A thread tying together some (hopefully semi-coherent) thoughts around bubbles, memes, and information theory.

h/t to
@EpsilonTheory
@WRGuinn
@jposhaughnessy
George Soros

This thread is a pastiche of ideas from all these folks.

Bubbles start with reflexivity. Reflexivity is where objective and subjective reality meet. What does that mean? Think of a DCF or LBO model. It’s based on data (err, should be at least) but there is also judgment involved. You can make the model *say* anything you want.

Put another way, we are talking about the intersection of hard facts and subjective judgment. Most investment decisions exist at this junction, because investing is an inherently probabilistic process.

The reflexive views of buyers and sellers are what create a market. You might get a chart like this one (shamelessly ripped off from @EpsilonTheory) Here you have a range-bound stock with high informational barriers at the so-called support and resistance levels.

What that means is that it will take a lot of *information* to move the price through one of those barriers. The support/resistance levels signify where there are strongly differentiated views about the stock’s price.

Here information = “a signal that changes your mind”

A bubble is a special case that occurs when the informational barrier to the upside (the resistance level) completely disappears.

Why would this happen?

Because market participants’ views have become effectively homogenous.

And how does that happen?

Reflexivity + Memetics

Recall that all reflexivity is really saying is that market participants CREATE market realities through their collective behavior. Markets exist in a perpetual feedback loop. It’s what people are talking about when they say “being early is indistinguishable from being wrong.”

Memetics is all about the viral transmission of ideas. Memes “infect” their “hosts” (us). When a powerful meme (such as the transformational growth! meme) is introduced into a reflexive system like a financial market, it has the potential to spread widely and rapidly.

Once the meme infects a critical mass of market participants, their behavior becomes effectively homogenous. Even those who are “immune” to the meme (contrarians) won’t take the other side of the trade, because why fight a wall of demand? Resistance to the upside collapses.

And why does the bubble eventually pop?

Eventually the meme’s host population becomes exhausted—tapped out financially. The process reverses. This time the informational barrier to the DOWNSIDE disappears completely.

I guess one practical implication here is that there should be insights for investment analysis from virology (particularly as relates to the dynamics of the “host population”) but that’s something that’s only just occurring to me.

Possibly I am high on my own supply and I’m just restating things everyone else already knows here, but this just snapped into focus for me on an intuitive level and I wanted to pull it all together.

/fin