Wang Chuan: How can one not feel anxious after the neighbor Old Wang made thirty times profit by investing in storage stocks? (Seven) - A quarter-century cycle

Author: Wang Chuan

This article is a continuation of Wang Chuan: How Can We Not Be Anxious After Neighbor Wang Invested in Storage Stocks and Made Thirty Times? (Part 6) - The Trap of Homogeneous Products.

1/ In the software service industry, there is a term called Net Dollar Retention rate, literally translated as "Net Dollar Retention Rate," which refers to how much a customer continues to pay you each month after initially starting with one dollar. If the NDR exceeds 100%, it indicates that revenue from customers is increasing; if it is below 100%, it is decreasing. However, when this term becomes "annualized" net dollar retention rate, some companies start to play tricks. For example, if an AI company sees a 50% revenue growth from the same customer over three months, the net dollar retention rate would be 150%. Executives can confidently promote that their net dollar retention rate is 500%, assuming that there will be a 50% growth every quarter, calculated using the fourth power of 150%, and they also assume this will continue every year, even though the actual growth only lasted a few months. Anyone who has done business knows that any rapid growth cannot be sustained long-term; sudden stagnation and reversal of growth are common. From the perspective of these companies, since everyone is exaggerating, as long as they can secure financing and boast, they don’t care about the flood that may come afterward.

2/ A very subtle point is that during the rising phase of an industry bubble, a significant portion of demand is not long-term rigid but exploratory, driven by panic and liquidity. This type of demand has a characteristic of "reflexivity": if others are exploring, if others are panicking, and liquidity is flooding in, then I also feel the urgency to follow suit and spend money. Once someone goes bankrupt and the situation reverses completely, when liquidity tightens, I will immediately cut budgets and investments, and that exploratory demand will quickly vanish.

3/ Corresponding to this "reflexive" demand for products, there is also a group of "reflexive" speculative buyers in the stock market. During the rising phase, they follow the trend, leverage up, and push stock prices to extremes; they are not long-term holders. If the situation reverses and many people panic-sell, they will also quickly scatter. The transaction price is ultimately determined by marginal buyers and sellers, and the high prices during the most frenzied bull markets and the low prices during the most panicked bear markets are created by these "reflexive" speculators.

4/ Therefore, we have a "reflexive" structure at both the physical and financial levels. During the industry's rising phase, the reflexive product demand at the physical level creates a tsunami-like strong positive feedback, attracting reflexive speculators at the financial level to enter the market, which also creates huge positive feedback in the financial realm, further pushing asset prices higher. This positive feedback at both levels will only stagnate and reverse when they simultaneously encounter rigid constraints at the physical and financial liquidity levels. Once a reversal occurs, there will also be a positive feedback, which is a downward avalanche-like intensifying feedback.

5/ However, in the storage industry, semiconductor industry, and the entire data center supply chain, there is an even greater risk: unlike Bitcoin, which has a precisely defined four-year halving cycle in its code, there are no statutory rules guaranteeing that after a stock price decline, it can definitely make a comeback within four years. In fact, several major old giants, Micron in 2024, Intel and Cisco in 2026, only broke through the stock price highs of 2000, and during this quarter-century, they experienced price retracements of over 80% or even 95%. Before his death, Ah Q famously said, "I will be a good man again in eighteen years!" For the high-tech industry, especially the hardware sector, Ah Q was overly optimistic.

6/ Why does this phenomenon occur? One reason is the "bullwhip effect" in the hardware industry supply chain mentioned earlier. (Wang Chuan: How Can We Not Be Anxious After Neighbor Wang Invested in Storage Stocks and Made Thirty Times? (Part 5) - Bullwhip Effect) When the industry completely reverses, the disappearance of demand is instantaneous, but the output of supply has delays and rigidity. Overcapacity will worsen for a period, and it will take several years to fully digest and reach a new balance. Even if balance is achieved, the severe supply-demand imbalance experienced during the rising phase cannot be fully reverted.

7/ Another more subtle reason comes from the narrative shift brought about by the downward bullwhip effect. The construction of narratives is essentially a recruitment mechanism to find more people to take over. When liquidity is high, many questionable high-valuation narratives are immediately believed by people who invest real money. It’s like when there are starving refugees everywhere, it’s very easy for heroes to recruit soldiers. The crazy high valuations during the rising phase are not only due to supply-demand imbalances but also a short-term layering of multiple "reflexive" factors, leading to an accelerating exponential rise in acceleration itself. Such widespread high-speed growth stories are rare and attract a lot of speculative capital to support fantastical high valuations. Once growth slows down, the "reflexive" speculative capital quickly leaves to chase the next high-growth story in another industry.

8/ Taking the profit and stock price comparisons of three major companies over twenty years as an example: Intel's profit in 2020 was twice that of 2000 ($20.9 billion vs. $10.5 billion), but the highest stock price in 2020 at $69 was lower than the highest point of $75 in 2000; Micron's profit in 2020 was $2.69 billion, nearly 80% higher than the $1.5 billion in 2000, but the highest stock price in 2020 at $75 was still 20% lower than the highest point of $97 in 2000; Cisco's profit in 2020 was more than four times that of 2000 ($11.2 billion vs. $2.67 billion), but the highest stock price in 2020 at $50 was only about 60% of the highest stock price of $82 in 2000. Twenty years later, although these companies are more robust, with revenues and profits much higher than twenty years ago, the soul of the highly overvalued narrative left long ago.

9/ A person who has just started investing and has repeatedly succeeded during the rising phase of an investment bubble will form two major mental stamps:

One is equating the current strong demand with sustained strong demand; a brief period of rapid growth of one or two years is equated with future continuous rapid growth. During the rising phase, stock prices continue to rise, and even if there is a brief decline, they generally rebound quickly. All negative information is ignored (or rationalized with bullish explanations), and any brief decline is seen as a buying opportunity. As time passes, this mental stamp is continuously reinforced. In the mental model of these people, when prices rise, don’t talk reason with me; rising prices are the hard truth. You’ve said so much reasoning, why aren’t my returns higher?

10/ The second is that making quick money and big money is easy. Here, "quick" means less than a year, with returns of at least double in a year. A thousand years is too long; we only strive for the present! It is said that SanDisk has already increased sixfold from the beginning of the year; those fund managers who are happy with a 20% return in a year are really too old-fashioned and out of date.

11/ Buffett once said: "The boundary between investment and speculation has never been clearly defined, but if most market participants have recently been successful, that line becomes even more blurred. Earning big money effortlessly is the fastest way to lose one’s mind. After experiencing such intoxicating success, normally rational people’s behavior patterns gradually become like Cinderella at a ball. They know that staying too long at the party—meaning continuing to speculate on companies with huge gaps between valuations and future cash flows—will ultimately lead to pumpkins and mice. But they still don’t want to miss even a minute of the revelry. The euphoric participants all want to leave before midnight, but there’s a problem: the clock in the ballroom has no hands."

12/ At this stage, you can see it as a game with asymmetric returns and risks. Continuing to play inside may yield twofold or even higher returns? But once the situation reverses at some unpredictable point in time, the entire valuation system collapses, with risks of over 80% price retracement and an outcome of waiting 25 years to break even. "Reflexive" speculators can’t wait even two or three years; how could they wait another twenty years?

13/ As for that neighbor Wang who claims to have made thirty times? In the event of a sudden price retracement of over 30% in the future, if he used three times leverage, he is likely to be liquidated. If he hasn’t used leverage, given the mental stamp of "making quick money and big money is easy," he will feel that the setback is just temporary bad luck, and he can quickly recover based on his courage. Didn’t Zhang Dashuai once educate his son, "When the moment comes, you must be bold"? So, neighbor Wang didn’t wait a few weeks and added to his position, heavily investing. But the previous experience of a rebound after a big drop suddenly didn’t work, and what awaited him would be a continuous decline like a dull knife cutting flesh. The narrative of high-speed growth belongs to the "world of yesterday" that has passed, and the eager neighbor Wang will frequently attempt various complex operations until he exhausts his resources and has to stop.

14/ This reminds me of what Schopenhauer once said, "Those who have experienced two or three generations of life are like those sitting at a magician's booth at an exhibition, having seen the same performance two or three times in a row. The trick is meant to be seen only once. When it no longer produces freshness and can no longer deceive you, its effect disappears completely."