Robert Schiller: A Lot of What Happens in Markets is Driven by Pure Stupidity

21 Jul

Probably the best quote I’ve read in recent memory, via TheAnalyst_HK, from Yale Economics professor Robert Schiller (emphasis mine):

Economists who adhere to rational-expectations models of the world will never admit it, but a lot of what happens in markets is driven by pure stupidityor, rather, inattention, misinformation about fundamentals, and an exaggerated focus on currently circulating stories.

I think the entire quote is nearly flawless, but the part I’ve highlighted, primarily the latter two issues, strikes me as effectively epitomizing the behavior I see day in and day out, whether in the financial media, my twitter/stocktwits stream, or in closer knit financial/economic circles.*  In a world of momentum and technical trading, these missteps are so widely prevalent and painfully apparent I often find myself close to banging my head on my desk.  I regularly see stocks return 5% or even 10% DAILY, on no real material news, let alone news that suggests a firm is instantaneously worth 10% more.

Efficient markets my ass.

When you treat stock prices as if they’re some ephemeral, transitory dot on a chart that moves based of supply and demand & trade accordingly, you ignore a great deal of information and, while you may make money in the short term (and good for you if you do), you’re taking on an enormous amount of unaccounted for risk in so doing.   Look at a firm I’ve briefly discussed here, ZAGG.  It’s up  ~80% in the past 2 months, and up over 100% year to date, showing no signs of going down anytime soon.  Has business improved so much, in less than a quarter, to rationalize such a run in the stock and current valuation?  I’d like to remind you of a quote from casino magnate Steve Wynn I’ve used here at least a handful of times before, via Long or Short Capital:

[Responding to a question as to why Wynn issued equity at $154 at the end of September and then paid a dividend of $6/share on December 10th. Note that Wynn shares had traded in the $80s in June of last year and at $120 yesterday.]

It is the job, and you can take this as a final statement on the subject going forward. It is the job of board of directors and especially of the CEO to take advantage of the market when that market movement is extreme. When a company increases its value by 100% in 60 days, that’s an unnatural movement of value and the market also goes the other way sometimes. These unnatural movements in value, no company gets to be worth twice as much in 60 days as it was before to any intelligent person, so when that happens, we take advantage of it.

New distribution deals are great, as are new product launches, but more often than not when you read beyond the headline, they’re little if anything to write home about, let alone send the stock price soaring.  In this case, the great new distribution deal is only for one freaking product for one phone on one cell network that combined will likely add maybe a few hundred thousand dollars in sales to a firm doing over a hundred million annually.  New products are great, but there’s probably not nearly as many people lining up to buy $100 iPad case/keyboards as there are iPads.  Not that ZAGG needs to sell the keyboard/case to everyone who buys an iPad, hell I’m sure they’d be ecstatic to sell to 1 out of every 100 of the 9.25 million iPad buyers last quarter.  Unfortunately, 1. they aren’t that popular (and likely won’t ever be) and 2. these announcements and the stock price moves they seem to instigate seem to be completely disconnected from the extremely long list of orange and red flags in the firm’s SEC filings.

I do not have, nor have I ever had a position in ZAGG.  Would I have liked to make money as the stock marched upwards?  You bet your ass!  Did I see it coming, even with strong momentum?  Nope.  Do I think it’s topped out?  Probably not, especially with the large short interest, although I’m not going to lie, if I can get my hands on some Aug or Sept $16 puts for under $2, I very well may pull the trigger.

Just to be clear, I don’t mean to attack momentum/technical/swing traders, not even by accident, as I have learned alot from them and I count many among my friends.  However I am absolutely attacking blind adherence to the strategy (or any strategy!) without paying attention to other factors.

As a fundamental guy, I’ve learned that I have to check out the technicals on a stock before I get in/out of a trade and set stops, lest I decide to say, bet against the market and get steamrolled ala Whitney Tilson and Netflix.  Similarly, technical traders would be well served, at the very least from a risk management perspective, to learn a little more about the fundamentals of firms they trade and monitor their own confirmation bias, especially when a lot of the time, all it takes is look at Stocktwits and a few financial sites!  I think just as fundamental investors can utilize technical/momentum information, tech/momo traders can use fundamental information to help them.  As lame as it sounds, I think we can all help each other, so long as we’re open minded to other perspectives.

Short term profits are absolutely awesome, until they suddenly go *poof* when the market capitulates or changes its mind.  Better to use all available information to see it coming and get out before hand (or avoid putting capital at risk in the first place).

CAVEAT EMPTOR

*No doubt I, myself, am sometimes guilty of these very things, but I try quite hard to be acutely self-aware, however good I am at it is another conversation for another time.

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15 Responses to “Robert Schiller: A Lot of What Happens in Markets is Driven by Pure Stupidity”

  1. Andrew July 21, 2011 at 4:24 pm #

    Terrible article. The real stupidity is watching people lose money every day trying to short stocks like ZAGG. They just gained 9 million new ipad customers to sell to in the last 3 months. Sounds like business has gotten much better to me.

    • The Analyst July 21, 2011 at 4:27 pm #

      The real stupidity is missing the point, not seeing the forest for the trees, etc, as you clearly have.

      I never said to short the stock, nor have I ever done so myself, not sure why anyone thinks otherwise. I frankly couldn’t care less if the stock goes up or down, but from what I’ve seen, I wouldn’t be comfortable touching it either way.

      • Andrew July 21, 2011 at 4:29 pm #

        Dont try to act like i missed the point of this article. Your calling ZAGG’s run stupid, your quite clearly short this stock. Otherwise, why bother writing an article like this.

        • The Analyst July 21, 2011 at 4:42 pm #

          I put ~50x more work into YOKU and I didn’t short that, even though had I done so, I could have made a very nice ~25% return. SSA is not an asset manager, although we publish information to help both those who are and the public at large. You should probably read our About page.

          To summarize myself, I saying ZAGG has run up very high, very fast, all in the midst of questionable – at best – fundamentals, and that this is likely to end in tears for some people who are long but don’t adjust their stops, trade actively, and/or practice good risk management techniques.

          The reasons for publishing material like I have on ZAGG are quite simple, in no particular order: 1. I see a lot (!) of people trading the stock who clearly have no idea what they’re doing, or are doing so with far less than all available information, and are thus likely to get slaughtered, 2. We are committed to investor education, and sharing commentary like this with the broader trading/investing community is in line with that goal. 3. Reputational capital.

          We have no ulterior motives here, attempt no misdirection, or anything of the sort, but the more we are accused of such, the more popular we seem to become, so in a way, I should thank you.

  2. ElCaliente2.0 July 21, 2011 at 4:27 pm #

    I love that Steve Wynn comment and have started following his earnings calls simply to hear more nuggets like that one.

  3. Brian July 21, 2011 at 6:17 pm #

    I Agree with Andrew…This Post is a Joke…..”To summarize myself, I saying ZAGG has run up very high, very fast, all in the midst of questionable – at best – fundamentals, and that this is likely to end in tears for some people who are long but don’t adjust their stops, trade actively, and/or practice good risk management techniques.”

    -Instead of being a scared little girl that it might come down a little, why don’t you take your own advice and look at a balance sheet or income statement. Zagg’s year over year revenue and earnings growth is amazing, hence the run up in the stock price. Their inventory levels are at the same percentage of next quarter sales as they have been the last 3 quarters. You clearly don’t even understand that inventory levels, DSO, or any basic corporate finance.

    You say you “2. We are committed to investor education, and sharing commentary like this with the broader trading/investing community is in line with that goal.”
    -How can you be committed to investor education when you can’t even read a balance sheet or statement of cash flows? You keep saying there is something wrong but you aren’t smart enough to do your own research and are another clueless “advisor” who just listens to what everyone else says.

    Andrew: He claims he “has no position” unless the stock drops, then I’m sure he’ll say he has a short position 😉

    • The Analyst July 21, 2011 at 8:27 pm #

      Read my prior post jackass. Why is a company that does no manufacturing hoarding $2mm of raw materials in inventory? Dig a little deeper my friend, read about how their IP is of little help, they have one supplier and a majority of their sales come from one part of one product line from best buy. If that’s the kinda company you wanna own, good luck.
      http://www.stonestreetadvisors.com

    • The Analyst July 21, 2011 at 9:01 pm #

      I apologize for calling you a jackass, its just frustrating when people like you hurl accusations (I haven’t looked at their second filings) when if you’d just clicked on a link I provided for your convenience and read it, you’d know that I have, and have cast a skeptical eye.

      The stock may very well run up even more, especially if the 10q revenue # knocks it out of the park, but I think if that does happen, and it is likely to, the footnotes as usual will paint a different picture than the headlines. Of course, no one bothers to read the footnotes…
      http://www.stonestreetadvisors.com

  4. Concurrent July 22, 2011 at 9:33 am #

    Fun read. Seems some of your readers aren’t distinguishing between being critical of the market nonsense itself and not being critical of (successfully/repeatably) making money on said nonsense. I dislike the former and enjoy the latter myself, but I’d prefer rational thought and efficient markets. The math is easier.

  5. RA July 22, 2011 at 10:54 am #

    Ha, ha. This article obviously hit a little too close to home for a few.

    • The Analyst July 22, 2011 at 12:04 pm #

      Whenever I post something throwing water on a hot stock that’s run up so much/fast like this, all of the momentum guys get their panties in a bunch and jump at me. It’s pretty funny, actually. I write something trying to add some logic, reason, and fact to the debate and not only do people actively ignore it, they attack it.

      Confirmation bias is a bitch, though…

Trackbacks/Pingbacks

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  4. July 26, 2011 – Best Lines I’ve Read Across the Blogosphere | Faceless Trader - July 26, 2011

    […] July 26, 2011 – Best Lines I’ve Read Across the Blogosphere Posted on July 26, 2011 by facelesstrader Best Lines I’ve Read/ A Series of Useful Links: 1.) It’s not valuation that matters.  It’s risk and reward in the growth cycle of each company.   – Leigh Drogen “The Coming Tech Crash” 2.)  Most importantly for the upside of the market, no one owns stocks. There are millions of traders flipping stock with institutions in high growth names, but there are no rational conversations about the growth opportunities.  – Howard Lindzon, There’s no Bubble.  There’s Entrepreneur Envy! 3.)  The media latches on to Steve Jobs not distributing the cash and thank god he laughs in their faces. Why should he trust the public with that cash. The public has proven to be imbeciles.  – Howard Lindzon, There’s no Bubble.  There’s Entrepreneur Envy! 4.) Err on side of caution, hit the gas when deemed apropos, and don’t paradiddle. – A comment to Chessnwine’s post , “You call yourself a trader, you sonofabitch” 5.) Nietzsche was right- what doesn’t kill you makes you stronger.  – Pension Pulse, “Put Yourself First“ 6.) “You’ve got to have the passion to do your time. If you haven’t done the time, you just can’t get there.” He goes on to argue that only by paying one’s dues through time, effort, devotion, and experience can we, “develop the rich experiences that make life meaningful.” – Top 10 Things That Determine Happiness 7.)Economists who adhere to rational-expectations models of the world will never admit it, but a lot of what happens in markets is driven by pure stupidity – or, rather, inattention, misinformation about fundamentals, and an exaggerated focus on currently circulating stories. – Robert Schiller, via Stone Street Advisors ” Driven by Stupidity“ […]

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