Humble Student Of The Markets: May 2021

  • In fact, in the aftermath of every bursting bubble, you hear talk of how more disclosure and regulations will prevent the next bubble. In fact, over confidence will overwhelm almost every regulatory and disclosure barrier that you can throw up. If the big market delusion is a feature of big markets, destined to repeat over time, it behooves us as entrepreneurs, managers, investors and regulators to recognize that reality and modify our behavior. Our policy advice to politicians, regulators and investors then is to stop trying to make bubbles go away. Not only are bubbles part and parcel of markets, they are not necessarily a negative. For instance, the dot com bubble hit a wall in March 2000 and burst in a few months, as public markets corrected first, followed by private markets, but the question of why it happened at the time that it did remains a mystery. A few have gone further and argued that such episodes are bad for markets, and suggested fixes, some disclosure-related and some putting restrictions on investors and companies. The big market delusion almost never stays confined to private markets and sooner or later, the companies in the space list on public markets and are often priced in these markets, at least initially, like they were in private markets.


    In recent years, the big markets have gone from just words to numbers, as young companies point to big total accessible markets (TAM), when seeking higher pricing, often adopting nonsensical notions of what accessible means to get to large numbers. Disconnect from fundamentals: If you combine a focus on growth as the basis for pricing with an absence of concern at these companies about business models, you get pricing that is disconnected from the fundamentals. Blindness to competition: When the big market delusion is in force, entrepreneurs, managers and investors generally downplay existing competition, thus failing to factor in the reality that growth will have to be shared with both existing and potential new entrants. When asked to justify the pricing of a company in the market, especially young companies with little to show in terms of fundamentals, entrepreneurs, managers and investors almost always point to macro potential, i.e., that the retail or advertising or cannabis markets were huge.


    With cannabis boutiques near me s in late 2018, much of the pricing optimism was driven by the size of the potential market in the United States, assuming legalization, but very few entrepreneurs, managers and investors seemed to consider the likelihood that legalization would attract new players into the market and that illegal sources of supply would maintain their hold on the market. With cannabis stocks, the rise and fall were both precipitous, with the stocks tripling over a few months and losing that rise in the next few months. The online advertising run-up has moderated much more gradually over a few years, and if that trend continues, the correction in this market may be smooth enough that investors will not call it a correction. Since the big market delusion leads to a collective over pricing, value investors can bet against a basket of stocks (sell short on an ETF like the ETFMG) and hope that the correction occurs soon enough to reap rewards.


    The obvious advice that can be offered to entrepreneurs and venture capitalists, to counter the big market delusion, is to be less over confident, but given that it is not only part of their make up but the driver for exploiting the big market, it will have little effect. That outperformance was driven in part by stories regarding how technology companies were going to disrupt or invent big markets from housing to entertainment to automobiles. All about growth: When enthusiasm about growth is at its peak, companies focus on growth, often putting business models to the side or even ignoring them completely. With social media companies, it took an even rawer form, with growth in users and subscribers being the calling cards for higher pricing. Finally, while you may be intent on delivering the metrics that are priced highly, such as users or subscribers, pay attention to building a business model that will work at delivering profits, and if forced to pick between the two objectives, pick the latter. Of course this period will be a good time to pick up quality stocks for keeps. As we have emphasized, however, there appears to be no way to time such corrections.



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