The only thing worse than a group of nitwits sharing silly ideas is a group of smart people all thinking the same way. The dullards are quickly discovered as such, but the smart people tend to command an undiscerning following. What’s also evident is that individual thinking tends to be more intelligent than intelligent people thinking together. The reason for this is groupthink. The assumption that because someone is intelligent, their thinking is sound and it’s this assumption that short-circuits others’ thinking. In this way, groups of highly intelligent people can give village idiots a good run for their money, which of course makes the line between smart and dumb a very fine one.
When it comes to money and markets, there is never any shortage of groupthink on display, which makes us especially keen in noticing it elsewhere in the world as well. It’s pervasive. So long as there are humans who defer to other humans, and have a natural inclination for taking short-cuts, there will always be groupthink. In some cases it’s as simple as following and belonging, while in others it’s also a function of expectation or pressure to fall in line. In the corporate world, managers and employees are expected to “toe the company line” even if deep down they feel differently. Financial incentive can be a powerful factor in driving how one thinks and how strongly they fall in line with the group. Security, financial incentives, and blind trust all play a role.
We’ve written fairly consistently about the role the Federal Reserve has played in financial markets and society more broadly. Our view is that the Fed’s easy money policies in recent years have done tremendous damage to both and have helped to create the inflation we’re grappling with today and the societal wealth inequality that’s fueling much of the social divide. Those closest to the monetary spigot have received the vast majority of the benefits while those toward the bottom of the wealth strata have received very little. As the great economist Lacy Hunt has said on a number of occasions, at the Fed “there can be no dissent”. It’s one line of thinking that supports the notion that the Federal Reserve can steer the U.S. economy, control prices, and drive employment outcomes by yanking monetary levers. If you work at the Fed, and you disagree with this, well then, your services aren’t quite as valuable to the cause.
This hyper-aligned institutional thinking has created a situation at the Federal Reserve and other global central banks where opposing views haven’t been fosters, discussed, or entertained. As a result, the Fed’s actions have contributed to the following:
- Financial markets reaching over 100-year highs in valuations – aka, biggest bubble in U.S. history.
- U.S. debt reaching ~$33 trillion or ~122% debt to GDP. History suggests countries cannot come back from these levels without major turmoil. Low interest rates and federal reserve asset purchases have enabled this accumulation of debt by the government.
- Inflation. First inflation in asset markets (which benefits the wealthy), then inflation in prices within the real economy (which devastates the less wealthy and poor) in an effort to stave off financial system collapse.
- The exacerbation of the wealth-divide due to the Cantillon effect, those closest to the easy money spigot receiving the majority of the benefits.
- Social strife. Wealth inequality drives resentment, disenfranchisement, and division. Division drives “us versus them”. “Us versus them” further fuels and entrenches groupthink.
Putting the central banking variable aside, groupthink has always played a key role in driving investor behavior as well. After all, the thundering herd and relative uniformity of thought is what creates bull and bear markets and extremes on both sides. The belief that stocks can rise without limit and that any tumble will lead to rescue has created a ubiquity of optimism among investors that has helped perpetuate the bull market of the last 13 years (which there’s a good chance ended early 2022—We’ll soon know). “Everyone’s doing it, so I may as well too”, is how the thinking goes. Ask the average stock market investor why he or she feels stocks (broadly speaking) are a good investment for the long term and you’ll likely get a blank stare. A sure sign that thinking isn’t a big part of the equation. On the other hand, investments that the like-minded herd leaves behind, especially for long periods of time, can be tremendous opportunities. Our clients and readers will know that broadly speaking, we feel examples of those opportunities currently are commodities and natural resource stocks. But, how can we be sure that the fields the herd isn’t grazing in are safe? Maybe they’re right to keep their distance? Here’s the way to think about it. The herd is myopic. No one buffalo can see beyond the rear-end in front of it. All it knows is that the buffalo it’s staring at is still grazing. Meanwhile, the old pasture the herd left years ago has regrown its vegetation. Waking up to this fact takes time, but eventually, one by one, the herd moves on. The moral here is that intelligence and rational thought can drift over time, but fortunately they’re cyclical, and it’s this process that creates new opportunities for long-term investors. In weighing them, here are some things to consider:
- Is there a dominant narrative that led to this particular investment being neglected somewhat unfairly? For most natural resource and commodity investments, the green, sustainable, or clean energy movement/narrative helped to divert money away from otherwise very profitable and societally valuable companies. Everyone’s been led to think in one direction and has thus neglected any thinking in the other.
- Is there a future for these companies/investments? In the case of the commodity sector, yes, and without question. The world has always and will always need commodities. As the energy experts at Doomberg say, “energy is life”. As such, commodities are life. At least life as we’re accustomed to living it. The idea that we can use less energy and fewer commodities going forward is counter to the concept of human flourishing. The only way we use fewer resources down the road, based on current technologies is to consciously choose to reduce the global population dramatically. No serious person would consider that a viable strategy worthy of acting on. To anyone who does I say, “You first”.
- Are prices attractive enough to make this a strong investment rather than a speculation? For most commodity categories, the answer is yes. Prices generally are as cheap as they were back in the 2000-2002 timeframe when commodities started a 10-year bull market where they outperformed stocks by extremely wide margins. Intuitively this makes sense given the dramatic underperformance to stocks over the last 12 years. Cycles tend to cycle. It’s important to clarify how important the concept of price and value are to long-term investment performance. A terrific idea, story, or company at the wrong price can make for a lousy investment. Those things that appear attractive today, at some point in the future, won’t any longer.
- Are there conflicts of interest at work preventing others from seeing this? Yes. Wall Street makes the vast majority of its money dealing in stocks and bonds. And because financial media caters to Wall Street, it also has an interest in promoting investment in stocks and bonds. There will always be a bias towards promoting those things that drive profitability. Hot narratives (where the start-ups and private capital are focusing on such things as AI and green energy currently), as well as stocks and bonds more generally will be where the investment industry attempts to steer the herd. Understanding this is critical.
- Something that’s also important to realize as you work through this process of evaluating really important investment implications is that you won’t have much support from peers or proof that you’ve made the right choice – at least not early on. All you’ll have is historical precedent, logic, and your own due diligence to guide you. If you’re seeking approval, then you’re out of luck, because if your friends or coworkers haven’t done the work, they won’t understand where you’re coming from. They might conceptually grasp why gold, silver, or a copper mining company might be a good investment long term, but because they’re hearing more about Nvidia or Nasdaq from the media, the internet, and their other friends, they have no reason to believe there’s anything wrong with the status quo.
Phases of a Turn
Below is a price return chart of silver from early on in the last commodity bull market, which we now know with the brilliance of hindsight ran from 2000 until the summer of 2011. An investor putting money into commodity-related positions in 2000 might have justified that move by looking at the relative cheapness of those investments compared to the more popular stock market – technology stocks in particular. You’ll notice that between the beginning of 2000 until the end of June 2003 silver declined -13%, and if that blue line represented the balance of your investment portfolio, you’d probably be slightly concerned about the lack of progress. Even if you did your homework and you concluded that silver (you could substitute with most commodities, but we’ll use silver to make the point) had a much better risk/reward profile than technology stocks, you’d surely be wondering if you missed something that others got right. No proof, no validation from others. A very lonely 3.5 years it would have been. The temptation to invest in something with better performance would have been strong.
As lonely as it is, you trust yourself and stick to your line of thinking, not because it’s yours and because you’re stubborn, but because it makes sense and despite your best efforts to find flaws in it, you don’t. The next chart more accurately reflects the opportunity that commodity investor in January 2000 likely saw. Once the shift from stocks into commodities got going, it continued to gain steam until after the financial crisis, and the return differential was vast. By the middle of 2010, silver was up more than 240% while the Nasdaq tech index was down more than -40%. The difference in outcome between the intelligent thinker and the group thinker are beyond compare. Quite simply, when it comes to their financial futures, one makes it and the other doesn’t. But the really, really important thing to remember with the help of history and hindsight, is that what prove to be little bumps in the larger picture will feel like giant setbacks along the way. This is normal and a function of scale. Any large opportunity, whether investment or otherwise, will have its share of temporary setbacks. Anything worth pursuing always does. What commodity investors have experienced over the last 2 years very closely resembles this 2000-2003 timeframe. Our view is that over time, it will prove a minor stopping point along the way.
Like turning the Titanic, changing the direction of the investment herd takes time. As that direction changes however, not only does the performance of those “unpopular” investments gradually get better, but the emotional experience in holding them does as well as the ever-so-important validation starts to kick in. As the old bubbles gradually deflate in pulses and phases, money flows change, new price trends are born, and the free-thinker on her solitary island starts to gain company. More people come around to a different way of seeing things as cognitive biases are revealed and released. A rebalancing takes place. As we discussed last month, that rebalancing could be messy depending on how extreme things were preceding it, but it allows for necessary and important changes to take place. Part of this change is new opportunities being recognized and realized. The trick for our individual thinker who managed to sidestep blinding groupthink is to avoid it in the future as more and more people come around to seeing things as she saw them. There is a certain intoxication associated with being correct and having a following. One must recognize when the island gets too crowded, the thinking too narrow, and life too comfortable – when what started off as smart is at risk of becoming dumb.
In summary, groupthink is everywhere. It’s been the driving force behind central bank policy, it plays a key role in driving bubbles and busts in markets, and you better believe it thrives in other important institutions and aspects of life as well. To change it would be to change human nature. What we must learn to do, however, is recognize where it’s happening, how it’s affecting the world around us, and adapt. The only way this is possible is if one commits to assessing situations for what they are, not for what one wants them to be. And the only way to do that is to occasionally remove oneself from the warm, cozy company of other, similarly thinking, smart people.
Editor’s Note: This article was originally published in the October 2023 edition of our “Cadence Clips” newsletter.
This blog is provided for informational purposes and is not to be considered investment advice or a solicitation to buy or sell securities. Cadence Wealth Management, LLC, a registered investment advisor, may only provide advice after entering into an advisory agreement and obtaining all relevant information from a client. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
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