The Cocktail Party

When trying to predict where we are in the market cycle, we found it’s best to rely on sentiment rather than valuations or any sort of macro prediction. That’s why our favourite indicator to use is Howard Mark’s pendulum analogy  which we’ve written about in this and this (and found it to be really quite telling), but our second favourite is Peter Lynch’s cocktail party analogy, which we replicate below.

In the first stage of an upward market – one that has been down awhile and that nobody expects to rise again – people aren’t talking about stocks (at the cocktail party). In fact, if they lumber up to ask me what I do for a living, and I answer, ‘I manage an equity mutual fund,’ they nod politely and wander away.

If they don’t wander away, then they quickly change the subject to the Celtics game, the upcoming elections, or the weather. Soon they are talking to a nearby dentist about plaque. When ten people would rather talk to a dentist about plaque than to the manager of an equity mutual fund about stocks, it’s likely the market is about to turn up.

In stage two, after I’ve confessed what I do for a living, the new acquaintances linger a bit longer – perhaps long enough to tell me how risky the stock market is – before they move over to talk to the dentist. The cocktail party talk is still more about plaque than about stocks. The market is up 15 percent from stage one, but few are paying attention.

In stage three, with the market up 30 percent from stage one, a crowd of interested parties ignores the dentist and circles around me all evening. A succession of enthusiastic individuals takes me aside to ask what stocks they should buy. Even the dentist is asking me what stocks he should buy. Everybody at the party has put money into one issue or another, and they’re all discussing what’s happened.

In stage four, once again they’re crowded around me – but this time it’s to tell me what stocks I should buy. Even the dentist has three or four tips, and in the next few days I look up his recommendations in the newspaper and they’ve all gone up. When the neighbours tell me what to buy, and then I wish I had taken their advice, it’s a sure sign that the market has reached a top and is due for a tumble.

Now these stages don’t have to go in any order, we can go from one stage to the next, and then come back a stage, but the stages are quite reasonable benchmarks as to where we are in the cycle. In late December last year, I felt that, especially for growth stocks, we were in stage four as I went from being asked what stocks people should buy to being told that I should check out stocks in the hydrogen battery space, in electric vehicles, in edge computing, and people who I knew for a fact had never invested in stocks before thought that ARKK had ‘lots of room left to run.’ For a while though, they all seemed right, and to my astonishment each of those stocks ran higher. Alas, nothing gold can stay, and the last 2-3 months have brought a swift end to this stage with growth stocks and SPACs meeting a very brutal rotation toward value, and almost all the stocks I was “pitched” are down 45-70%. However, given that most indices are still close to their all-time high, one would think that we still may be in stage 3 or 4 of the stock market, and I thought the same, until I recently attended my own cocktail party.

Due to Singapore’s group restrictions it was a small affair at a friend’s house that my wife and I attended. Besides the host, we didn’t know anyone else, so upon arrival we did introductions. I introduced myself as an investment advisor to HNIs/Family Offices, and got a few polite nods. As the night progressed, I got a question on the structure of Farrer Wealth, and was preparing for the subsequent “what are you investing in” or the “what stocks are you buying” or “what do you think of x stock” questions when the attention quickly turned to the lady on my right. She had just mentioned that she had invested in dogecoin at 3 cents. Now this lady, who later revealed she had only just started investing, didn’t quite understand the implication of capital gains tax, and had confused a limit order for a stop loss order, was the centre of attention, and was almost being treated as a demi-god. Ok I’m stretching that a bit, but was certainly treated as someone who had made a great investing decision. Now perhaps she has, after all the point of investing is to make returns, but my point is that there was a definite feeling of later-stage-cocktail-party-conversation-driven euphoria. The conversation also turned to discuss a mutual friend of those in attendance who had made millions of dollars in crypto and whose recommendations to the group had netted them 100-200% gains in a few weeks.

As this discussion unfolded, I sat there mostly in silence and couldn’t help but think about Lynch’s cocktail analogy, and how this group was firmly in stage 3 if not stage 4 of the crypto cycle. They were certainly reaching bubble territory, and if they are not then perhaps I need to find a new profession! Also before the crypto fans come after me, an asset can have a lot of long-term value but still be in a short-term bubble, two things can be true at the same time. Don’t get me wrong, those who benefited from the crypto boom should celebrate, I’ve read many amazing stories about crypto investors who have paid off student debts, mortgages, and gotten their lives back on track. Our observation simply suggests that the cocktail party attention has shifted away from stocks and into the crypto space, which in turn has perhaps shifted the stock conversation back to stage 1 or stage 2. It’s an interesting paradigm as the stage shift in stocks seemed to have occurred perhaps less because of a crash in stock prices (although thats the case for unprofitable growth stocks, it is not for the market in general), but more due to a shift in attention away from traditional assets.

When thinking about this piece, we came across this short-blog post by Bronte Capital, which compares the google search interest in the US for “How to buy stocks” to “How to buy dogecoin” and the results are very illuminating.

Interest over time - “How to buy stocks”

This first graph shows interest over time for “How to buy stocks'' and shows two peaks: one during lockdown and the second during the growth/meme stock boom in late-Jan and early Feb this year. This coincides with the shifts in cocktail party stages we’re experiencing lately. But just look at the graph when overlaid with “How to buy dogecoin” (in red)

Interest over time - “How to buy stocks” (blue) vs “How to buy dogecoin” (red)

It’s a bit hard to see, but the difference in interest in dogecoin/interest in stocks was 2x during the Jan/Feb 2021 spike, but now, it’s more than 3.5x higher. We also did a comparison with “how to buy crypto” and that’s more than 4x higher. Now I’m terrible at market timing of any kind, but I do have a feeling we’re going to see a cocktail party shift in the crypto world sooner rather than later.

The point of this piece is to discuss two things - 1) where we are in the stock market cycle, and based by Lynch’s framework we seem to be in a stage lower than we were at during the end of last year and 2) to understand where the conversation has shifted to - and the answer to this is clear, crypto, which in our humble opinion is in a much later stage than at the end of last year. Now none of this means that stocks (and especially growth stocks) can’t go lower, and crypto can’t go higher. This might very well be the case. But I do have a feeling that one hand, one shouldn’t be too pessimistic about stocks at this point, and on the other hand one should perhaps contain their euphoria on crypto.

Thanks for reading all, and as usual happy investing! For those reading this from countries where the second or third wave has hit incredibly hard (like India), we hope you and your loved ones are staying safe.