A weekend topic starting with the Journal Record. "Today we dive deeper to better understand the anatomy of a bubble. In Poor Charlie’s Almanack, discussing the need for more reconciliation of psychology and economics, Mr. Charlie Munger cited a study by Colin Camerer of Caltech. In the study, high-IQ students, playing for real money, were caused to pay price A+B for a 'security' they knew for sure would turn into A dollars at the end of the game."

"What follows is Mr. Munger’s assessment: 'This foolish action occurred because the students were allowed to trade with each other in a liquid market for the security. And some students then paid price A+B because they hoped to unload on other students at a higher price before the day was over. What I will now confidently predict is that, despite Camerer’s experimental outcome, most economics and corporate finance professors who still believe in the ‘hard-form efficient market hypothesis’ will retain their original belief. If so, this will be one more indication of how irrational smart people can be when influenced by psychological tendencies.'"

"So, Mr. Camerer’s study shows that even when participants know with certainty that a 'security' is worth A, a speculative bubble can break out into what is, in essence, a game of hot potato. Although the real world does not provide such clear-cut examples, the recent price behavior of 'meme stocks' seems to be the best recent real-world analog to the Caltech study."

"I previously alluded to meme stocks (e.g., GameStop Corp.) in a recent column regarding the Dunning-Kruger Effect, which was initially introduced here in a late December 2020 column in which I drew parallels between poker and investing. The Dunning-Kruger Effect is a cognitive bias that predicts that the most ignorant people on a subject will be the least aware of their own ignorance and, therefore, will overestimate their ability in a given field."

"Drawing a connection between the Dunning-Kruger Effect and the Caltech study, note that being ignorant on a topic (investing in this case) does not necessarily indicate that you are an individual with an unfortunately low IQ. In fact, the Caltech study specifically calls out that high-IQ students participated. It may follow then that those at the highest risk of falling prey to the Dunning-Kruger Effect are not those with low aptitudes generally, but those that are of generally high aptitude who have been professionally successful."

"It should be noted that even highly credentialed and experienced investment professionals are not immune to these sorts of psychological pitfalls. If this were not the case, the truly systemic bubbles of recent memory (i.e., the dot-com bubble of the late-1990s and the housing bubble of the mid-2000s) would not have been possible."

From CNBC. "Stock trading app Robinhood warned of a potential slowdown in trading revenue and new clients as the boom in retail investing starts to decelerate. The slowdown is coming off booming levels. The Menlo Park, California-based free-trading pioneer estimates second-quarter 2021 revenue between $546 million and $574 million. This would be a 129% surge from the $244 million in the second quarter of 2020."

"However, the company estimates a net income loss between $537 million and $487 million in the second quarter of 2021, compared with a $1.4 billion loss in the first quarter. Robinhood — which offers equity, cryptocurrency and options trading, as well as cash management accounts — benefits from more speculative trading practices from its clients. Options trading accounts for about 38% of revenue while crypto is 17% of revenue. Plus, margin and stock lending trading levels have been elevated in 2021."

"The company alluded to clients who created accounts around January’s GameStop short squeeze, but perhaps have discontinued trading as the frenzy subsided. 'We experienced strong growth in new customers during the first six months of 2021,' the filing said. 'We do not know whether, over the long term, cohorts comprised of these new customers will have the same characteristics as our prior cohorts. To the extent these new customers do not grow their cumulative net deposits or trading frequency on our platform to the same extent as new customers that joined in prior periods, our ability to expand and grow our relationship with these customers will be impacted.'"

From Barron's. "Soaring house prices these days get play on general television news and the front pages of newspapers, not just the business section. Throughout the saga, the Fed has provided tanker cars of liquidity, by slashing its short-term interest rate target to near zero and by buying $120 billion of securities per month since the spring of 2020 to counter the pandemic’s economic impact."

"A question that many critics want answered is whether the Fed will continue purchasing $40 billion of agency mortgage-backed securities per month while the housing market is superheated. Powell testified that the impact of MBS buying isn’t significantly different from that of the Fed’s monthly purchases of $80 billion of Treasury securities, because the bond market sees the two sectors as similar."

"That $40 billion of net monthly mortgage securities purchases actually is an understatement, says Barry Habib, the founder and head of MBS Highway, an advisory firm. After taking into account reinvestment of interest and principal payments that homeowners make on their mortgages, plus cash flows from refinancings, the Fed actually is buying about $100 billion of MBS a month, he contends. He notes that the FOMC's policy directive now specifies purchases of 'at least' those amounts of agency MBS and Treasuries."

"Builders can’t keep up with demand, as the fiscal third-quarter earnings D.R. Horton, the nation’s biggest builder by volume, suggests. Even though net income per share rose 78%, year over year, topping analysts’ forecasts by 8%, its stock slumped 2% Thursday. Future orders were down, not because of a shortfall in demand, but because the company is holding back sales. 'Based on the stage of completion of our current homes and inventory, production schedules and capacity, we expect to continue restricting the pace of our sales orders,' D.R. Horton’s chief financial officer, Bill Wheat, said on the analyst conference call."

From Clay Today. "Northeast Florida’s housing market desperately needs more homes. In June, the region’s residential market continued its frenzied pace, with low-interest rates and a limited inventory fueling record-high sales prices. June’s median sales price of $301,000 leaped 18% from $255,000 in June 2020. Meanwhile, the average sale price of a home in Clay County and on the First Coast was $373,378, a dramatic 20.7% increase from the year before when the average price was $309,269."

"'Many buyers have gone to the sidelines and are continuing to rent or double up with others, as the affordability of homes compared to incomes becomes a bigger issue,' said Missi Howell, president of the Northeast Florida Association of Realtors. 'Several builders have slowed production due to uncontrollable and unforeseen but anticipated price increases that may have them building beyond what the market value appraisal could bring.'"

From My Prince George Now in Canada. "89 building permits worth approximately 100-million dollars have been awarded for single and multi-family homes according to city officials. Bob Quinlan with RE/Max Core Realty admits while the city is growing and housing supply needs to be improved, how much our population will increase is still anyone’s guess. 'When I look at see what is there and I see all the projects going on, I am little concerned that we are going to be overbuilt but that may not be a bad thing.'"

From News.com.au in Australia. "As the RBA continues to insist that rate hikes are not coming 'for at least three years,' the reality is arguably quite different. In the words of New Daily columnist and economic commentator Alan Kohler: 'The RBA has absolutely no idea what’s going to happen. Nobody does.'"

"We are in entirely uncharted waters, with a highly distorted financial system and economy. All supported by $4 billion a week in RBA bond purchases and a predicted federal deficit of almost $2 billion per week. The almost universal consensus among central bankers of the Western world is the current inflationary pressures are transitory – temporary and will pass – therefore justify not raising interest rates for years to come. Broadly speaking, economists generally agree it will be at least 18 months before we begin to see rate hikes."

"But there is rather large elephant in the room. Does it mean six more months of rapidly rising prices well above central bank inflation targets? Nine months? Or even longer than that? So far it’s a question that central bankers have generally remained tight lipped on, allowing themselves quite a lot of scope to shift their commentary, due to the ambiguity of how they define the word 'transitory.'"

From Mercer University. "Dr. Antonio Saravia, associate professor of economics at Mercer Univeristy, explains what causes inflation, why it’s worrisome, and what might be coming in the future. Inflation is a 'monetary phenomenon,' Dr. Saravia said. 'If we have more money circulating in the economy, we will have inflation,' he said. In an effort to pull the country out of a recession brought on by the COVID-19 pandemic, the Federal Reserve, which is the central bank of the United States, and the federal government injected money into the economy."

"'We’re talking about massive, massive amounts of money,' Dr. Saravia said. 'On one hand, we receive these checks, and then on the other hand, we have money that is cheap because the interest rate continues to be low. So what do we do as consumers? We spend.'"

"'The problem is timing,' he said. 'During an inflationary process, salaries may not go up as fast as the rest of the prices. They will eventually catch up, but if they lag behind for a period of time, then we may see that our purchasing power goes down.'"

"In addition, consumers should be cautious about making large purchases, like a house, or adding credit card debt while interest rates are low, he said. 'We are in the middle of a new housing bubble fueled by the low interest rates,' he said. 'Don’t just continue to spend and put things on credit because it is cheap at the moment. Eventually, you’re going to have to pay for that.'"

"At some point, the Fed will have to step in to control rising prices by ceasing to print more money and raising the interest rate, Dr. Saravia said. That could be painful, he said. 'It’s like if you get addicted to something and you’re running with this substance, and all of a sudden you have to do a cold turkey stop,' he said. 'You know it’s going to be good for you in the long run, but in the short run, it’s going to be very, very painful.'"

"Ending inflation is an art, and some changes could be done gradually to make it less painful, but Dr. Saravia still predicts that when that happens, the U.S. economy will fall into a short recession. 'I think we’re going to have to pay for the money printing and the massive stimulus one way or another,' he said."