Fear & Greed
Be fearful when others are greedy, and be greedy when others are fearful. - Warren Buffett
On March 27th, 2000, Cisco’s market capitalization touched $569 billion making it the most valuable company on earth. Cisco was at the center of the dot-com bubble and at one point, the average Cisco employee had over $250K in stock equity. Cisco pioneered the development of networking equipment and investors poured money into the company betting that the demand for networking equipment would grow exponentially with the internet. The funny part was that the market was so irrational with Cisco’s growth prospect that economist Burton Malkiel pointed out that at Cisco’s implied growth rate, it would become larger than the entire U.S. economy within 20 years.
But, we all know what really happened. As with all euphoric growth stories, Cisco’s stock came crashing down with the rest of the market as the dot-com bubble popped. The company lost nearly 90% of its market value following the crash and has never touched the ATH it hit during the peak dot com bubble.
Fast forward 8 years, and we were in the midst of the global financial crisis and Goldman Sachs was facing significant liquidity problems. Bear Sterns, Lehman Brothers, AIG, and many household names had gone down, and the entire financial system was on the brink. This was when Warren Buffett made a $5 billion investment in Goldman Sachs that gave Berkshire preferred shares with a 10% yield and warrants to purchase shares of Goldman Sachs at an attractive price. Just 3 years later, after the market turmoil had calmed down, Berkshire exercised its warrants to buy and sell 43.5 million shares of Goldman Sachs for an astounding $1.2 billion profit.
If you look at it objectively, both companies are great institutions providing valuable services. But, the investor returns from both would differ vastly depending on when you made the investment. Someone who invested in Cisco at the top would still be down 40% after 20 years whereas Goldman Sachs is now trading at 5x its price from the 2008 crisis.
It’s very easy to get carried away by a growth story when everything is going great. Tech stocks during the dot com bubble, the housing market in 2007, and ARKK funds, NFTs & the crypto bubble after the start of the Covid pandemic - we have seen time and again investors piling onto the wrong investments just because they were made to look like “the next big thing”.
JP Morgan recently released a report highlighting the effectiveness of using consumer sentiment for investing - On average the S&P 500 returned only 4% in the next 12 months if you invested when the consumer sentiment was at its peak whereas if you invested when the consumer sentiment was at its lowest, over the next 12 months, your average return was 24.9%! A 6x increase in returns just by investing when everyone else was skeptical to do so.
Obviously, the above analysis suffers from classic hindsight bias – we cannot know in advance if the consumer sentiment we are seeing today is at a new peak or at an all-time low. But, we do know how consumer sentiment has trended over the past 70 years and how market returns were inversely correlated to consumer sentiment.
Given that we are now experiencing one of the lowest consumer confidence levels since the global financial crisis, it’s the right time to dig into whether we can use consumer sentiment to our advantage: