place in much more sophisticated markets, with more knowledgeable investors who, because of more stringent SEC regulations, are much better informed than any group in the past. Yet the characteristics of crowd behavior Mackay describes and Le Bon analyzed, though they go back centuries, closely resemble the U.S. markets of the past diree decades. It is also remarkable how predictable and repetitive these crowd actions in markets are.

Market history directly contradicts our academic friends who theorized that investors were always rational, completely unemotional creatures. Investors continually overestimate die outlook for some investments and underestimate the prospects of others. Often the euphoria or pessimism goes to exti-emes. Here we come to an important rule that we will observe time and again.

RULE 41

A given in markets is that perceptions change rapidly.

When they do, the values of favorite investments can wither quickly to a fraction of their previous prices, while unfavored investments are suddenly reevaluated sha ly higher.

There is a common denominator among the South Sea Bubble, die IPOs, and stocks on the telecommunications superhighway. People driven by powerful cognitive and group psychological forces are far too optimistic or too pessimistic about the outlook for a stock, an industry, or the market. It doesnt matter whether we are looking at Florida swampland in the mid 1920s, the boom then bust in the real estate or the art markets in the eighties and early nineties, or IPOs in 1997.

The following table looks at manias in different eras. They range from tulipmania (when rare tulip bulbs sold for more than todays top-of-the-line Mercedes), through the Enghsh South Sea and French Mississippi bubbles of the early eighteenth century, to the manias of the past 75 years. As you can see, prices swing enormously when investor expectation changes from ebullient to pessimistic. The fate of American investors pursuing hot IPOs and concept stocks in the sixties, seventies, eighties, and nineties was not much different from that of the frenzied Dutch, English, and French crowds centuries earlier.

Four general principles seem to emerge from a study of financial speculations. First, an irresistible image of instant wealth is presented, forming a crowd around it.

Second, a social reahty is created. Opinions converge and become "facts." Experts become cheerleaders approving events and exhorting

Table 16-2

Market Bubbles Through the Ages

Price Declii from High

Florins; Pounds sterling; Livres; "Low Price" = closing price on Dec. 31,1997.

the crowd onward. Overconfidence dominates, standards and experience of many years are forgotten.

Third, the image in the Le Bon magic lantern suddenly changes, and anxiety replaces overconfidence. The distended bubble breaks and panic ensues.

Fourth, we do not, as investors, learn from our mistakes-things really do seem different each time, although they are really pretty much the same.

As we have seen, even though the investors of the 1980s and 1990s were armed with exacting fundamental tools, these did not save them from going as wild as the Enghsh and French of centuries earlier.

What I hope the chapter demonstrates, then, is that the cogniUve biases we examined in chapter 10 often can be reinforced by expert, crowd, or group opinion in the marlcetplace. The result is the irradonal investor behavior we have just reviewed.

I am sure you can see the striking dichotomy between the radonahty assumed by the EMH advocates and what we saw of cognitive biases and crowd behavior. We have yet to capture even a snapshot of the EMHers rational man. Instead, we have frame after frame of frenzied investors, in Bourse after Alley after Street, paying ridiculous prices for companies with little but sizzle, and ultimately, little hope of survival, let alone staggering profits. Something is amiss. Are the academic researchers and the market historians looking at behavior on the same planet?

The final chapter provides the answer to this question.