Fear of Missing Out or FOMO has moved into the mainstream lexicon in the past decade. When it comes to markets, it encapsulates the fear of losing out on big returns that happen in a fast moving market like we have now. For most investors, fear dominates: they hate losing money more than they like getting more. It’s an understandable feeling, many of us have worked very hard for that money, we don’t want to see it disappear in an instant on a bad investment.
For this reason, much of the psychology around investing centers around helping people remain vigilant when there are market corrections. The typical novice investor behavior leads them to buy high and sell low rather than the opposite. When markets are trending upward and the media starts to portray individuals who get rich off of risky single investments, they want in too. So these new investors pile in and drive up segments of the market, or the whole market, even more. Yet the party always comes to a halt at some time or another. It could be benign, with a number of years of weak returns for formerly hot stocks, or it could be a sudden correction brought on by events out of a company’s control. When this happens, everyone tries to rush for the exits, sending prices plummeting. Retail investors used to be called “dumb money” by institutional investors for this reason: they only caught onto stocks at their peak and they sold quickly in a downturn, producing big losses. Many of these people get burned and scorn the stock market as a rigged game and often don’t return. 2020 flipped this narrative on its head and had the hedge fund managers and institutional investors chasing the trends of retail investors.
Having been a young active investor during the financial crisis as well as the dot com boom, I have seen the dizzying highs like we are experiencing now as well as the traumatic lows. Counting the Covid drop in the markets last year, that’s 3 markets I have been investing through with drops in excess of 30%. From this, I have learned to master the psychology of a long term outlook and holding steady when things are really bad. It has helped me to even do the counter cyclical investing that dictates accelerating investments when the market is trending down.
Lately however, it’s been more difficult for me and I’m sure others, to not avoid the FOMO of the “melt up” we are currently in. I am the first to admit that I missed the tech rally. I was heavy into individual stocks as the market roared back from its 2009 lows and for a number of years I saw outsized gains in a number of my holdings. The best pick of which was probably Lowes stock (LOW), the home building superstore which competes with Home Depot. I knew at the time that home improvement supplies were a staple of the economy and Lowes ran a tight ship: it used the organizational model of Wal-Mart to make its operations as efficient as possible. I bought Lowe’s stock near its low during 2008 and 2009 for an average of around $15 a share. That same stock now trades at around $163 a share today, almost 11 times what I bought it for at that time. It took about 3 years for the momentum to take hold but when it did the stock skyrocketed and made me feel like a smart and patient investor given that I had waited a few years to see this gain play out. Below, you will see the breakout performance of the stock from 2012 to 2018.
Clearly I had to deal with much bigger price swings than the investor in an index but I was following all the rules for a diligent investor: I had picked a company with a “wide moat”, good management and good industry outlook.
I relay this story not to brag about my gains or tell you that Lowe’s stock is in trouble but because it exemplifies what many new investors may be going through right now: the elated feeling you have when you have just made a good amount of gains and are beating the market.
Mastering Downturns Then FOMO
The way I was able to master the psychology of market downturns was understanding the history and resiliency of returns. The markets would come back, like they always do. It may take time but you have to have faith. Actually mastering FOMO was harder but an exercise I did with my portfolio a few years ago helped me.
None of us like to dwell on our losses or failures but analysis of your failures is an important part of the investing process and mastering the markets. My Lowes investment hid a darker side: when I reviewed the totality of all my investments back in 2017 which I made since 2008-2009, I found that my great gain in Lowes overshadowed underperformance for the past few years in other stocks. I had made heavy, anti-cyclical investments in banks and emerging markets. The initial bounce back in these shares was very strong post crisis and for a number of years my performance was trouncing the returns of the S&P 500, just like I predicted it would. Around 5-6 years post crisis though, the rally took a different turn and big tech started to take over and I was left underexposed to the sector.
Once the big tech rally started to take hold, all my prior investments started to under perform the market. I did have index funds which helped me keep on track, mainly those in my retirement accounts. I always had a dual strategy of keeping my retirement funds more conservative and diversified while my brokerage account was attempting to hit home runs. This gave me a base of comparison which I was able to track against my risky personal investments. So I did a comprehensive analysis of my index returns versus my individual stock picking returns over a period of 10 years and to my surprise I found that I would have been better just buying an index and focusing on maximizing my contributions to those indexes. This is what convinced me to start making indexes the majority of my portfolio and stop the FOMO routine of either being counter cyclical or following the hot sector.
FOMO Now
With Bitcoin topping $40,000 as of January 8, I have to say I started to have the feeling of missing out again. I have no exposure to crypto for a very simple reason: I don’t know when it ends. There is no exit point that anyone can spot based on a valuation or production of Bitcoin. There’s no doubt that the long term holders of Bitcoin feel very smart right now. Some of them may be millionaires and the hype around the recent price surge has no doubt lured other in to invest.
It’s the same story with Tesla (TSLA) shares. A speculative momentum has taken over the stock both on a retail and institutional level, especially since its inclusion in the S&P 500. This has provided an almost 800% return on the stock over the past year. In terms of stocks listed in the S&P 500 as of last year, only Etsy (ETSY) came anywhere close to this return with a 280% return in the past year. Again, right now investors in these shares who got in even when the stock was considered overvalued at the beginning of the year feel quite smart. The media fans the flames by fawning over the company, its stock price and its founder Elon Musk. It’s been such an un precedent ride because it’s very rare for a mid cap stock to rocket into large cap status in such a short amount of time. Even those who hold index funds have benefitted from its rise with funds that track the entire NYSE already benefitting from its rise even before it was added to the S&P 500 late in 2020.
The main risk and the question for Bitcoin and Tesla investors is: when does it stop and when do you exit? For those that experienced the rise up, it has been a great run, but where do we go from here is not such an easy question to answer.
For Bitcoin, everyone conveniently forgot that after its last peak in December of 2017 at around $19,500, the price fell by 84% to around $3,100 per Bitcoin. There will no doubt start to appear stories of some lucky speculator who purchased at this price or lower and “had faith the entire time” and is now a millionaire on their investment. Long term investors should not be dazzled by this and let greed take over. There’s a valid case for cryptocurrencies as a diversification tool, just because it is an asset that has a correlation which is not one to one with any other asset, but this is also the justification for recently weak performing asset classes like hedge funds and energy stocks. Bitcoin has taken off while other cryptocurrencies like Ethereum have had strong recent runs but nothing like that of Bitcoin. This points to Bitcoin itself being in a bubble within the crypto world. With no fundamentals to back what the value should be, it all becomes subject to the greater fool theory, that there will be some greater fool around to buy it at a higher price, we know where this always ends up.
The same goes for Tesla shares. Valuations are at unprecedented levels, a P/E of over 1,700 and P/S of over 30x. There isn’t a company in existence that can live up to these type of valuations without the price coming down to more reasonable levels at some point.
Diversification
The answer if you want to invest in these is to include them as a small part of a diversified portfolio. The next hot market is in an area that many are not talking about right now. Diversification across asset classes such as US, foreign, small cap, mid cap, growth and value allows you not only to experience all the hot markets before they happen, when viewed on a broken out basis as part of your portfolio, they allow you to spot momentum changes while others are dazzled by the lights of the most recent winners. For example, an “everything rally” seems to be developing at the moment based on low rates and anticipation of a bounce back. That means beaten down stocks in sectors such as energy and tourism will see much of the upside going forward. Likewise, Emerging Markets have seen significant momentum in 2020, with valuations so high elsewhere, it’s likely that the naysayers on these markets will be proven wrong in the short term and momentum could continue. I’m not saying to avoid tech and avoid crypto. Rather I am saying pursue these as a part of a diversified portfolio to grab the momentum they offer while positioning yourself in the “not hot” sectors for when they become hot. This way, you are almost always participating in something hot and raising your overall returns.
The gurus on the internet now are having their moment in the sun. It’s very easy to make tons in a market where almost everything is rising. Just like my investing in banks and housing companies during the last downturn, they will seem smart for a while and can easily outperform the market. When the market shifts though, many will not realize it until it is way too late and these same gurus will be caught flat footed and likely lose much of their following as everyone jumps on the next hot investment trend. We’ve seen it before and it will happen again.
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