Is investing a luxury?
Photo: Richard McCall. Source: Pixabay
Economics is funny. Usually, when prices go up, demand goes down. But for some items, demand goes down when the price falls. Imagine you come across an offer for a delightful getaway for two for a week on a Caribbean island; travel, meals, and gratuities included; all for $250. Most people would wonder what’s wrong with the offer, or what’s the catch. Am I going to be hounded by sales agents, or asked to be a drug mule?
Over a hundred years ago, the economist Thorstein Veblen coined the term “conspicuous consumption” to describe spending more on certain goods than their intrinsic worth. He noted that wealthy people purchase these goods for their role as status symbols, rather than for their function. Designer jewelry, fashion, and fancy transportation are all examples of “Veblen Goods,” luxury goods whose value to consumers increases when their prices go up.
Higher education behaves like a Veblen Good. Colleges typically don’t worry about demand falling when they raise their tuition. In fact, the opposite is often true. Schools are hesitant to cut their price tag because it could send the wrong signal – that these are inferior goods. During the Covid crisis, many schools provided significant discounts. After all, online learning caused their fixed costs to fall dramatically. But these discounts have almost always been framed as temporary adjustments.
A luxury good? Photo: Nikolay Georgiev. Source: Pixabay.
Stock Market Investments
While Thorstein Veblen lived and worked well before equity markets became central to our financial economy, he would have noted how investors behave as if their stocks are luxuries. People are far more likely to invest in securities they can brag about at the proverbial “cocktail party.”
A recent study by a Columbia University professor noted how retail investors and corporate CFOs both look to the most recent past to form their expectations about the future. That is, if the stock market recently went down, they get depressed and figure that prices will just keep going down. But if the stock market went up in the past six months, they figure those happy days are here again, and prices will just keep rising.
This makes some sense, at least psychologically. We’re attracted to things that delight us, and we’re repelled by that which causes us pain. For investors, higher prices delight us. It gives us pleasure to look at an account statement with a lot of gains. The average investor sees these gains and says, “I’ll have what they’re having
Similarly, it pains us to see negative numbers in our portfolios. There’s a reason why no financial websites use red as their primary marketing color. Red is the color of losses, red is the color of pain. Stocks become bargains by inflicting pain and losses on their holders. And nobody wants to double down on pain and losses. As a result, no one was bragging about buying Facebook shares at their Initial Price Offering when, six months later, the shares were trading at half of their IPO price.
Facebook the first year after its IPO. Source: Bloomberg.
What a difference a decade makes! Those shares have become “ten-baggers” and people can’t get enough. Of course, it helps that the company’s revenues have grown from 4 billion in 2011 to an expected 115 billion this year.
That’s part of what makes investing so hard. Successful investors need to be dispassionate and look at their portfolios with a cold and calculating eye. We only have one global economy, and every investment derives its value from how it participates in that cash-flow engine. If companies gain an increasing share of the economy’s activity, their value will increase – as the tech giants have over the last decade. But eventually, a security’s price can become so elevated that it is virtually impossible for the company to deliver a positive return. That’s why the best investors adjust their expectations when prices move. Low prices indicate higher future returns; high prices are a sign that future returns will be lower.
Investing isn’t a luxury, and investors shouldn’t shy away from bargains. A market that’s gone down may indicate there are problems ahead, or it may simply be adjusting to a new normal. Cash flows – and future prospects – are all that really matters. Everything else is a distraction.