The Remembrance of Times Past
The past is another country but when it comes to investing in stocks it’s one that it pays, occasionally, to visit. It’s not so much that the past signposts the future – because it doesn’t – but because it gives us a lot of handy hints about what we can expect from markets and investors. Both go mad from time to time and dealing with this requires a level of belief that you’re not likely to get from personal experience.
Personal Experience Isn’t The Best Guide
For example, the collapses in the stockmarkets over 2007 and 2008 are unlike anything that’s been seen in developed markets since the early 1970’s. There are investors around who remember the chaos wreaked on the markets by the oil crisis provoked by OPEC but, frankly, not that many. Even those that were around then will have had their memory dimmed by the passage of time.
The point is, of course, that stockmarkets frequently behave in ways that are simply outside of the experience of individual investors. We can’t rely on past personal history to provide guidance in a crisis but we can refer to the history books. Over the last couple of hundred years most possible market scenarios have been faced and overcome and by delving into the past we can gain some comfort and understanding of the present.
Should Investors Be Historians?
Most long term investors need to be students of stockmarket history to a limited extent. Trying to interpret the present without the background of previous events will, given the psychological flaws we all suffer from, almost certainly lead to overemphasis on short-term news to the detriment of longer-term trends. Mostly the short-term is just noise, while the longer-term carries the real information. It’s just that our receivers get swamped by the noise and fail to pick up the bigger picture.
That bigger picture tells us that stockmarkets are safe places to invest over long periods of time as long as you keep your money invested, don’t try to engage in market timing and re-invest dividends. It should also tell us that any money we make in stocks over and above other types of investment is because we’re taking on more risk. Fortunately time reduces that risk to negligible proportions. This is why it’s really important not to get frightened into selling stocks in the middle of busts. It’s equally important not to start chasing booms as well, by buying into some hot sector.
1819
Way back in 1819 (1) there was a collapse in the US markets at the end of the boom following the War of Independence from Britain, which coincided with the creation of the New York Stock Exchange. From its very genesis Wall Street has been synonymous with booms and busts.
The subsequent collapse in the American economy was inextricably linked to a collapse in confidence in the fledgling nation’s banks. Sound familiar?
1873
In 1873 there was another US collapse, coming at the end of another period of expansion in the wake of the Civil War. This one was marked by huge capital investments in the dotcom of the time – the railroad. In part the 1873 panic was set off by a flu epidemic – only this time in horses, not humans, which were essential to the movement of raw materials (2). Without horses wood and coal couldn’t be delivered to the railways and the trains stopped running. The actual collapse was triggered in Vienna and led to banking failures across the globe, but especially in New York where the stock exchange was closed for ten days. US unemployment reached 14% and the ensuing depression lasted half a decade.
Overinvestment in a new industry supposedly destined to transform the world, banking failures and flu epidemics. Sound familiar?
1907
In 1907 the New York market fell 50% from its peak due to a crisis which started with an attempt to corner the market in the stock of the United Copper company. The failure of this scheme led to a banking run which migrated to the so-called trust companies – investment banks. Other banks, unsure about where the skeletons were buried, refused to lend leading to a liquidity crisis which threatened to destabilise the whole market until J.P. Morgan stepped in to rally both bankers and the government.
Liquidity crises, fearful banks and massive government intervention. Sound familiar?
More Recent Crashes
We could go on – the Wall Street Crash of 1929 and the market collapse in 1973-74 were yet to come. The 1929 Crash is so well documented we won’t go into it, but the oil crisis in the seventies bears touching on. The New York Stock Exchange dropped a very nasty 45% while the London market fell a positively vertigo inducing 73% over 1973 and 1974. London then rose by 150% in 1975 when the government removed property rent freeze restrictions that were causing huge distortions in property valuations.
The reality is that bank runs, recessions, liquidity crises, overinvestment in “transformational” technologies and flu scares have been with us before and will be with us again, just as soon as investors, regulators and politicians have forgotten the latest problems and been lulled into complacency by another period of apparent stability. Then, once again, markets will crash, recover and maintain their long term trend upwards in line with general economic growth.
Unscrupulous Markets
In previous eras the main danger stockmarket investors faced were unscrupulous operators using inside information to transfer wealth to themselves from the gullible and the possible complete collapse of specific markets. Think of Russia in 1917 or post-war Germany where shareholders were more or less wiped out. In a globalised world most people should easily be able to protect themselves against the latter problem – we’re no longer limited to our local markets; although investors often artificially restrict themselves to the markets and companies they know well. Of course, the unscrupulous are among us yet, many of them in the guise of advisors and helpers, but those of us who don’t feel able to deal with them can easily avoid the problem by investing using an index tracker.
To gain some perspective on these issues none of us needs to spend our time reading lots of history books. However, from time to time we should remind ourselves of the problems. Of all the books written on this Charles P. Kindleberger’s Manias, Panics and Crashes is probably still the best overview. J.K. Galbraith’s The Great Crash, 1929 remains the zenith of analysis of that crisis in particular and the genesis of all such problems in general. The wave of books arriving daily about the causes and effects of the current crisis are all too early – our recent problems require the perspective of time and distance to provide a rational viewpoint.
History in the markets is being made daily, but the long-term trends are unchanging. Remember, though, that in the very long term, we’re all dead. Which is why overinvesting in shares is dangerous. We’ll look at that next time out.
(1) There’s a good write up on the Panic of 1819 by Murray N. Rothbard. It’s a full 200 pages, though.
(2) The impact of horse flu on the USA in 1872 is covered in this article, which is rather shorter.
Previous: Stepping Stone #2: Understand Why Investing in Shares is Necessary
Next: Stepping Stone #4: Don’t Overinvest in Shares, Get Some Balance
The past is another country but when it comes to investing in stocks it’s one that it pays, occasionally, to visit. It’s not so much that the past signposts the future – because it doesn’t – but because it gives us a lot of handy hints about what we can expect from markets and investors. Both go mad from time to time and dealing with this requires a level of belief that you’re not likely to get from personal experience.
Personal Experience Isn’t The Best Guide
For example, the collapses in the stockmarkets over 2007 and 2008 are unlike anything that’s been seen in developed markets since the early 1970’s. There are investors around who remember the chaos wreaked on the markets by the oil crisis provoked by OPEC but, frankly, not that many. Even those that were around then will have had their memory dimmed by the passage of time.
The point is, of course, that stockmarkets frequently behave in ways that are simply outside of the experience of individual investors. We can’t rely on past personal history to provide guidance in a crisis but we can refer to the history books. Over the last couple of hundred years most possible market scenarios have been faced and overcome and by delving into the past we can gain some comfort and understanding of the present.
Should Investors Be Historians?
Most long term investors need to be students of stockmarket history to a limited extent. Trying to interpret the present without the background of previous events will, given the psychological flaws we all suffer from, almost certainly lead to overemphasis on short-term news to the detriment of longer-term trends. Mostly the short-term is just noise, while the longer-term carries the real information. It’s just that our receivers get swamped by the noise and fail to pick up the bigger picture.
That bigger picture tells us that stockmarkets are safe places to invest over long periods of time as long as you keep your money invested, don’t try to engage in market timing and re-invest dividends. It should also tell us that any money we make in stocks over and above other types of investment is because we’re taking on more risk. Fortunately time reduces that risk to negligible proportions. This is why it’s really important not to get frightened into selling stocks in the middle of busts. It’s equally important not to start chasing booms as well, by buying into some hot sector.
1819
Way back in 1819 (1) there was a collapse in the US markets at the end of the boom following the War of Independence from Britain, which coincided with the creation of the New York Stock Exchange. From its very genesis Wall Street has been synonymous with booms and busts.
The subsequent collapse in the American economy was inextricably linked to a collapse in confidence in the fledgling nation’s banks. Sound familiar?
1873
In 1873 there was another US collapse, coming at the end of another period of expansion in the wake of the Civil War. This one was marked by huge capital investments in the dotcom of the time – the railroad. In part the 1873 panic was set off by a flu epidemic – only this time in horses, not humans, which were essential to the movement of raw materials (2). Without horses wood and coal couldn’t be delivered to the railways and the trains stopped running. The actual collapse was triggered in Vienna and led to banking failures across the globe, but especially in New York where the stock exchange was closed for ten days. US unemployment reached 14% and the ensuing depression lasted half a decade.
Overinvestment in a new industry supposedly destined to transform the world, banking failures and flu epidemics. Sound familiar?
1907
In 1907 the New York market fell 50% from its peak due to a crisis which started with an attempt to corner the market in the stock of the United Copper company. The failure of this scheme led to a banking run which migrated to the so-called trust companies – investment banks. Other banks, unsure about where the skeletons were buried, refused to lend leading to a liquidity crisis which threatened to destabilise the whole market until J.P. Morgan stepped in to rally both bankers and the government.
Liquidity crises, fearful banks and massive government intervention. Sound familiar?
More Recent Crashes
We could go on – the Wall Street Crash of 1929 and the market collapse in 1973-74 were yet to come. The 1929 Crash is so well documented we won’t go into it, but the oil crisis in the seventies bears touching on. The New York Stock Exchange dropped a very nasty 45% while the London market fell a positively vertigo inducing 73% over 1973 and 1974. London then rose by 150% in 1975 when the government removed property rent freeze restrictions that were causing huge distortions in property valuations.
The reality is that bank runs, recessions, liquidity crises, overinvestment in “transformational” technologies and flu scares have been with us before and will be with us again, just as soon as investors, regulators and politicians have forgotten the latest problems and been lulled into complacency by another period of apparent stability. Then, once again, markets will crash, recover and maintain their long term trend upwards in line with general economic growth.
Unscrupulous Markets
In previous eras the main danger stockmarket investors faced were unscrupulous operators using inside information to transfer wealth to themselves from the gullible and the possible complete collapse of specific markets. Think of Russia in 1917 or post-war Germany where shareholders were more or less wiped out. In a globalised world most people should easily be able to protect themselves against the latter problem – we’re no longer limited to our local markets; although investors often artificially restrict themselves to the markets and companies they know well. Of course, the unscrupulous are among us yet, many of them in the guise of advisors and helpers, but those of us who don’t feel able to deal with them can easily avoid the problem by investing using an index tracker.
To gain some perspective on these issues none of us needs to spend our time reading lots of history books. However, from time to time we should remind ourselves of the problems. Of all the books written on this Charles P. Kindleberger’s Manias, Panics and Crashes is probably still the best overview. J.K. Galbraith’s The Great Crash, 1929 remains the zenith of analysis of that crisis in particular and the genesis of all such problems in general. The wave of books arriving daily about the causes and effects of the current crisis are all too early – our recent problems require the perspective of time and distance to provide a rational viewpoint.
History in the markets is being made daily, but the long-term trends are unchanging. Remember, though, that in the very long term, we’re all dead. Which is why overinvesting in shares is dangerous. We’ll look at that next time out.
(1) There’s a good write up on the Panic of 1819 by Murray N. Rothbard. It’s a full 200 pages, though.
(2) The impact of horse flu on the USA in 1872 is covered in this article, which is rather shorter.
Previous: Stepping Stone #2: Understand Why Investing in Shares is Necessary
Next: Stepping Stone #4: Don’t Overinvest in Shares, Get Some Balance
1 comments:
A fine summary, and I totally agree when people look at recent history they make unfounded presumptions.
In the extreme, I think it was Taleb who said the idea that the stock market always recovers eventually rings rather hollow if you were invested in Russia in the early 20th Century before the communists seized control!
Regarding the previous big crashes, my understanding is shares didn’t just recover but flew after some of those crashes (see the Telegraph article I linked to in my recent post on 20% returns).
All the best!
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