The Market will Always Fall and Rise

Published on 12th January 2009

Tough Economic times
In 1593, a newly appointed botany professor from Vienna brought to Leyden (a city and municipality in the province of South Holland in the Netherlands) a collection of unusual plants that had originated from Turkey. The Dutch were fascinated with this new addition to the garden but not with the professor’s asking price.  

One night, a thief broke into his house and stole the tulip-bulbs which were subsequently sold at a lower price but at a greater profit. Over the next decade or so, the tulip became a popular but expensive item in Dutch gardens. Many of these flowers succumbed to a nonfatal virus known as mosaic. This virus caused the tulip petals to develop contrasting colored stripes or flames. 

The Dutch valued highly these infected bulbs, called bizarres, and in a short time, popular taste dictated that the more bizarre a bulb, the greater the cost of owning it. Slowly, “tulipmania” set in. At first, bulb merchants simply tried to predict the most popular variegated style for the coming year. Then they would buy an extra-large stockpile to anticipate a rise in price. 

Tulip-bulb prices began to rise wildly. The more expensive the bulbs became, the more people viewed them as smart investments. Ordinary industry of the country was dropped in favour of speculation in tulip bulbs. Nobles, citizens, farmers, mechanics, seamen, footmen, maid-servants, even chimney sweeps and old clotheswomen dabbled in tulips. Everyone imagined that the passion for tulips would last forever and buyers from all over the world would come to Holland and pay whatever prices were asked for them. People who said the prices could not possibly go higher watched with chagrin as their friends and relatives made enormous profits. The temptation to join them was hard to resist and few Dutchman did. 

In the last years of the tulip spree, which lasted approximately from 1634 to 1637, people started to barter their personal belongings, such as land, jewels and furniture, to obtain the bulbs that would make them even wealthier. Bulb prices reached astronomical levels. Apparently, as happened in all speculative crazes, prices eventually got so high that some people decided they would be prudent and sell their bulbs. Soon, others followed and like a snowball rolling downhill, bulb deflation grew at an increasingly rapid pace, and in no time at all, panic reigned. 

Government ministers stated officially that there was no reason for tulip bulbs to fall in price, but no one listened. Dealers went bankrupt and refused to honour their commitment to buy tulip bulbs. A government plan to settle all contracts at 10 percent of their face value was frustrated when bulbs fell even below this mark. And prices continued to decline. Down and down they went till most bulbs became almost worthless-selling for no more than the price of a common onion. 

You may be reading this in amazement and thinking that this sort of thing will never happen in our time. Well, unfortunately, you will have to be disappointed. From early March 1928 through early September 1929, the stock market percentage increase in the US equaled that of the entire period from 1923 through early 1928. Stock market speculation was a national past time. People were borrowing to buy stock that was way overpriced. 

On 3rd of September, 1929, the market reached a peak that was not surpassed for a quarter of a century, even though business activities and sentiments have fallen months before. On 5th September, the market suffered a sharp decline. Even though bankers and government officials assured the country that there was no cause for concern, the market ignored it. 

When customers began selling their holdings due to their inability to meet the margin calls, market fell further. The market panic reached its peak on 29th October 1929. Prices fell almost perpendicularly and by the time the lows were reached in 1932, most blue chip stocks had fallen 95 percent. Similar mad chasing of returns occurred from the 1960s onwards.  

In the 60s and 70s, it was about growth stocks such as IBM and Texas Instruments that were sold at ridiculous prices but buyers bought because they firmly believed that many will be willing to pay a much higher price. In the 80s, it was about new issues or otherwise known as initial public offerings. This is especially so for biotechnology companies which may have no current earnings to show but simply a pipeline of potential products, which may never get its chance to see daylight. 

Closer to our memory, is probably the biggest bubble of all time, the internet bubble. In the year 1999, everyone was buying technology and internet related shares and unit trusts. Everyone felt that the future was in the internet. You looked stupid if you stay off such investments. You see, the internet represented a new technology that offered new business opportunities that promised to revolutionalise the way we obtain information and purchase goods and services. Even though these companies have no earnings to show at all, but simply a concept or hot idea, speculators flocked to it as long as they have a dot com name attached to it. Even professional managers believed in it and the bulk of these funds were set up in 1999 & 2000. But in the middle of 2000, the NASDAQ crashed. 

This time is not different. So how does knowing the history of the stock markets help us? 

Investment professionals always say: “This time is different.t” I disagree. I say there is nothing new under the sun. The history of the stock market showed us that “tulipmania” repeated itself since the 17th century. The greed of humans will keep us buying even though prices are at a ridiculous high and will sell in panic when we realize how ridiculous we have been. Most of us never learn from history, we always succumb to that desire of making lots of money in the shortest period of time.

Professionals are not always right The internet bubble has clearly shown that professionals are not always right. In fact, they could many times be wrong. How could fund managers, investment advisers, wealth managers, so called experts not know that those internet stocks were selling at a ridiculous price? Well, many probably knew, but they eagerly feed our greed, even as they satisfy their own desire, maximization of profits and advancement in career. 

Human sentiments does not determine the true value of your investments. While we all hate to lose money, we dislike it even more when others are seemingly making lots of it and we are not. So we follow the crowd. When everyone sells in fear, we believe in the majority and follow suit. We don’t realize that that having a majority decision doesn’t always means the right decision and human sentiments have no bearing on the true value of businesses. 

The market will fall and rise once again. So how should we invest? Using the stock market history as a lesson, it is really not difficult to make money from investing. Find sound businesses with long term sustainability and at a reasonable price to invest in. Ignore the short term fluctuation as it has nothing to do with your businesses. Ignore what professionals tell you, especially those who make more money selling you than advising you. Invest in the stocks for the long term.  

Sounds simple? Well it is really that simple but unfortunately not easy. Many may not know how to identify those good businesses. Short term fluctuations may cause us to lose our sleep and give us ulcers that we may not be able to invest long term and professional’s advice seems too hard to ignore. So what can we do? 

To avoid having the need to pick the right stock, buy all the companies in the stock market through a low cost index fund or ETF. If you dislike the fluctuations, diversify your investments over different geographic regions and asset classes. Ignore short term noise as the human greed and fear has absolutely nothing to do with your long term investments. In fact, if you are a long term investor and a net saver, you would rejoice when the market falls as it presents you with a chance to buy at sale price. When the market is rising wildly, you would be sad as there is no opportunity to save. 

If you have to listen to a professional, make sure you choose one that takes care of your long term goal rather than fulfill their own short term ambitions. How would you know and how can you ensure that he deliver what he promises? Instead of paying him huge commissions for each product he sells you, put him on a regular payroll instead. Remove him if he cannot do the job. We are compensated this way too, why should we pay our advisers differently? 

So should you be worrying too much about the current global financial crisis? Having gone through the Asian financial crisis, the internet bubble, SARS, the Iraq war, the oil price surge over the last 10 years or more, and having read the history of the market for the last 300 years, this is what I can tell you: Just as the sun will rise from the East and sets in the west, the market will fall and rise once again. It has always been and it will always be. If you have done your investments correctly, sleep well. Tomorrow is a new day. 

By Christopher Tan

Chief Executive Officer, Providend, An independent private wealth management firm licensed by the Monetary Authority of Singapore. 

First published in  Conjoncture, A Bilingual Journal of PluriConseil

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