The financial media loves a catch phrase and, with the apparent emotional hook of the ‘fiscal cliff’ diminished, we needed a new one. The current best candidate is the so-called ‘Great Rotation.’ The idea here is that investors, finally and completely fed up with the dismal returns from bonds, are going to move heavily back into equities. This is the ‘Great Rotation.’ When I Google the term, there are 820,000 search results. Not bad for a phrase that was invented in October 2012 (in a research note from Bank of America, apparently). Continue reading
In this post, I continue the discussion of behavioral finance with examples of some of the key behavioral biases and where they can be seen in recent market behavior. The specific focus of this post is those biases that drive investment fads and bubbles.
It is almost invariably the risk that we ignore that really hurts us. The market today is, for the most part, discounting inflation risk. Historically, inflation has been a major threat, especially to bond investors. Today, with yields at historic lows, the implied inflation expectations are exceedingly low. The process by which the market comes up with rationales as to why a risk, that has historically done major damage, no longer matters is at the heart of every bubble. We have had the housing bubble (in which investors became convinced that houses were an infinite source of capital appreciation), the Tech bubble (in which investors decided that valuations based on earnings were irrelevant) and now the government debt bubble (in which investors are implicitly assuming that inflation risk is no concern). The bubbles get out of control largely because people assume that what has worked recently will continue to work. Continue reading
In Part 1 of this series, I set the stage for a discussion of behavioral finance and game theory as they pertain to how market participants behave. In Part 2, I expand upon some of ways that individuals and institutions behave in ways that can be explored from this perspective.
Giving People What They Want
One of the most striking features of the capital markets of the recent year or two has been the ‘Las Vegas’ feeling to much of the action in the markets. There has been tremendous excitement around IPOs of companies including Zynga (ZNGA), Groupon (GRPN), and most notably Facebook (FB). The hoopla around the Facebook IPO, in particular, is without precedent. Why do the financial media and corporate management work together to create this frenzy? The answer is simple: people buy it. If investors ignored the carnival atmosphere around these firms, we wouldn’t see this kind of media. If people say that they want to invest in solid well-run profitable firms, but clearly signal that what they are actually buying is shares in IPOs of companies with enormous dreams but untested business models, we know what Wall Street will provide. If investors seem to be seeking investments that behave like lottery tickets, it is perfectly rational for venture capitalists to fund such companies and to rapidly take them public. I view the marketing of Facebook’s IPO as perfectly executed to exploit behavioral biases. I am not a conspiracy theorist, but even the trading delay on the day of the IPO helped to bring the frenzy to own shares to a fever pitch. The Facebook IPO and others like it suggest that Wall Street is very effectively playing a game that many investors do not really understand. Continue reading
A new article in Knowledge@Wharton highlights a body of research that suggests that the universe of public companies is very different than in the past. There are, for example, 44% fewer publicly-listed companies on U.S. exchanges than there were only fifteen years ago. The Wharton article is a review of a range of work, including both experts who believe that we are seeing a decline in the role and significance of public firms and those who conclude that we are seeing a natural part of the business cycle. In the late 90’s, it seemed as though every small company, with or without a proven product of earnings, was rushing to cash in on IPO fever. Many of these companies subsequently failed. Today, after a decade of weak market performance and with individual investors increasingly skeptical of the stock market, it is not surprising that fewer firms are going public. The Wharton article also cites increased oversight and regulation of public companies as encouraging firms to remain private. Continue reading
I have not seen this type of brand name IPO trading volume for quite some time. From Groupon (GRPN) and Pandora (P) to Zynga (ZAGG) and now Avaya, the media would have you believe that investing in a brand name IPO is a quick fix for your portfolio.
Take the recent public stock offering in LinkedIn (LNKD) for example. The IPO price was set at $45 and jumped to $90 after one day of trading. As of this writing, the price is just below $73. At its current valuation, Morningstar estimates the Price-to-Earnings (P/E) ratio at 466. By comparison, the tech-heavy NASDAQ has a P/E of less than 20 (as of this writing).
Clearly, many people are very excited about the LinkedIn IPO and it shouldn’t surprise you that investors have had a long history of enthusiasm for IPO stocks. But has this enthusiasm ever paid off over the long-term? Continue reading
Zoom. IPOs are making headlines again.
Ten companies completed their initial public offerings last week, making it the biggest week for IPOs since November 2007. Chinese offerings dominated, with Youku.com (YOKU), described as a “cross between the US’s YouTube and Hulu” jumping $161 in its first day of trading. That’s the largest “first-day pop since Baidu went public in 2005″ according to Renaissance Capital.
Of course, IPOs are often volatile and for every Youku, there’s a Make My Trip (MMYT). That Indian online travel planning site has suffered a big drop in the last few months. Continue reading