Every market bubble reveals important lessons after it bursts. Some of those lessons are one-off, tied to a specific bubble. The important lessons emerge each time prices reach euphoric heights.
John Kenneth Galbraith highlighted two such lessons from the 1920s bubble during a Congressional Hearing in 1979. His first is discussed often (so I’ll keep it short). His second can be found outside bubblier times too.
A sound idea carried too far
Prices first went up because of good earnings. Then they took leave of reality. The market was taken over by people for whom the only important fact was that prices were going up. Their buying then put up the prices but with the certainty that when the supply of such speculators — and gulls — ran out, as eventually it would, the upward movement would come to an end and prices would collapse in the rush to realize and get out. This, to repeat, is the classic speculative sequence.
If the only reason for buying a stock is because the price went up…buyer beware.
There’s no denying that the draw to get rich quick is a hard one to ignore. Especially when it seems to be happening to everyone else.
It’s a sequence that repeats itself throughout history — the South Sea Bubble, the Mississippi Bubble, British Railway Mania, the Florida Real Estate Bubble of the early 1920s, the Dotcom Bubble, and the most recent Housing Bubble, to name a few.
What begins is an investment for the right reasons, turns into speculation for the wrong reasons. The few who get in early may escape unscathed, but the one’s who show up late to the party, suffer certain losses.
Wealth does not equate to wisdom
There are, however, other lessons from that time. One is that personal association with large sums of money, while it does produce good manners and good tailoring and a manifest certainty of manner and statement, does not necessarily induce great wisdom.
It’s remarkable how much weight people put on the words of the wealthy…without question. Sometimes its deserved, just not always.
A case in point was the belief in 1929 that certain people had a gift for avoiding crises. The Great Crash revealed the truth.
Many “gifted” people went from riches to rags in the crash. Yet, prior to it, they freely shared an optimistic view of the market. Why wouldn’t they? Their growing wealth was tied to the bubble not bursting.
For example, take Charles E. Mitchell, Chairman of National City Bank. He and his bank famously stepped up to lend money after margin rates spiked to 20% on a rough market selloff in late March 1929.
Mitchell’s consistent message was that stocks were “fundamentally sound.”
There is nothing to worry about in the financial situation of the United States. — September 20, 1929
…the industrial condition of the United States is absolutely sound and our credit situation is in no way critical. — October 8, 1929
Although in some cases speculation has gone too far in the United States, the markets generally are now in a healthy condition. The last six weeks have done an immense good in shaking down prices. Many leading industrial securities are now at levels which would have been considered perfectly sound and conservative even by the standards of ten years ago. — October 15, 1929
The decline in stock market prices has carried many issues below their true value. — October 23, 1929
I am still of the opinion that this reaction has badly overrun itself. — October 25, 1929
Why would he share such a thing? Because he did what any fund manager does in front of a camera. He talked his book.
Mitchell bet a large chunk of his personal wealth, alongside sizable margin loans, that stocks would continue rising. His message aligned with the outcome he needed.
And Mitchell wasn’t alone:
Thomas Lamont had to explain why he and George Whitney, another Morgan partner, did not tell the police when they learned that Richard Whitney, vice president of the exchange, had filched some millions of dollars from his customers and the exchange benevolent fund. Richard Whitney himself went to Sing Sing, where, however, he distinguished himself as first baseman on the baseball team.
Their wealth may have gotten them into elite circles but it definitely didn’t make them smarter. In the end, it likely made them more desperate to protect their money.
No one these days needs to be warned or should need to be warned against economic predictions. They are known to be what the economist in question wants to believe or what the public official…needs to have happen….
I do strongly urge that we be as cautious as ever in reposing too great confidence in men of great financial position… We need to be as skeptical now as people learned they should have been then.
People with money or standing in society might be wise or lucky fools. They might “generously” share their opinion.
Be careful of associating what they say with facts. Especially, when the topic falls outside the person’s field of expertise. And finally, when it comes to investing, it’s best to first ask: how might they benefit from it?
The Great Depression: Can It Happen Again?
- Marks Memo: Uncertainty II (pdf) – H. Marks
- Micro-Efficient, Macro-Inefficient – Klement on Investing
- Why We’re Blind to Probability – M. Housel
- Our Dangerous Addiction to Prediction – UnHerd
- Repetition Economics: the Story of the Hunter, the Mammoth, and the Wolves – Breaking the Market
- Two Centuries of Innovation and Growth – Verdad
- CFA Virtual Conference w/ Howard Marks, Annie Duke, and More – CFA Institute
- Michael Lewis on the Power of Intelligent Leadership (podcast) – Masters in Business
- Einstein’s Two Mistakes – The Conversation
- Peter Jackson’s LOTR Was an Improbable Miracle, and We’re Lucky to Have It – Paste