1. This quote is often attributed to John Maynard Keynes, but the first documented use of the expression was by A. Gary Shilling in the early 1990s.
2. Harry Markowitz has made this observation at several conferences, including our own Investment Research Retreat. We are not aware of a written citation.
3. Consider bitcoin. A software engineer, Laszlo Hanecz, made the first commercial transaction with bitcoin in 2010, famously buying two pizzas for 10,000 bitcoins. These 10,000 bitcoins would have been worth $190 million at bitcoin’s peak. Assuming the two pizzas were worth $25, this implies a market value at that time of $0.0025. Bitcoin crossed the $100 mark in early 2013, having appreciated 40,000-fold, reaching a market capitalization of $1 billion. Suppose we had believed it was an obvious bubble and an obvious short, and acted on that view. Before the end of that year, when bitcoin crossed $1,100, we would have lost 10 times our money. By the time of its 2017 peak, its value exceeded $19,000 and we would have lost 190 times our money. While most bubbles collapse, few collapse as soon as we might expect.
4. Those who deny the existence of bubbles based on market efficiency and rational expectations ignore a host of contrary evidence, including the experimental replications of bubbles by Nobel Laureate Vernon Smith and others, as well as roulette, lottery, and slot machine gamblers who place bets with a negative expected return. Furthermore, Brunnermeier and Nagel (2004) showed that sophisticated hedge funds profitably invested in momentum strategies during the 1999 technology bubble buildup, adding even more hot air to the bubble in the process.
5. Amazon serves as an example of the salience bias and representative heuristic investigated by behavioral economists Daniel Kahneman and Amos Tversky (1973) who observed that investors tend to have an easy time recalling spectacular successes such as Amazon, while forgetting the hundreds of failed enterprises. Who remembers the social networking site Theglobe.com or the search engine Excite.com? The ease in recalling successes leads us to neglect base rates and overestimate the probability of, as was the case with Amazon, growing into those lofty expected cash flows. This process of benign forgetfulness sows the seeds for the next growth-story bubble.
6. That winner would be Microsoft, which eked out a 40-basis-point annualized return above the S&P 500. The top 10 tech stocks at the start of 2000 were Microsoft, Cisco, Intel, IBM, AOL, Oracle, Dell, Sun Microsystems, Qualcomm, and Hewlett Packard. Sun Microsystems, after delivering annualized losses of −8%, and Dell, after delivering annualized losses of −24%, privatized in 2010 and 2013, respectively. Two others, AOL and Qualcomm, delivered negative total returns, and the remaining five companies produced anemic positive returns between zero and 4% a year, lagging the S&P 500.
7. To be sure, some of these stocks are not categorized as being part of the technology sector, but few would disagree that all of them owe their success to their dominant technological edge in their respective business niches.
8. Over the last five quarters, Exxon Mobil has replaced JPMorgan Chase in the tenth spot of the top 10 list, and the order of the top nine has also changed.
9. Asness (2017) provides perspective on historical average levels of return impact.
10. Sometimes investors look for an event that can be interpreted as a “bell” that sounds the top or bottom of a market. While the quest for this kind of signal is more an entertaining parlor game than serious investment science, examples abound. We wonder if the launch of the FANG+ futures contract might be that bell. The futures contract tracks 10 equally weighted cult stocks: as of June 30, 2019, these are Alibaba, Amazon, Apple, Baidu, Facebook, Google, Netflix, NVIDA, Tesla, and Twitter. Once a quarter, the contract can drop one of the 10 component stocks that is newly out of favor and add one that is newly hot. The result is that investors can buy a portfolio of bubbles at up to 10x leverage! Disclosure: One of the authors (Arnott) often has a short position in these futures, and another (Cornell) has a short position in Tesla at the time of the writing of this article.
11. Even after the ferocious market rally in 2019, bitcoin (as of June 30, 2019) traded at a 45% markdown from its all-time high. Source: Coinmarketcap.com.
12. Count us as skeptics that bitcoin will become an accepted currency. If nothing else, a currency is supposed to be a stable source of value, including intertemporal stability: it should buy tomorrow essentially what it can buy today. In this sense, the biggest attraction of bitcoin for many holders—its high price volatility and growth potential—is a tremendous hurdle to its fulfilling the roll of a viable currency. Stablecoins, such as Tether or Facebook’s Libra, mitigate this problem by tying the price of their coins to an established fiat currency. In so doing they also remove the speculative lottery-like characteristics that have attracted many early investors to cryptos.
13. An underreported but interesting sideline is the value of the data Tesla collects from its fleet of cars. Exactly how valuable these data are or how these data can be monetized is unclear, but that the data are perceived as having some value shows the benefit of first-mover advantage and the integration of Tesla as a part-technology company.
14. Advocates for Tesla will point to the company’s network of charging stations and its patents as high-value assets that should provide a substantial floor to the price. Not so fast. Tesla’s bondholders are entitled to the first $20 billion of the value of these assets, if they are even worth that. The company’s debt amounts to $120 per share of stock and four times the book value of the company.
15. Our asset allocation research suggests a 9.0% expected return on emerging market equities over the coming decade, compared to 2.7% for a cap-weighted US equity portfolio. More information is available on the Asset Allocation Interactive tool on the Research Affiliates website. More information on the premium we foresee for emerging market value strategies over the coming decade is available on the Smart Beta Interactive tool on the Research Affiliates website.
16. The first reference we could find for this delightful witticism is in a short 1999 article by Robert Sobel of Hofstra University.
17. Asness (2000) contains some wonderful examples drawn in real time from the peak of the tech bubble.
Arnott, Rob. 2010. “Too Big to Succeed.” Research Affiliates Fundamentals (June).
Arnott, Rob, Bradford Cornell, and Shane Shepherd. 2018. “Yes. It’s a Bubble. So What?” Research Affiliates Publications (April).
Asness, Clifford. 2000. “Bubble Logic: Or, How to Learn to Stop Worrying and Love the Bull.” AQR Capital Management Working Paper.
———. 2017. “Still (Not) Crazy After All These Years.” Cliff’s Perspective, AQR (June 14).
Brunnermeier, Markus, and Stefan Nagel. 2004. “Hedge Funds and the Technology Bubble.” Journal of Finance, vol. 59, no. 5 (October):2013–2040.
Kahneman, Daniel, and Tversky, Amos. 1973. “Availability: A Heuristic for Judging Frequency and Probability.” Cognitive Psychology, vol. 5, no. 2 (September):207–232.
Ritholtz, Barry. 2017. “Markets Will Fluctuate.” The Big Picture, Ritholtz.com (August 18).