counts. Does ice run in their veins, or some  delicious combo of Gatorade and a first quality protein shake? They are certainly passionate, and often brilliant, thinkers who really do their homework.

Fed by Fantasy, Greed, Money Lust

Perhaps the initial modern culprit/catalyst of bubble mania occurred in Holland in 1637. In a very small country, a ‘rare’ bulb had the equivalent value of 12 acres of land, or the annual salary of a journeyman craftsman. John Law et al perfected the Mississippi Scheme several decades later. Bubbles feed, and are fed by, fantasy, greed, money lust, curiosity, and financial myopia.

The only sure things are indeed taxes and death, regardless about how we feel or think about the human condition.

By way of a lively current example, the largest free standing mansion in Manhattan is back on the market. The asking price is a tad under $15 million for a 12,000 square foot home with 12 bedrooms and 11 bathrooms with an additional 3,500 square feet of outdoor space.

In 2006, the Schinasi Mansion went on the market for $31 million. No takers. It’s a French Renaissance masterpiece built in 1909 for Morris Schinasi, a Turkish immigrant who made his fortune by introducing Turkish tobacco to America. A consortium of well-heeled Yuppies could create a penultimate “animal house” at 351 Riverside Drive. It is indeed a residence of beauty and elegance. Thirty one million dollars (or approximately $2600 psf) is a hefty price tag for what is now offered at $14.95 million (a tad under $1250 psf).

Value is in the eye and pocketbook (or treasure chest) of the buyer in concert with market conditions and, hopefully, some semblance of reality or what we think reality should be.

The Constant Motion of Bubbles

Things change, times change, value changes, taste and style evolve. It’s all about movement. Nothing is static. Human beings need bubbles, we want bubbles, we crave bubbles. Bubbles tantalize and excite, and feed fantasies and dreams. They are certainly not boring. But they can wreak havoc and chaos, and yield considerable pain.

Truly savvy money managers thrive on bubbles. They sit on the sidelines and watch bubbles grow and grow, and trade at the precise moment where the money train is explosive. These are men of talent and vision. Again, they have keen eyes (and brains) for what seems to be obvious.

Shareholders and investors can track the top 10 hedge fund managers. Explore and study what they are up to; monitor and analyze their “comings and goings.” Try to get a feel for the types of company and management styles they like and trust as best they can.

Determine if they have mounted campaigns, or engaged in shareholder proposals. Explore the notion that even they may have “corporate gadfly tendencies.”

After all, they are intent are making huge sums of money, and they don’t like, by their nature, being jerked around. Personality wise, they are focused, tough, pragmatic, and realistic. They know their mission quite well.

Keep in mind that their commission structure and bonus plans are among the best in the business. In terms of my professional practice, they have always been a most exciting, lively, bright, creative group of clients and patients.

Hopefully, understanding the mass mania that drives “bubbling” will enable you to peel off from the herd and take steps to safeguard your investments (or at least jump that a runaway train before it plunges off the cliff).

To contact Christopher Bayer directly, please email Christopher.Bayer@TheShareholderActivist.com.