This post diverges from my usual to focus on market psychology. We tend to think market behavior is focused primarily on economic fundamentals, but human psychology is actually the more influential driver. The title above is the famous quote from Alexander Pope's poem An Essay on Man, published in 1732. It speaks to the idea that whether life is fair or unfair, hope is the thread that pulls us through. It also speaks to Freud's drive theory.
The primary point I want to make is something experienced market traders will have learned, probably the hard way, and that is the proximate cause of historically significant market tops and subsequent deflationary crashes is typically caused by overvaluation, also known as market "bubbles". The proof of this is markets frequently go up, and then go down, when they are supposed to be doing the opposite.
Where do we get the idea markets are "supposed to do" this or that? It's always based on the idea that markets will continue doing what they've been doing within the current context of existing durable trend directions.
One of the more famous examples of this kind of thinking is two weeks before the 1929 stock market crash, economist Irving Fisher stated that stock prices had "reached what looks like a permanently high plateau". He also argued that the market was undervalued and that security values were not inflated.
In retrospect we know markets were terribly overvalued due to the previous decade of the roaring 20's.
However some people knew then that markets were overvalued and due for rough sledding, and they were prepared.
So, people generally do not do what successful investors do, which is buy low and sell high. Warren Buffett put it succinctly - "sell when investors are greedy and buy when they are fearful". The problem is of course one can only do this if they track markets continuously, whether up or down.
And Buffett has recently followed his own rule, raising cash holding to the tune of 50% of Berkshire Hathaway's total market cap. The fact Buffett has never raised that quantity of cash before has my attention, and is something worth considering. The inference of course is the potential for a bear market that is worse, more lengthy and deeper, than those of recent memory.
Irving Fisher is typical of market economists in that they typically "cheerlead" investors to stay the course come hell or high water. That has worked (to a point) in the 2000 and 2008 crashes because the government devalued the dollar so drastically in this period. Which makes markets appear to be more valuable than they actually are.
And then the "Corona Crash", which is now only a blip on the long term market screen, was the cause of the most rapid money creation in US history.
So if overvaluation is the proximate cause of market tops and crashes, what are the secondary causes? A formal definition may be helpful:
"In the context of law and causation, a proximate cause is the primary, most direct cause of an injury or event, while secondary causes (also known as intervening or superseding causes) are events that occur after the initial cause and may contribute to the outcome, but are not considered the primary cause for legal purposes."
Investors who do not track valuation metrics tend to ascribe secondary causes as being the primary causes. And the secondary causes can be an odd thing in the sense the primary is invisible, so to speak, whereas the secondary is the only metric that is "visible". And this is part of the reason investors tend to stay in markets that are crashing, and avoid markets that have come down to good values again.
Well, we are herd animals, and to be good investors we have to "train" ourselves to follow valuation metrics instead of our feelings. And that is not as easy as it sounds, and typically requires relatively long periods of study.
And now tariffs are seen as the proximate cause by those who have not been following valuation metrics, when in fact tariffs are the secondary cause, the more visible of the two. Valuation metrics do not tell us in advance exactly where a market top will be, and they do not tell us what the secondary cause will be, only that there will be one, and it will will typically take all the blame when actually it belongs mostly to overvaluation.
