Don’t Be a Lemming and Follow the Crowd
April 26, 2016
Image used with permission: iStock.com/DrawnToBeWild
Don’t Be a Lemming and Follow the Crowd
People in a group often behave differently than they do individually.
Hockey historians will recall such group behaviour from March of 1955 when otherwise law-abiding citizens took to the streets outside the Montreal Forum to protest the season-ending suspension of Maurice “Rocket” Richard. Stores were looted, cars overturned, newsstands set ablaze and the rioters clashed amongst themselves and with police until three in the morning. When the smoke cleared, there was almost $900,000 (in current dollars) of damage to the neighbourhood, more than 30 injured police officers and demonstrators, and more than 50 arrests. When the Vancouver Canucks lost to the Boston Bruins in the 2011 Stanley Cup playoffs similar mob mentality ruled the streets, and anyone who has taken a first year university course in Sociology, has probably studied the phenomenon as it relates to the December 1969 Altamont Free Festival in Northern California, when the crowd of 300,000, and the Hell’s Angels meant to police them, became so unruly that even The Grateful Dead had the sense to refuse to perform.
Crowds make bad decisions, yet people love to be part of the crowd. Solomon Asch was a renowned social psychologist who ran a number of “conformity” experiments in the 1950s to observe and ultimately explain how a person’s behaviour might be altered when they became a member of a group. In one of his better known experiments, he would gather eight college students in a room. Seven of the students were his confederates and one was the “subject”. The group was shown a chart with four lines and asked which of lines, A, B or C, matched the length of line X. It would have been obvious to all that there was one correct answer, but as the confederates responded, they all gave the same incorrect response. The pressure to conform had the subject “yield” and go along with the group’s incorrect answer one-third of the time!1
Following the crowd into bad outcomes has been a common theme in investing for centuries and is well documented in the popular book, Extraordinary Delusions and the Madness of Crowds, written by Charles MacKay and originally published in 1841. “Fear of missing out” caused many Dutch citizens to bid up prices of tulip bulbs in the 1630’s, often exchanging livestock and land of significant value, only to have the bottom fall out of the tulip market.2
In more recent times, we have witnessed tech bubbles and housing bubbles as fools rushed in, no longer able to withstand the haughty airs of their increasingly wealthy neighbours. In Canada, Bre-X Minerals went from penny stock status to having a market capitalization of $6 billion, on the back of salted core samples, and Nortel Networks, after having gained 730% in a year and a half, represented more than one-third of the of the value of the entire TSE 300 index before its painful and well reported fall from grace.
Not long ago, CNBC’s “rantmeister”, Jim Cramer, coined the term “FANG” to describe a small group of stocks which he felt could outperform the market because of their above average fundamental growth characteristics. Facebook, Amazon, Netflix and Google (now Alphabet) were the darlings of the stock market in 2015, and Mr. Cramer’s table-pounding endorsement and the stocks’ subsequent trajectory were too much to resist for the many investors who wanted a piece of the future, regardless of valuation. In the spirit of full disclosure, we do own Alphabet in client accounts, but unlike Facebook which trades at 26 times forward earnings, Amazon at 44 times and Netflix at 77 times, we feel that Alphabet trades at a reasonable valuation of 19 times forward earnings.3
It is difficult not to yield to groupthink. At Nexus, we have employed a disciplined investment approach since the firm’s inception. A long record of investing success gives us the confidence to continue with the investment philosophy and process which has benefitted Nexus clients for many years.
1. Michael J. Mauboussin, More Than You Think (Columbia University Press, 2006), p.67.
2. Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds (Harmony Books, 1980), p 89-97.
3. Source: Bloomberg.