By Sheryl Sutherland*
“Once a boom is well started, it cannot be arrested. It can only be collapsed.” ~John Kenneth Galbraith
I have been watching the various dramas around crypto currencies with much interest, it has all the hallmarks of a bubble. Given that I thought it might be instructive to look at some history – history always provides the best lessons as its predicted on our actions.
Optimism skews our beliefs and judgements. Optimistic people are a pleasure to be near but what happens when optimism becomes rampant and the market displays irrational exuberance? (Look for the book of the same name).
The French say everything changes, everything stays the same – that adage could also be expressed as whatever changes, people stay the same. Rampant optimism or irrational exuberance lead to market bubbles. Market bubbles are a fusion of millions of investors’ emotional responses, mostly greed. Market bubbles are not a recent phenomenon, nor are they uncommon.
The Black Tulip is about one of the most impressive market bubbles that occurred in Holland in the 1630s. And, yes, the commodity so highly sought after was the tulip bulb. Over a five year period tulip mania inflated bulb prices to the point where one bulb was worth 10 times a yoke of oxen, around US$100,000. Then, the story goes, an out-of-town sailor inadvertently popped the bubble as, mistaking a valuable bulb for an onion, he ate it. Panic erupted (herding behaviour) and within a week the bulbs were almost worthless.
If you think you would be tempted by rampant financial optimism consider a self-binding scheme. The classic tale is that of Ulysses who ordered his men to tie him to the mast of his ship so the Sirens’ song did not lure him to his destruction. This clearly illustrates a freely chosen hedge against his weakness of will.
Consider this: Living in a new era…has ushered in a new type of economy. Those who stick to the old ways will be left behind. Traditional company valuation techniques do not capture the value of this revolution. If you lived in 1850 you would have said the railroad, in the 1920s the radio, in the early 1990s you might have said biotechnology. In each case, this rationalisation accompanied a great bull market and proceeded a great decline.
Spot the bubble: The 1929 market crash and the dot-com bubble in 2000 were very similar. And both bubbles crashed spectacularly eroding shareholder wealth. In both cases the market was:
- Driven to new highs.
- Supported by margin trading.
- Overconfident after a long bull run.
- Characterised by talk of ‘a new era’.
- Promoted by “celebrities”.
Ask yourself this: By what logic could anyone believe that internet companies are worth anything like the ludicrous sums the market has attached to them?
Here are the words of Jim Cramer, television pundit and sometime hedge-fund manager. He is quoted here by the editor of the High-Tech Strategist newsletter as saying:
The only way to catch up is to join the crowd…they are buying Google (Alphabet) because, what the heck, when the markets up buy Google… there simply aren’t enough training days left to make a lot of money… the clock is ticking…’Darn it all, I gotta get in’
Media influence anyone? No cool rational thinking here, or any comment on such old-fashioned concepts as value. Foolhardy investors will regret their enthusiasm quickly. Take the low road, the boring sensible one and create a well-diversified portfolio.
*Sheryl Sutherland is director of The Financial Strategies Group, and author of Girls Just Want to Have Fund$ – Every Women’s Guide to Financial Independence, Money, Money, Money Ain’t it Funny – How to Wire your Brain for Wealth, and co-author of Smart Money – How to structure your New Zealand business or investments and pay less tax. You can contact her here.
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