The Real Risk In The Stock Market Is Arrogance
Beware the Peril of Pride: How Arrogance Can Sabotage Your Stock Market Success
Summary
During the financial crisis, everybody thought home prices would keep rising forever, so banks handed out loans to everyone and consumers bought houses they couldn’t afford.
The crypto maxis thought (and mostly still think) that bitcoin is going to take over the world and they’ll soon become crypto millionaires.
I think we’re starting to get to that point again.
How many times have we heard stories about how overconfidence has ruined investors?
During the financial crisis, everybody thought home prices would keep rising forever, so banks handed out loans to everyone and consumers bought houses they couldn’t afford. Then the whole thing came crashing down.
During the tech bubble, investors thought the internet would take over the world, so they bought any stock that had any link to the tech sector expecting triple digit returns. Then the whole thing came crashing down.
The crypto maxis thought (and mostly still think) that bitcoin is going to take over the world and they’ll soon become crypto millionaires. Bitcoin is still more than 50% below its 2021 peak.
As I often like to say…
I think we’re starting to get to that point again. There’s a greater sense of “everything’s going to work out just fine” than there has been at just about any point since the start of 2022. Investors simply aren’t pricing in the level of market risk that actually exists right now and that complacency and overconfidence could be what makes the next market correction even worse.
We saw another round of “irrational exuberance” just this week. The U.S. CPI reading for March increased by 0.1% month-over-month versus expectations for a 0.2% increase. March PPI dropped by 0.5% compared to expectations for a flat month-over-month reading. Through the first four days of this week, the S&P 500 was up nearly 2%, while the Russell 2000 was up 3%. Guess what? Nothing really changed! A 0.1% difference in headline inflation doesn’t change the narrative, but investors think this is a big reason to go risk-on? Softening CPI is a lagged effect from interest rate hikes that took place months ago. In fact, it’s easier to argue that the Fed has already overdone it and is risking a deflationary bust in the next several quarters.
The changes in stock prices are just one indication that investors have gotten overzealous. Simple sentiment indicators show the same thing.
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