Shoe Shine Boy
In 1928 in New York City, John D Rockefeller was having his shoes shined. The shoe shine boy does not know who Rockefeller was, he started to give him stock tips. John took his shoe shine boy’s advice but decided that it was time to exit the market. He decided that if a shoe shine boy was giving stock tips then it was time to get out of the market. He did and it was the reason his family was able to survive the Great Depression, and became one of the richest in history.
During euphoria stage, there are many equivalent to the shoe shine boy, he can be the taxi driver or the auntie at the market selling vegetables telling all her friends to buy shares. It is important to improve market sentiments by observing the people around you. When many people are aggressive investing in stocks, it is probably time to get out.
In 1636, the tulip bulb became the fourth leading export product of the Netherlands, after gin, herrings and cheese. The price of tulips skyrocketed due to the speculation in tulip futures by people who never saw the bulbs. Through the process, many men made and lost fortunes overnight. Tulip mania reached its peak during the winter of 1636–37, with tulip bulbs changing hands ten times in a day. However, there was no deliveries made to fulfill any of these contracts. In February 1637, tulip bulb contract prices collapsed abruptly and the trade of tulips ground to a halt.
Sir Isaac Newton
One of the most intelligent man – Sir Isaac Newton lost equivalent to today’s millions of dollars through the South Sea Company. The company was established in the early 18th Century and was a monopoly on trade in the South Seas in exchange for assuming England’s war debt. Investors loved the idea of this monopoly and the company’s shares rose.
In early 1720, he profited handsomely from his shares and he reinvested all his money on the expectation that the company shares would continue to rise. There was no warning on earth that can save people who are determined to get rich fast.
Newton added, “I can calculate the movement of stars, but not the madness of men.”
Refer to the above chart of the South Sea Company’s stock price, and Newton’s emotional journey from greed to happiness and then more greed and ending in despair.
2015 Shanghai Stock Market Meltdown
The Chinese stock market rallied more than 150% as the Shanghai Composite Index rose from 2,037 at the end of June 2014 to its peak of 5,166 in June 2015. Many naive investors shared the share journey as Sir Isaac were lured into the market near the peak. They suffered large financial losses. The stock market isn’t meant to be a casino. Its primary purpose is to help high-quality businesses to raise capital at a reasonable cost to bring innovative goods and products to the consumers. In efficient stock market, strong businesses and talented entrepreneurs attract capital and thrive. Weak companies which are not able to attract capital will be eliminated.
However, in this bubble and a moment of euphoria, shady firms and dishonest entrepreneurs exploited the market to raise capital. In the recent A-shares bubble, retail investors paid more than 400 times earnings for firms with no actual assets or sales. Perverse entrepreneurs sold a dream to investors and profit from their optimism and trust through offloading their personal shares at all time high prices in exchange for quick profit.
This turns the stock market into a wealth transfer mechanism from the massive poor to the handful rich with no positive benefit to the real economy.
Ken Fisher’s book “Market never forgets (but people do)“, history is an excellent guide for investor. Remember history and use it to profit and know when the market becomes too depressed, it is the time to become greedy and when the market is in a state of euphoria, it is time to get the money out.