The truth about bubbles, FOMO, and why stock valuations defy logic

Yahoo Finance

135 views • 3 hours ago

Video Summary

Richard Thaler, a Nobel laureate in Economic Sciences and a pioneer in behavioral economics, discusses his new book, "The Winner's Curse: Behavioral Economics: Anomalies Then and Now." Thaler explains that behavioral economics incorporates psychology into economic models to create more accurate representations of human behavior, moving away from assumptions of perfect rationality and selfishness. He notes that while the core principles of economics haven't revolutionized textbooks, behavioral economics has become integrated into academic departments and journals, influencing younger economists. Thaler also delves into market efficiency, asserting that while beating the market is difficult, stock prices are not always accurate reflections of intrinsic value, citing historical bubbles like tulips, the dot-com era, and more recent phenomena like meme stocks and Bitcoin as evidence. He suggests that for most individual investors, ETFs are a more sensible approach than individual stock picking, as excessive trading often leads to poorer outcomes. Thaler expresses uncertainty about whether AI represents a bubble, drawing parallels to the dot-com era where predicting winners and losers was impossible, and highlights the unpredictability of future economic returns from new technologies. He points out that identifying bubbles is challenging, especially when fundamental data like revenue is absent, and that even monopolies are not guaranteed long-term success due to evolving competition. Thaler attributes the current market's resilience despite geopolitical and economic uncertainties to participants hoping for a return to normalcy and a belief that negative factors are temporary. He names Warren Buffett as his favorite investor due to his long-term track record and stock-picking acumen

Short Highlights

Behavioral economics incorporates psychology to make economic models more accurate by acknowledging that people are not perfectly rational or selfish.
The efficient market hypothesis is challenged by numerous historical bubbles and speculative manias, suggesting stock prices can be wildly wrong.
For most individual investors, buying an ETF index fund is a more effective strategy than active stock picking, as more trading generally leads to worse results.
The true economic impact and potential bubble status of AI remain uncertain, with parallels drawn to the unpredictable outcomes of the dot-com era.
The resilience of the current stock market despite global uncertainties may be due to investors hoping for a return to normalcy and believing negative factors are temporary.
Warren Buffett is cited as a favorite investor due to his long-term track record and skill in stock picking

Key Details

Introduction and Behavioral Economics [00:00]

The podcast features Nobel Prize winner Richard Thaler, distinguished professor at the University of Chicago, and co-manager of Fuller & Thaler, which oversees $30 billion in small-cap assets.
Thaler has authored a new book, "The Winner's Curse: Behavioral Economics: Anomalies Then and Now," updating his earlier work from 1992.
Behavioral economics is defined in contrast to traditional economics, which often models people as perfectly rational and selfish. Thaler argues that adding psychology makes economic models less wrong, even if the math becomes more complex.
Over the last 40 years, behavioral economics has gained significant traction, with behavioral economists now present in most top economics departments and business schools.
While the revolution hasn't drastically changed economics textbooks, it has influenced younger generations of economists.
"And the field gets less wrong."

Market Efficiency and Bubbles [06:31]

The efficient market hypothesis, developed by Eugene Fama, suggests stock prices are correct reflections of intrinsic value and that it's impossible to beat the market.
Thaler believes the "no free lunch" component (inability to beat the market) is approximately true, stating that while it's possible, it's very difficult for most individuals and even most mutual funds.
However, he asserts there is virtually no evidence that stock prices are correct assessments of intrinsic value, citing numerous examples of bubbles, including tulips, the late 1990s tech bubble, the 2008 financial crisis, Bitcoin, and meme stocks.
He often notes that while he can be confident a stock price is too high, it doesn't guarantee it won't go higher.
"As to whether prices are correct, I would say there's virtually no evidence to say that that's true and lots of evidence to say it can be wildly wrong."

Investing Strategies and AI [09:16]

For individuals interested in picking stocks as a hobby, Thaler advises allocating only a sensible portion of their portfolio to it and doing something sensible with the rest.
He suggests that very few individual investors will perform better than buying an ETF index fund.
The more individuals trade, the worse they tend to perform.
Regarding the AI "bubble," Thaler states he doesn't have a professional opinion and that it's difficult to know in real-time, drawing parallels to the dot-com era where outcomes were only clear in hindsight.
He acknowledges that there will be winners and losers in AI, but we don't know who they will be or the extent of AI's economic impact.
The iPhone is cited as a life-changing technological advancement; it remains to be seen if AI will have a greater impact.
"And we don't know how big AI will be in terms of economic returns."

Identifying Bubbles and Market Psychology [14:14]

Identifying a bubble involves looking at fundamentals, but in early stages with no revenue, it's impossible to make judgments about future revenues and competition.
The history of video rental stores illustrates market evolution: mom-and-pop stores were driven out by Blockbuster (a monopolist), which was then disrupted by Netflix, and later faced competition from Amazon Prime. This shows even monopolies are not safe.
The current stock market's resilience, despite tariffs, policy uncertainty, and slow overseas growth, is puzzling.
Thaler suggests market participants might be experiencing a "bad dream" and expecting a return to normalcy, but notes that economists widely view tariff policies as detrimental.
"The only story I can tell is PE market participants think there's a bad dream and it's going to go away."

Favorite Investor and Conclusion [18:30]

When asked for his favorite investor, Thaler names Warren Buffett due to his long-term track record and stock-picking ability.
He humorously adds that Buffett also benefits from selling to "widows" at good prices.
Thaler's new book is "The Winner's Curse: Behavioral Economics: Anomalies Then and Now."
"Well, you got to go with Buffett. Uh, long-term track record and um, you know, "