How financial markets became even more manic

Peter Thal Larsen (0:03)

We are living through an extraordinary period in financial markets. In the US, major stock market benchmarks keep making new highs, even as valuations are already very stretched. Earlier this year, trading in American equities soared above $1 trillion a day. SpaceX has just completed the largest ever stock market listing, and some more trillion dollar plus companies are hoping to join it. Meanwhile, retail investors are more active than ever, with tens of millions of people regularly trading stocks, options and other assets through their smartphones.

This frenzy provokes some big questions. Is what we're witnessing a cyclical boom, as the world has experienced many times before, or is something fundamental changed in the way stock markets work? Do the old and tested rules of investment and valuation still apply? And how should individual investors navigate this increasingly noisy and confusing world?

So, this week on The Big View, we're going to talk about the wisdom and the madness of stock markets. It's what we do at Reuters Breakingviews. We tap the top experts around the world for a fresh insights into the biggest stories in finance, business, and economics. I'm your host, Peter Thal Larsen.

And to talk all this over, I'm delighted to welcome Alex Edmans onto the show. Alex is a Professor of Finance at London Business School, a former Morgan Stanley Investment Banker and an advisor to several investment funds. He's written books about corporate finance, statistics, and corporate purpose. His latest book is called The Madness of Markets, Why Smart Investors Make Crazy Decisions and How to Exploit Them. And he joins me from his home in London. Alex Edmans, welcome to The Big View.

Alex Edmans (1:47)

Thanks so much, Peter. It's great to be here.

Peter Thal Larsen (1:50)

So let's start with the current moment. We've got indices at various markets, the S&P 500 hitting all-time highs, trading in US stocks is at record levels in terms of volumes. Valuations are close to peaks. SpaceX has gone public. Millions of people are trading stocks on their phones. I mean, you studied markets, the history of markets, all the weirdnesses of markets over the years.

How mad would you say markets are at the moment?

Alex Edmans (2:23)

I'd actually say the first thing to curb is our own madness. So we would love to say we can call the market. So there might be some people who say, well, AI is absolutely going to be in the future. Let's buy this. Others will say, well, there's clearly an AI bubble. These valuations just don't make sense. I know that the earnings of these AI companies are not sustainable because the hyperscalers are going to be curbing their investment. But the thing to notice is that markets are driven and traded by professional investors who look at this every day, and they have their team of analysts and they might have direct access to management. And if the price is what it currently is, it is probably because the experts who do this for a living, believe that it is roughly the fair price. There are probably just as many experts arguing that markets are underpriced as there are overpriced. So I think for any amateur investor, so including me in this, because even though I do have some knowledge of finance, I don't have the contacts and the time to study stocks just like a professional. Actually, I think the best piece of advice is to be in the market and not try to time the market. Just the power of compounding is so great that the returns to getting in and staying in and withstanding short-term volatility are very high.

Peter Thal Larsen (3:41)

Yeah, okay. That's good advice. I guess I would say even though there are lots of experts who are devoting all their time to this and applying all their wisdom and knowledge and experience, we do know from history that there are periods of exuberance and there are periods where that deflates again. I think you write in the book, this stuff has been happening for centuries and it's not going to stop.

So how do you think about that? Is it just part of the ups and downs and you've just got to live through it? Yeah.

Alex Edmans (4:20)

So that's certainly one way of understanding the markets is that there will be falls and there will be upswings and if you are just to be in the market for any reasonable period of time and to be a buy and hold investor, then you're going to do pretty well. But your question is a good one, Peter, because you're hinting, can you do even better than pretty well? And this will be sort of the level two, the full fat version of what I'm writing. Can we do better than just buying and holding the market? And yes, you could do if you're willing to take a stomach, a little bit of extra risk. What systematic evidence has found that the market does tend to overreact to information? So we saw this in the tech bubble where some companies had massive valuations. Cisco, for example, it had a price earnings multiple of 190