Bubbles: Learning from the past
By: Billy Peterson
Expectations and outcomes can often come together in perfect harmony. It’s a very wonderful and beautiful thing when this happens. In sports, you expect your team to win the Super Bowl or the World Series every year, and when they actually pull it off after all of the emotional investment you do not see how things can ever get any better. Same story when you get the promotion you have been hoping for, ace the test, win the race, or hit a new personal record at the CrossFit gym. When you invest a lot of emotion into anything, you feel elated when things finally come together. Sadly, this never lasts for long- that is unless you are the NY Yankees and have enough money to buy a winning pennant every year!
When it comes to investing we can learn from the past and realize that getting too emotional (fearful or jubilant) is detrimental. Take the markets as of late. For those who are currently invested it’s a time to rejoice. The markets have rewarded you for being an investor- a patient investor. Since financial markets are so actively traded and so liquid, people of all walks of life have an opinion on its future movements. This is both a blessing and a curse- it really just depends on your temperament. A large number of people sold off all their investments just a few short weeks ago due to the media driven craze around the “Brexit” decision.
Apply the investment concept another way. If you purchase a home or a piece of land you will not be easily distracted from your long term investment decision. After all, you do not necessarily plan to get a quote on the value of your home every day. Being unconcerned with day to day price swings nor the buying and selling behaviors of those around you provides confidence. Feels good right? Now just imagine if you carried that same principal over to your investment and retirement account.
Oftentimes values of certain assets get stretched. We can look back at history and come up with a list longer than a dance recital. These manias attract speculators, gold diggers, rocking chair quarterbacks, and gray haired widows. The point is that everyone wants to get in on the action when something seems to be a sure-hit money-making home run. I’ll offer a few real life events to reflect upon.
Tulip bulbs were the craze in Holland in the early 1600s when speculation drove the value of tulip bulbs to extremes. As crazy as this sounds, it actually happened and people were compelled to buy bulbs at prices topping six times the average person’s annual salary. This would be equivalent to spending $250,000 on a single bulb today. Of course we all know what happened. Bulb prices fell out of bloom (see what I did there?) and investors lost life fortunes.
The South Sea Company was created in the year 1711 and investors in Europe snapped up shares in the company as they saw a monopoly by the British government in their trading agreements with the Spanish colonies of South America. The speculation was so rampant to buy these shares that prices increased more than eight times (from 128 lbs to over 1050 lbs all in one year). The price soon collapsed and people were exposed to steep losses on their investment.
The Dot-Com bubble was another example of pure speculation and most of us had some level of experience with it. The internet brought with it a huge amount of new ideas as well as new speculation. I still remember hearing prognosticators on the TV saying that the way we used to value businesses was out the window. The internet was so life-changing and so powerful that somehow company valuations were unlimited. People who had never invested in stocks before were cashing in their CD’s and buying shares in Pets.com, Cars.com and a whole sea of start-up companies with no earnings or no concrete business plan. The NASDAQ Composite index which was home to most of the dot-com companies soared from a level under 500 in 1990 to over 5,000 in March 2000. The index crashed an astounding 80% by October 2002. The NASDAQ finally surpassed its high in 2015, this time without the froth and speculation. Many of the same prognosticators said it would never reach its former high. Kudos to those who invested in the surviving companies when they were inexpensive.
And then there was the US Housing bubble which was the most recent and is still causing aftershocks some nine years after it officially began. Investors piled into real estate at a frantic pace from 2002-2006. Sub-prime loans came about, house flipping, residential development, and collateralized mortgage obligations were all the rage. The endless supply of funds provided by banks and financial institutions and backed by the good ol’ US of A ignited an endless chain of new contractors, building supply companies, insurance companies, real estate agents, title companies, and the list goes on. When the dust settled, millions of people had lost their jobs, thousands of banks were closed, thousands more companies went bankrupt, and housing prices crumbled by 40-70%.
What should we heed from these examples? Human beings are very predictable and therefore, speculative bubbles can occur time and time again. It’s like watching sheep or a herd of cows. They all eventually follow wherever the leader takes them. Currently financial markets are much unloved and therefore we do not see a bubble being formed. There are many leaders trying to take the herd in different directions. I am going to go on record right now and let you in on a little secret- The markets could have several more 10-15% corrections in your investing lifetime if you have more than 10 years to invest. The next one may happen at any time. The frothy, speculative and hard correcting manias are what we need to watch out for. If we are lucky we could have the opportunity and take advantage of price levels that we only get a chance at a handful of times in our lives. How do you know when this is happening? It should begin when every neighbor, colleague, actor and sports athlete is getting involved. That should be your telltale sign that the party may be coming to an end.
The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Billy Peterson and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected. This material is being provided for information purposes only and is not a complete description, nor
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