Too Many Assholes

This will be the only financial essay I write, I promise.

The study of finance is the study of human behavior. The study of emotions. The study of mass psychology. The study of irrationality. I don’t know many people who disagree with this assertion, but then they go stick their heads in the spreadsheets, looking for the answer.

But there are no answers to be found in the spreadsheets. I haven’t opened up a spreadsheet in 15 years, and I do pretty well at investing. People ask me my process all the time. I watch what people are doing, and I listen to what they are saying. That’s pretty much it. I look for extremes in optimism and pessimism. But in order to do this, I must remain emotionally detached, and observe the sentiment around me, free from bias. It's not easy to do. And I make mistakes from time to time. But the key thing about investing with sentiment is that you usually stay out of trouble.

If you are buying stocks when everyone is miserable, you might not pick the absolute bottom. If you are selling stocks when everyone is jizzing all over themselves, you might not sell the absolute top, but you will be in the neighborhood. It is possible to make small mistakes, but it is very hard to make big mistakes, if you are disciplined. And the amazing thing is that normal, average retail investors can be the best sentiment investors, if they choose to be, by making subtle changes in their asset allocation near big turning points in sentiment. We just had one, after all. But as usual, people were too caught up in the sentiment to take advantage of it.

I have always been wired this way, to be a contrarian. Now, “contrarian” is a word that tends to be overused in finance. There aren’t many true contrarians out there. Because to be a true contrarian, you have to do things that are insane. And if you really are a contrarian, you will be ridiculed constantly. Back in 1997, when I first started investing, I used to look up mutual funds in Money magazine. I noticed that all the “science and technology” funds were returning 30% a year, and the value funds were making low single digits. I figured the gains in the tech funds were unsustainable, and that the value funds would revert to the mean. And that’s what happened, over a period of 5-6 years. I missed out on some gains in tech, but I would have lost it all afterwards, anyway. I ended up doing pretty well during that time period, by investing in value. Keep in mind that I wasn’t a value investor, per se—just observing that people were pretty bulled up on tech, and that value was unloved. I was 23 years old, and hadn’t even been to business school yet. I was born this way.

When I was an ETF trader at Lehman, I used to listen to the orders being shouted across the trading floor. If there were more sell orders, I would start building a long position. If there were more buy orders, I would get short. A bank trading floor has a certain feel to it—you can tell whether the market is going up or down just by listening to the chatter. Back then, the vibe of the trading floor was a big part of my process, and I thought that when I left, I wouldn’t be able to function without the flow of information. But there was a new social media website popping up around that time called Twitter, which I started using in earnest in 2011, which is the biggest source of sentiment data in the world.

I’ve often said that if you made me get rid of either my Bloomberg terminal or Twitter, I’d get rid of Bloomberg. Twitter is that valuable. I evaluate the sentiment contribution of every single tweet, and it goes into the computer in my head. But I also use anecdotal data—things I hear from friends and family. Like when my uncle is piling into stocks—typically a good indicator. Neighbors, friends, acquaintances talking about housing, or putting in a new roof, or buying a new car. All of it is crucially important economic data on the markets and the economy. Yes, you’re dealing with small sample sizes, which is why you want to collect as much of this anecdotal information as possible.

And here is where people have a problem with sentiment investing—it’s anecdotal. It’s stories. It’s qualitative, and therefore, voodoo, because everything in finance must be quantified. Au contraire—nothing in finance must be quantified. What we do isn’t a science, and it resists all attempts to make it into a science. It is an art. Back in 2011, I heard a story of a barbershop in New Jersey where a kid walks in with a blowout haircut, like from that reality show Jersey Shore, and starts dispensing stock tips. Buy SLV, he said. Oh shit. That literally was the high in silver to the day. The difference between me and other people is that I actually act on these anecdotes. Most people discount them, because it is just one dildo in a barbershop, right? Sometimes you hear things at a certain time for a reason. The universe is trying to tell you something.

The thing is that you have to put sentiment in buckets. You don’t need a lot of buckets, just two: smart sentiment and dumb sentiment. 95% of people are wrong all the time—they go in the dumb sentiment bucket. But you do have some friends who are good at investing—you want to put them in the smart sentiment bucket. When these two buckets line up, when you have your dumb friends piling into stocks and your smart friends selling—that is the best information of all. And there is also such a thing as smart dumb sentiment, when quote unquote “smart” guys pile into a trade, and it gets crowded. That’s what happened with energy a couple of months ago, which prompted my comment that there were too many assholes in the trade. You’ve seen situations like this before, when a stock gets crowded with smart guys and turns into a hedge fund hotel. Too many assholes.

Having said all that, sentiment investing is just a piece of the puzzle. It isn’t the entire puzzle. I use technical analysis as well, so I can get a little more scientific about entry and exit points. But I never use fundamental analysis, or almost never. I think fundamental analysis is pretty useless, because the fundamental bull case always seems most compelling at the highs, and the fundamental bear case always seems most compelling at the lows. And that’s the thing about sentiment investing: you’re always getting in fights with people, because you find yourself arguing with folks who are looking at the fundamental data in a static fashion, when the data look the best. It’s hard, because there is no reason to be shorting XYZ stock on the highs—all the reasons are right in front of you, and telling you that you are wrong. People ask me all the time: what is your thesis? And I say, I don’t have one, other that people are too happy about this trade. That’s not a thesis, they say, and I say, oh yeah? And down the elevator shaft it goes. Too many assholes.

When I put on a trade, I like to imagine some hedge fund guy on the other side, sitting at his desk, with his shoulders up around his ears, experiencing a great deal of stress. Feeling the pain. But he’s holding on, because he’s convinced that he’s right. At some point he’ll capitulate. And I’ll be there, with a catcher’s mitt, ready to close out my position. That’s when it’s fun. There are times when it’s not fun, when I am on the receiving end of this, when I have miscalculated sentiment. But the best way to tell when a trend is going to reverse is when it fills up with assholes. There have been plenty of examples just in the last couple of years, crypto being one of them.

When everyone is feeling smart, and complacent, and not at all worried about how things can go wrong, that is usually when things go wrong. I have seen my share of assholes. There have been dot com assholes and housing assholes and FANG assholes and everything in between. The definition of a bubble is when people are making money all out of proportion to their intelligence or work ethic. It’s not hard to spot, if your eyes are open.

Go fuck yourself,

Jared

Music recommendation: Cream - Kaleidoscope. Cream, also known as Krzysztof Kupczakiewicz, was born in Krakow. Poland, and currently lives in Jaroslaw. The dude has been DJing and producing since 1984. I’m guessing he’s sixty. In electronic music, the older the better. This guy is consistently good.

P.S. We’re Gonna Get Those Bastards will always be free. Please forward to whoever you like.