Extraordinary Popular Delusions and the Madness of Crowds

When I was kid, my grandfather, the small-town Ohio doctor I mentioned in the Introduction, and I were sitting at his humble kitchen table one morning when I was thirteen. He had in his hands this hardback book with a rustic, old-looking cover.  He said to me, “This book is going to explain why we do what we do, and you will use this book to take advantage of market opportunities.” Stocks and bonds were his forte, after-hours, even for a small-town doctor. He was buying battery companies long before the cell phone, and he kept saying we will “harvest” the Sun one day.

He used to tell me a lot of stories, and when I moved to Texas at fifteen he just said one thing while handing me a few dollars for the road: “When you get to Texas, just put your hand out to any and every one because if you do, you will fit in just fine.” I don’t think he had ever been to Texas, other than driving Route 66 back in the day. It was great advice, but he did leave out one thing I had to learn, and learn quick, “yes, sir” and “yes, ma’am.” Many people who know me, even in recent years, who will read this know I will shake your hand and say, “yes, sir” quickly, especially if another Texan, regardless of where I currently am in the world, is with me.

After the 1987 October, Black Monday where the Dow Jones Industrial Average lost 23%, I called my grandfather the next day to see how it affected him. He was a matter of fact, calm, and seemed as if nothing had happened. I asked, “Did you lose money?” He said, “Yes, I did.” But, he said it with a tone that revealed that he was not a happy camper. “What did you lose money on?” I asked. His reply, “My S&P 500 puts expired in September!” “So it goes,” which was his reply to many things until he departed at 93, a few years back.

After college, and I don’t recall the year he finally gave me this book. I keep it nearby to always manage my thinking. The book is special and I am thankful and glad it has served me well, too.

There are untold stories of human nature in this book and they could be applied to situations back then, today, and tomorrow.

I am sure many of you are familiar with the ‘Tulip mania’ story?

A story of human nature that no mathematical or software tool could ever prevent us from succumbing to. Tulip bulbs went to not $100/bulb, but over $700/bulb in the now infamous Tulip mania in Holland in the 1600’s. We have plenty of stories just like this today, especially if you have been around the commodity and energy markets for even just a few years. The 2008 Financial Crisis is a result of human nature. Today, in LA, you can’t drive around and not see an untold number of Mercedes’ on the roads—same story, human nature.

In 1980, everyone thought oil was going to $100/bbl. I was making $33,000 at 18 in 1984, just before the oil prices crashed. It didn’t hit $100; it went back to the low teens. I saw many good people go bankrupt, lose everything. Today, history has repeated itself.

We got to a point recently, too, where everyone believed oil would never go lower than $100/bbl., or today already where people propose that the price will never recover from the currently overwhelming amount of oil inventory we have today – twice what the U.S. had just a dozen years ago when you include both private and the strategic petroleum reserve inventory stock.  If you have read the book, The Prize by Daniel Yergin, you already know this is a long-standing volatile, boom and bust cycle, going back to the 1800’s, which is a must-read book, too.

By now, you understand why I think it is important that we begin with human nature so that you too do not fall into the repetitive human nature cycles, and/or pendulum swings taking into overcorrecting markets.

Therefore, I suggest human nature is so important in developing hedging and risk management programs. Wading through, understanding and ensuring to the greatest extent possible, so that everyone from the boardroom to the back-office understands the hedging and trading strategies you employ. By doing this, you will minimize the risk. This is one of the few times I will use “minimize,” you will too soon learn.  And, that risk is your risk, not the companies per se. To avoid misunderstandings, and from anyone creating perceptions vs. the facts of how and why our hedging and trading strategies do and do not make money, but to maximize our risk/reward profile will soon change your outlook. Regardless, human nature is human nature, but do your part to avoid issues by following the path this book takes to help you develop and maintain, year after year, decade after decade, and for decades after you leave, a successful legacy. Leaving not a carbon footprint, but a footprint people want to follow long after you leave.

As for perceptions, please also do not take away an idea that I do not think judgment is very important in any program, it is. When markets, politics, economics, military, and acts of God occur, sometimes it is prudent to allow human judgment to take over and override any policy. But, this must be spelled out in any hedging and risk management program. Not a disclaimer, but to ensure validation of your program is understood start to finish.