Marcus Today on Life: Tulipomania
1623, Tulip Mania. A single tulip bulb sells for a thousand Dutch florins, seven times the average annual wage. The average tulip trader makes sixty thousand florins a month. 400 times the annual wage. 40 bulbs sell for 100,000 florins. You could have bought 3,333 pigs for the same price. People were selling possessions to speculate in the tulip market. One sailor mistakenly ate a bulb with herring, thinking it an onion. It would have paid his ship’s crew for 12 months. Some tulip traders started selling tulips that had only just been planted. Others sold bulbs they intended to plant. Gotta love those Futures traders. They called it “wind trade” at the time, because that’s all the tangible assets you had, thin air.
There has been a lot written about bubbles, and how to spot them. Here are the lessons from 400 years ago. How to spot a bubble:
- Everybody is making gains.
- People believe the passion for stocks will last forever.
- Your ordinary industry is neglected.
- Tangible assets are converted to cash to speculate in shares. (Equity mate).
- Other asset classes are deserted.
- Luxuries of every sort rise in price.
- Assets are bought to sell, not bought for their return.
Now let’s turn this on its head and see the opposite of a bubble, A period in the stock market when everyone is undervaluing everything, when everyone is being too bearish. If so then the following should be happening:
- Nobody is making money.
- People believe long term investment is over forever.
- Everybody is concentrating on keeping their jobs.
- Everyone is trying to pay down their debts.
- Other asset classes are swamped (term deposits).
- Luxuries of every sort fall in price (discretionary retailing in a hole).
- Assets are bought for their return not to sell (income stocks favoured).
All a bit simple, and there are other factors that suggest you are closer to a bottom than a top. For instance:
- There is a lot of cash ready to invest.
- The yield gap favours equities over bonds. Yields are historically high.
- Equities are historically cheap versus the long term average.
- Balance sheets are historically strong.
So what holds us back at the bottom? The answer isn’t price, the price is right, the answer is “Risk”. Anyone who invested through the GFC got a salutary lesson in risk and its consequences including volatility, uncertainty, insecurity, fear, smashed expectations, lost time and ultimately, all that really matters, capital losses. People get fed up of losing money basically and go blind to the opportunity.
But even in the 82% fall in the Japanese stock market over 22 years after the peak in 1989 there were 7 bull markets averaging 58% and lasting on average one year and four months each. Periods when the risk aversion eased enough for the herd to go back in for a trade. There is always opportunity, even in a bear market.
For equities to rally, you need a catalyst, anything that turns the focus away from fear and risk to greed, or more likely, the need for a return.
It could be blue sky on the negative issues that have seen a market sold down. It could be the pitiful returns and over pricing of fixed interest instruments and other safe havens like gold (zero return) and the mattress (zero return). It could be a rally for no reason that causes a stampede.
But more likely it is going to be the cash simply busting out of its seams. Consumer, investor and corporate balance sheets are rebuilt in a sell off. Everyone becomes more prudent. The cash builds up and there is a lot of money ready to chase a return again. When you hear companies announcing big share buybacks and increased dividends you know the world is becoming flush with cash once again and before long investors will put that money to work as the focus goes from risk to return once again.
A waterfall starts with one drop.
(The Dutch are still very much attached to their Tulips)