Invest With the Wolves, Not the Elks

• 6 min read

Without fear, the financial markets become dangerous places. Which asset lacks fear today?

Invest With the Wolves, Not the Elks

In 1995, Yellowstone National Park had only one beaver colony. Today, there are 9 beaver colonies and more coming. What made the change?


More specifically, fear of being eaten by wolves.

In the 1930s, the grey wolf was killed off in Yellowstone. With one predator gone, other animals thrived. One in particular was the elk.

As a result, elk populations did very well-perhaps too well. Two things happened: the elk pushed the limits of Yellowstone’s carrying capacity, and they didn’t move around much in the winter-browsing heavily on young willow, aspen and cottonwood plants. -Brodie Farquhar (link)

The elks didn’t have to move as much in winter to avoid wolves, so they had more time to stand around and graze on young willow trees. As a result, the willow population declined. Without the willows, beaver colonies were not able to survive. And without the beaver dams, the fish had less cool water for fish. And less willows meant less habitats for songbirds.

All of that chaos could be traced back to one thing: the lack of fear.

Once they reintroduced wolves back into the park in the mid-1990s, the elk population started moving, willows were healthy, and beaver colonies expanded. The ecosystem returned to a healthier state.

Fear In Financial Markets

Markets are the same way.

No one likes a stock market correction or bear market, but those events are the very things that give stocks their above-average future returns. Without them, stocks would be risk-free and, therefore, would be priced so high that they have the same return as other risk-free assets (like US Treasury bonds).

When investors forget risk, bad things are bound to happen. Prices get well beyond where they should and investors who buy at or near the top are the ones that ultimately suffer for it.

When there is a healthy balance of fear in the marketplace, prices tend to stay near reasonable levels; therefore, investors can make reasonable returns.

And when there is too much fear (like in March 2020), prices tend to get unreasonably low, which creates the opportunity for larger-than-average future returns.

One of the best things you can do before making any investment is to ask yourself: "Do I feel any fear doing this?" You can also look around you, listen to what others are saying, and ask whether others seem to feel any fear.

If the answer is "No," be careful.

Case in Point: ARKK

The best recent example I can think of is ARKK. Every YouTube video I posted had at least 10 or 20 glowing comments about ARKK. A few commenters ridiculed me in my dividend ETF videos for being "old fashioned."

With so many people pushing ARKK and the hype train running off the rails, I posted a warning video suggesting that funds with such high inflows have historically underperformed quite badly after the money poured in. That was February 20, 2021 with ARKK at around $153 per share.

ARK Innovation ETF (ARKK). Source: Yahoo! Finance as of May 22, 2021

That video was met with predictable anger. Here were just a few comments. (I won't mention names; I don't mean any disrespect.)

Many experts bashed Apple, Microsoft, Facebook and Tesla couple years ago, said it was all over. And now, it's ARKK's turn. Those Nay Sayers will eat your words soon enough again!
You missed the boat. Nice vid, but look at the last 10 years, the last 5 years, the last year -- more relevant times. QQQ crushes VOO and your momentum etf MTUM in recent times, especially in the "stay at home" era. The only ETFs I would take over QQQ are ARKK and ARKW.

The data from past fund explosions (which it looked to me like ARKK was in) suggested it would likely underperform by 50% or more over the next decade. That was based on the data (not necessarily my opinion). Well, that happened a bit earlier than expected.

It's now trading at $106 - down over 30% from the highs.

Now, I'm not intending this as a "I told you so" post. I could've easily been wrong and have been wrong plenty of times before. The markets have humbled me more times than not.

My point is actually that there is no prediction or fancy analysis required to avoid some bad decisions. I didn't investigate the stocks within ARKK or do some kind of detailed valuation on them. I didn't necessarily disagree that the story (that technology would drive the future) was wrong. In fact, I didn't even comment about the strategy itself, as this commenter said:

I did note that not one word was spoken of why the philosophy of the fund is why the fund failed.  I'm guessing Nathan thinks that disruptive technologies will be passé in a year or two.

My 'analysis' was simply based on emotion. There was a clear lack of fear about ARKK, which smelled like trouble. So far, that seems to be accurate.

What's the Next Bubble?

It will happen again. It always does. But where?

So, if you want to know where the next bubble is, just observe your surroundings. Where do you find that a lot of people are optimistic about? Let me know in the comment section.

Here's my two cents.

Everyone seems to think the stock market is in a bubble, which - to me, at least - is what gives me the most confidence that it's probably not. I'd be more worried if no one thought it was in a bubble, or worse, if everyone said it definitely was not in a bubble.

The latest craze is cryptocurrency, which I expect will likely meet the same fate. It's not that crypto isn't a great idea or technology; it's only that the optimism surrounding it has reached irrational levels. Everyone is asking about it; a lot of people are buying it as part of their asset allocation; many proclaim those who don't as having subpar intelligence; few actually understand it.

Again, I'm not hating on the underlying idea or technology. That stuff doesn't matter. We could be talking about tulips or lumber or anything. What it is makes no difference. All we need to know is how much fear or greed there is.

You don't have to do any fancy analysis to see how much optimism there is around Bitcoin or dogcoin or whatever other cryptocurrency right now. And when optimism runs rampant, everyone buys. And after everyone buys, there's no one left to buy it. And in the absence of any real substance underlying cryptocurrencies (i.e.: they are not productive assets like companies or real estate), there is nothing left to power gains higher.

This is just my opinion. I'm not making any buy or sell recommendations here; you should always do your own research and come to your own conclusions. But I think we've seen the all-time high for Bitcoin already. I don't think it ever trades above $60,000. Digital currencies are probably here to stay, but that doesn't mean they are worthy 'investments'.

Take Away: Do You Feel the Fear?

So, before you make any investment, check yourself with these questions:

  1. Do you understand what you're buying and why you're buying it? Or are you just buying because you saw it on YouTube or the news or a friend told you about it? If you don't understand something, don't invest in it.
  2. Do you feel the risk and uncertainty? Or does it feel like a 'can't miss' investment? If it feels like you can't lose, you probably can (and will).
  3. Do you sense other people being cautious about it? Or are you seeing a lot of hype around you? If everyone is hyping it within your friend group, on YouTube, or on Facebook, you should avoid.

The answer to those questions can help you make some smart decisions and avoid some potentially stupid ones.

DISCLOSURE: This is not investment advice. I'm not recommending that you sell or buy anything. Do your own research before investing. I'm an old stodgy investor trapped in a 31-year-old body, so I may be too old-fashioned to see the future. Maybe I'm wrong and Bitcoin goes to a bajillion dollars like everyone else seems to think. And, for the record, I have no position long or short in ARKK, Bitcoin, or any other cryptocurrency in this article nor do I plan to initiate any within the next 48 hours.

← Is the Stock Market in a Bubble? Part I: Tulips
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