Issue 8 - The Lessons of History
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" Those who fail to learn the lessons of history are doomed to repeat it "
A variation of this quote is attributed to both Winston Churchill and George Santayana. Mark Twain notably said that " History doesn't repeat itself but it rhymes ". This is the underlying message of this week's newsletter. As we potentially stand upon the precipice of a major stock market correction, it's instructive to look back in time for comparable situations & see what we can learn.
I like to study financial history as I feel it helps us to put better context on current events & to understand how they might evolve. I have read several of the most prominent financial history books including the following :
Boom and Bust: A Global History of Financial Bubbles Quinn, William;?Turner, John D
Manias, Panics, and Crashes: A History of Financial Crises (Wiley Investment Classics) Kindleberger, Charles P.
Extraordinary Popular Delusions and The Madness of Crowds: All Volumes - Complete and Unabridged Mackay, Charles
This Time Is Different: Eight Centuries of Financial Folly Reinhart, Carmen M., Rogoff, Kenneth S
Devil Take the Hindmost: A History of Financial Speculation (Paperback) Edward Chancellor
I also subscribe to the writings of Jamie Catherwood, who has a vast database of financial history and an absolute treasure trove of boom/bust stories. For the younger people among us - financial history didn't begin with the great depression!
A large part of today's newsletter is extracted from Jamie's most recent piece.
" This was the worst week for U.S. indices since COVID-19 eviscerated markets in March 2020. For the NASDAQ in particular, this marked a brutal?week?in an increasingly brutal?year. The tech-heavy index has fallen 12% YTD on the prospect of higher interest rates and waning demand for pandemic darlings’ products. The monster rally in tech & work-from-home stocks largely originated from an assumption that life would never be the same, post-pandemic. Business travel would never return as we now have Zoom. No one would go back to gyms as we now have Pelotons. Streaming services like Netflix can keep adding subscribers indefinitely as everyone will be stuck at home in need of content, Right? Whoops!
Sentiment Check: Boom, Roasted.
There are countless examples demonstrating how sharply sentiment has shifted from exciting speculative & innovative assets. It reminds me of the scene The Office (US) where Michael Scott goes around “roasting” each one of his employees, saying “Boom, roasted!” after each insult.
Here's how speculative assets that dominated headlines during the pandemic are faring:
A Poisoned Chalice
These companies are the victims of their own success. The pandemic has been a poisoned chalice as investors now expect companies that thrived from a work-from-home environment to continue generating similar results.
Peloton was a classic pandemic darling as it sold at-home fitness equipment at a time when everyone was forced to stay home. During lockdowns, sales soared. But investors began setting these exceptional sales as the new benchmark for future results. Peloton could not meet expectations as people returned to gyms and the unique ' work from home ' environment, driving their sales, faded.
Netflix felt the brunt of this poisoned chalice as shares fell 20% on the back of disappointing subscriber growth figures. Netflix benefitted from the pandemic as people were stuck at home, in need of content to consume. Two years on, however, most people that would subscribe to Netflix have already done so.
The problem for growth stocks is that their accelerated growth, in this unique WFH environment, has “pulled from?future?growth”. This means disappointment, going forward, unless baseline expectations are reset.
During the 19th-century railway boom, expectations of growth & demand decoupled from reality. Leading up to ' The Panic of 1857 ', much of the speculation in land & railroads was tied to the expectation of settlers in a given territory. More settlers meant rising land prices, encouraging railways to build lines, thus further increasing land prices. This was particularly true in Kansas:
“ These new lines, with their aggressive land-purchasing policies & far-reaching plans for transcontinental expansion, provided the principal speculative opportunities for railroad investors of the 1850s.?Their fortunes depended on a continuing inflow of settlers & the growth of commerce on the frontier, which required confidence in the viability of expansion westward.
In the spring of 1857 confidence abounded. The Cincinnati Enquirer reported “railroad fever”… a “fever of speculation in Kansas lands was raging, men selling homes, giving up well paid positions & even borrowing money at 10% to purchase farms.”?Newspapers described “a veritable torrent of humanity.” The lure of Kansas lands led some to expect Kansas to “increase by 70,000 people that year.” In April, settlers arrived at a rate of 1,000 per day.
Since the success of their speculation was largely contingent upon the growth of settlers, investors in Kansas began to extrapolate booming short-term growth into long-term assumptions. This is often where the problem arises. Just because settlers were arriving at a rate of 1,000 per day in April 1857, that does not mean there would?always?be 1,000 new settlers arriving daily. Just because Peloton sold a ridiculous amount of bikes during quarantine, that does not mean they would?always?sell that many bikes.
So What?
Flashy growth stocks and speculative assets are starting to lose their shine. The work-from-home trade that pushed stocks like Peloton higher is fading as companies struggle to maintain the?extraordinary?performance achieved during?extraordinary?times. The increasingly negative sentiment for growth stocks is also important for investors owning other stocks, as history shows that problems in one corner of the market can quickly spread. When a large company or institution falls from grace, investors start to scrutinize their own investments more closely. There are countless historical examples of financial institutions collapsing during a speculative mania, causing investors to withdraw funds from other institutions. Bank runs ensue.
For instance, the recent underperformance of tech stocks has had knock-on effects in the private markets as startup valuations are being questioned and IPOs get delayed. The?Wall Street Journal?reported:
“Waning enthusiasm for tech stocks in the public markets is casting doubt on valuations in the private market, where prices last year hit stratospheric levels.
The public arenas have begun to dial down their fervor for high-growth tech stocks, with investors punishing companies that don’t make money—startups in tech & biotech, blank-check companies etc. V.C investors are rethinking how much they should pay in private deals…
Founders of later-stage companies are getting pushback on their valuations. Market conditions have also put a brake on public listings by some V.C-backed companies.”
Maybe the events of recent weeks are just a blip, or maybe the unchallenged dominance of growth stocks & speculative assets is waning. Either way, this episode has offered a useful reminder that investing isn’t always as easy as just buying the hot new thing.
The railway manias of the19th century offer a perfect example of how narratives of exciting technologies can quickly turn negative when something goes wrong.
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“The 1860s witnessed Britain’s 3rd & final railway mania. This mania managed to delude investors into pouring immense sums into the expansion of a public infrastructure, by introducing a variety of “financial innovations” reminiscent of those involved in the 2008 GFC .
That period, just like ours, featured new technologies, novel business models, rapid globalization, dramatic increases in speed of information transmission & proliferation of misinformation & disinformation. Combined with progressive relaxation of government regulation & extremely opaque accounts, the “financial engineering” of the 1860s misled even very knowledgeable & inquisitive observers. The results led to the ruin of many individuals & businesses & a large, but inefficient, expansion of the rail network. There are striking similarities to many aspects of modern financial markets that might be instructive, especially in the widespread reliance on a “ search for a greater fool ”
" One clear lesson from the 1860s, that arose in subsequent manias, is the danger of combining “financial innovation” with opaque accounting, especially in complex systems.
The bicycle mania in late 19th-century Britain was a wildly speculative affair, with 671 bicycle companies forming in just 2.5 years.
This paper uses a sample of 12,000 investors during an asset price reversal in the shares of British bicycle companies between 1895 & 1900. Informed investors reduced their holdings substantially during the crash, suggesting that they were riding the bubble. Those who performed worst were not the least informed groups, but gentlemen living near a stock exchange, who had the most time, money & opportunity to engage in speculation.”
Perhaps no “Golden Age of Fraud” is better known than 1720, when both the South Sea and Mississippi Company bubbles imploded. One of the most famous anecdotes from the South Sea Company debacle provides excellent insight into the levels of speculation rampant in London at the time. The number of new startups being launched dramatically fell after the collapse of South Sea Company stock, demonstrating how the failure of one stock can cause difficulties in other areas of the market.
As expected, the South Sea Bubble of 1720 offered a perfect example of how investors will herd into newly formed companies following the outsized success of a particular stock in the hopes that they will “win the lottery” and experience a similar rally.
“ Starting on Friday, December 18, 1719, the?Daily Post carried an ad for an
‘ extraordinary scheme for a new insurance company to be proposed,’?with ‘ permits to subscribe ’ offered for ￡0.05 each. No names of projectors, nor details of the scheme were cited.
The sale of the ‘ permits ’ took place on Thursday, December 24.?Two days later, this same paper had an ad which offered refunds for the ‘ several hundred ’ of those permits that had been sold and explained that the whole thing was a hoax designed to show how easy it was to ‘ impose upon a credulous multitude ’.”
The French have a saying " La plus ca change, la plus c'est la meme chose " which translates as " The more things change, the more things stay the same ". Read that last paragraph again & ask yourself if it is any different from a SPAC.
300 years on, the public is still falling for the same old snake oil!
?Life Lesson #8 - 1982 - Back Yourself !
In Life Lesson #7, last week, I described how I came to leave my first job at Bank of Ireland ' in search of greater things '. I made unsolicited applications to several banks & ended up at a small foreign bank as a ' Trainee Dealer ' in Nov 1981
My new boss, the Head Trader was Alex. Alex was everything you would expect a Head Trader to be: Saville Row suit, immaculately groomed, flash car, highly professional in all of his interactions with employees & customers, knowledgeable about the business and calm under pressure.
Alex was a good guy to learn from and was certainly a role model for aspiring young traders like me to seek to emulate. He had a small team of senior traders who knew the business well & did a pretty good job of training this young rookie who had big ambitions but no knowledge. Trading is all about ' being street smart ' and was even more so, back then, when bigger players had more & earlier market information, bigger trading limits and more substantial customer flows. It was often like trying to surf the ocean without being bitten by the sharks or swallowed by the whales.
We made our profits from customer business & from trading FX & Money Markets. Derivatives were just a glint in some innovator's eye at that point so it was mostly cash business. We did ok, in our own modest way, making reasonable profits without ever ' shooting the lights out '. But Alex moved to Hong Kong and he was replaced by Louis.
Now Louis was pretty much the polar opposite to Alex. He was casual & relaxed. He was ' carrying a few pounds '. He enjoyed a good lunch, dressed more like someone you would meet at a cattle fair and had a jolly disposition. However, he had two problems and those problems would eventually lead to my departure.
His two problems were that he loved coffee & he couldn't write. Let's take those issues one at a time:
Coffee Every morning a tray of chocolate biscuits and a large Cona pot full of steaming hot coffee was delivered to the trading room. Louis gulped the coffee & grazed on the biscuits. The more volatile the market became, the more coffee he drank and this is where the problems started. If his FX position was ' going south ' he became stressed and if he became stressed, he drank more coffee.
On a volatile day, he would get ' caffeinated up to the nines '. The guy we all knew & loved, became stressed-out & incoherent. Instead of focusing on resolving his loss-making trades, he would rail at the world, his bad luck & those bast**ds who had sold him dollars that were devaluing faster than a hare with a dog on his tail. Louis would invariably let the position run, more in hope than expectation, that it would return to profit, which it rarely did.
Customers didn't like to deal with Louis when he was stressed, so they invariably asked for me. This didn't always end well as conversations often went like this
" Can I speak to John, please " " He's busy, This is Louis here, can I help? " It's ok, I'll wait " " He could be a while. I'm Louis, the Chief Dealer, can I help? " " It's ok, just ask John to call me back "
At this stage, the volume would rise several decibels " I'm the Chief Dealer, not the fu**king coffee boy " & Louis would slam down the phone.
Another customer lost
Writing
Louis could write but his writing was like that of your local doctor: a series of illegible hieroglyphics. This was the world before Excel spreadsheets and all of our trades & positions were transcribed from the deal tickets onto a manual ledger.
Now, this is where the fun started. It was my job to maintain the ledgers, taking the info from the traders' deal tickets. For the tickets of the other traders, it was straightforward but for Louis' tickets, I had as much chance of transcribing them correctly as decoding Einstein's theory of relativity. His 9's looked like 7's and his 8's looked like 3's so there was a constant ' back & forth ' as I asked him to clarify numbers for me.
The outcome of this was that a number of transcription errors arose. After a period of time, the Treasurer called me into his office & told me that he didn't think I was made out for the trading business. He warned that, if there were any further errors, they would have to let me go. When I showed him Louis' tickets and asked him to tell me if those numbers were 8's or 3's, he was unable to do so. Nevertheless, I could see which way the wind was blowing. A Chief Dealer from Head Office was always going to be favored over a junior trader still. ' wet behind the ears '.
This was a bitter blow to my career plans and for a brief moment, I considered a career change to a less stressful job. After all, I had been told by senior management that " I wasn't up to it " in terms of surviving in the trading world, never mind prospering in it. Thankfully, my rather large ego told me that I could still make it so I decided not to wait for the bank to fire me.
' The darkest hour is just before the dawn'. Ultimately, my threatened firing was a blessing in disguise. Two weeks later, I became a Senior Trader at BNP, doubled my salary & ended up there for the rest of my career
The moral of the story - back yourself! Don't make career decisions based on what others tell you. Use your own judgment & bat for the fences!
I comment on Financial Markets CLICK #jcobservations to see my posts
2 年Please reread the last paragraph of the main article of this newsletter, where I compare the scams of yesteryear with the SPACs of today & then look at today's ' SPAC article ' by Wolf Richter, below Talk about history repeating itself! Be careful out there - there are a lot of landmines that you don't want to be stepping on https://wolfstreet.com/2022/02/12/the-collapse-of-the-ev-spacs-retail-investors-got-fleeced-swiftly-and-spectacularly/
CEO at SEAL Distribution
2 年Great article - look forward to more. Very informative.
Financial Services Executive | Client Advocate | Stakeholder Engagement Expert | Board Member | Speaker | Subject Matter Expert
2 年Great post John!
CEO | Interim CEO/COO/CRO/GM | Advisor | Operating Partner l Board Member | Transformational Fixer I Growth & Change | Turnaround & Restucturing | Performance & Profit | Certified Turnaround Professional | American ????
2 年Great article, John.
Vice President, Investments at The Jeffrey Matthews Financial Group LLC.
2 年Old news happening to new people.