Page 162 - Psychology of Money - Timeless Lessons on Wealth, Greed, and Happiness-Harriman House Limited (2020)

People can look at Yahoo! stock in 1999 and say “That was crazy! A zillion
times revenue! The valuation made no sense!”
COBACOBA

But many investors who owned Yahoo! stock in 1999 had time horizons so
short that it made sense for them to pay a ridiculous price. A day trader

could accomplish what they need whether Yahoo! was at $5 a share or $500
a share as long as it moved in the right direction that day. And it did, for
years.

An iron rule of finance is that money chases returns to the greatest extent
that it can. If an asset has momentum—it’s been moving consistently up for
a period of time—it’s not crazy for a group of short-term traders to assume
it will keep moving up. Not indefinitely; just for the short period of time
they need it to. Momentum attracts short-term traders in a reasonable way.

Then it’s off to the races.

Bubbles form when the momentum of short-term returns attracts enough

money that the makeup of investors shifts from mostly long term to mostly
short term.

That process feeds on itself. As traders push up short-term returns, they
attract even more traders. Before long—and it often doesn’t take long—the
dominant market price-setters with the most authority are those with shorter
time horizons.

Bubbles aren’t so much about valuations rising. That’s just a symptom of

something else: time horizons shrinking as more short-term traders enter the
playing field.

It’s common to say the dot-com bubble was a time of irrational optimism
about the future. But one of the most common headlines of that era was
announcing record trading volume, which is what happens when investors
are buying and selling in a single day. Investors—particularly the ones
setting prices—were not thinking about the next 20 years. The average
mutual fund had 120% annual turnover in 1999, meaning they were, at

most, thinking about the next eight months. So were the individual investors
who bought those mutual funds. Maggie Mahar wrote in her book Bull!: