Friday, 19 May 2017


I’ve been reading Memiors of Extraordinary Popular Delusions and the Madness of Crowds (free on Kindle!) and I’ve got to the chapter on alchemy, the philosophers stone and the water of life… one paragraph in particular stands out:

“Three causes especially have excited the discontent of mankind; and, by impelling us to seek remedies for the irremediable, have bewildered us in a maze of madness and error. These are death, toil, and ignorance of the future”

Alchemy, or the means to turn base metals into gold and silver, was a big thing for a long long, long, time only moving out of favour as the rigours of scientific endeavour starting making their presence felt. The book lists lots of people who wasted their lives seeking a means to allow them to cast a magic spell and have gold appear instead of toiling for it. The book also goes into the tulip mania, the South Sea bubble and other cases of mass hysteria when companies offered the impossible in the markets, amazing riches in short spaces of time, with surely no risk.

To ask whether we are in the middle of a stock market bubble is not a new one reading this and a couple of other things made me wonder about the passive debate and whether it’s creating its own passive bubble.

Firstly what is a bubble, google will provide some good alternatives, I’ve heard that its irrational exuberance or fundamentals getting so far out of whack that the mean reversion is hideous. Or long dated exposures on short term money. Others will be able to explain better than that and everyone knows a bubble after it bursts!

Is this a stock market bubble? Are we in the midst of a passive index mania? Can anyone get rich quick? Is the popular delusion that you just need a simple tracker and that’s it, let riches come your way?

The S&P500 is very high, the Shiller PE has only been higher twice and that was before the Wall St crash and the dot come boom. The Reformed Broker said:

If we are in the midst of a mania that implies lots of people involved who have no idea and simply participating gets them rich. If so, and when therefore markets correct, those people will be burned and will not come back to the market for some time. That implies lower returns for longer and potentially the comeback of actively managed funds, even if that is only a reaction to people rotating out of passives.

No matter I hear you say – periods of lower performance are find because that means I’m buying cheaper units so my future returns on those units will be higher, so fine. However, I was also listening to the podcast (by Capital Allocators) where they discuss the 'Bet with Buffet', you know, the one where he bets a hedge fund guy they can’t beat the S&P500 over a ten year period. Well, in that there are a few excuses for losing but equally there was the assertion that the S&P hasn’t had such a strong run over such a sustained period.

This isn’t to say simply following the market and using passive indexes won’t continue to work and outperform a multitude of active funds, but has this period of outperformance been artificially driven? If it's artificially driven up, can it be artificially driven down? If you’re wholly passive and expecting a 7% or 8% total return and that falls to 4% or 5% for a similar period, 10yrs, how does that impact your retirement plans?

It seems that as soon as something is entirely assumed in the market such as; “passives are the only way for performance, everything else fails”, it seems the rug will be pulled out from under you. Maybe I’m just reading too much about the markets at the moment from a FIRE lens which applies the passive approach a lot more than others, however it seems unlikely that markets can continue on the winning streak and the above is a possible outcome following a big drop.

When thinking about all this I remember a sketch from Mitchell and Webb. Webb asks Mitchell about alchemists. Mitchell, a stockbroker, provides an explanation and then asks if Webb had ever thought about the coincidence that the allure of alchemy faded away through the 17th and 18th centuries just as stock exchanges came into being across Europe…

I’m not, and can’t, suggest an appropriate alternative for you, nor can I reveal the future, but like most things it pays to keep an open mind and a check on your emotions.

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