The year 2020 has truly tested everyone’s resolve. It appears that the isolation and fear related to COVID-19 have tentacles that reach far beyond physical health. Poll after poll has shown that depression, anxiety, substance abuse, and other mental illnesses have risen sharply. Given the current situation and the fact that Thanksgiving is right around the corner, I hope that you and your family can take some time to appreciate the things in your life that you are thankful for.
In my personal life, I found that being thankful and being optimistic can be valuable tools. I have also witnessed the positive attributes that it has had on other peoples’ lives. Generally, I have found that my clients on the optimistic side of the table have realized better portfolio gains than the clients who are on the pessimistic side of the equation. This could be attributed to the optimists’ comfortability with including stocks for a portion of their portfolio. Historically, stocks have frequently outperformed other less volatile investment options over long time horizons. Despite the fact that optimism can be a benefit towards investing, when optimism is not adequately tempered it can be a detriment.
When I started in the investment business around 24 years ago, home computers and cell phones had just started to gain popularity. Many people surmised that the growing popularity of home computers and cell phones would help fuel a new boom in technology. The extreme level of optimism towards technology’s future translated to technology stocks growing through the roof. At the time, people were buying these stocks with the belief that technology would continue to boom and that the stocks would continue to go up with the boom. To help highlight the public’s growing appetite for technology during this time, it is worth illustrating the growth of cell phone subscriptions. The graph below illustrates cell phone subscriptions from 2000 through 2010.
As you can see, the graph illustrates that cell phone subscriptions more than doubled in the United States in ten years. In addition to cell phones’ popularity increasing significantly, we also were having a technology boom with workplace technology, home computer ownership, software, computer programs, and various other tech-related companies that were being born. Now that we understand the growth in technology let’s look at how technology stocks fared during this time frame.
Source: Dimensional Fund Advisors Returns Web, Growth of Wealth 1/1/2000-12/31/2010 NASDAQ Composite Index
The graph illustrates how the technology-laden Nasdaq lost over -30% of its value from January 1, 2000, through December 31, 2010. The reason technology stocks crashed over this time frame cannot be remotely related to slowing technology use as technology use was exploding throughout the developed world during this time frame. In my opinion, the explanation for technology stocks crashing can be attributed to irrational exuberance. Irrational exuberance occurs when the bar is set so high that it can never be attained. When investors realized that many tech companies could never realize the unattainable earnings that were being projected, investors began to sell these stocks. It is unfortunate to see great companies lose value despite their ability to grow revenues exponentially.
Irrational exuberance has manifested itself many other times in the past. This occurred with Japanese stocks in the 1980s, tulip bulbs in 1637, and toilet paper in 2020. I don’t know where the next bubble of irrational exuberance will arise, but lately, there has been a tremendous amount of optimism regarding investing in technology stocks, gold and pharmaceutical companies that are developing COVID-19 vaccines. Despite the excitement for these categories, we are encouraging investors to temper their optimism with balance. Overindulging in one investment category can increase a portfolio’s risk beyond acceptable levels.
Although we don’t encourage overindulging in investment categories, we do encourage overindulging on turkey, apple pie, and whatever else your Thanksgiving brings you. Everyone at Bernicke Wealth Management is very thankful to serve you. Have an excellent Thanksgiving!
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Stock investing includes risks, including fluctuating prices and loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.