You Can Be Right And Still Go Bankrupt
Be careful about investing in bubbles
The best interview in the world of investing that happened this week was over at the “What Goes Up” podcast by Bloomberg.
This is the first time I’ve listened to his podcast, and it is definitely going onto my ever-growing list of must-listen podcasts.
The guest on this episode was Rob Arnott, who’s the chairman of “Research Affiliates|” A firm that specializes in market research. But like, market research that is actually interesting.
With Tesla passing a $1 trillion market cap, they decided it was a good a time as any to talk about bubbles.
Rob gave two pretty interesting points about how to identify a bubble.
You need to make implausible assumptions to justify valuations
The marginal investor does not care about valuation models
The discussion was focused more on possible “microbubbles,” which refer to single companies that might be a bubble as opposed to the entire market.
As Rob points out, when you are investing in a bubble environment, the risk is amplified, especially when you are getting into active investing rather than sticking with boring old index funds.
As he says:
You can be right but bankrupt
To highlight this, Rob recounts the Zimbabwe stock market during its period of hyperinflation in 2008. It looked like a stock market that was ready to collapse, and Rob cautions what would have happened to someone who shorted the Zimbabwe stock market during the summer of 2008.
Over the next 6 weeks:
The Zimbabwe currency fell 10-fold… BUT
The stock market went up 500-fold.
In U.S dollars, it went up 50-fold.
The investor’s losses who used 2% of their net worth to short the market would have been 50X2%=100% of their net worth.
8 weeks after that, the Zimbabwe stock market went to essentially zero.
This investor would have been right to think the Zimbabwe stock market was going down the drain, but they also would have been bankrupt.
This teaches us two things:
Don’t fool around with dangerous tools like options.
Bubbles can go longer and higher than any rational person would expect.
I’ll include a link to the episode below; it’s worth a listen.
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This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions