Schiller observed that anyone, taken as an individual, is tolerably sensible and reasonable – but, as a member of a crowd, he at once becomes a blockhead. Have we been witnessing a demonstration of the truth of this in the recent behaviour of world stock markets? There are plenty of precedents for what happened last October. Let us go back in history and take a close look at one of them – the 17th century tulip mania in Holland – in order to see if we can identify any parallels to the great equity boom of the 1980s.
Tulips were introduced to Western Europe in the middle of the sixteenth century, and had grown steadily in popularity by the year 1634 when the tulip mania proper took off. For many years rich people had been sending to Constantinople for rare tulip bulbs, paying higher and higher prices for them, and it had become de rigueur for any man of fortune to own a collection of tulips. Eventually the craze for possessing them spread to merchants and shopkeepers, who began to compete for the most exotic and expensive flowers. At this stage the tulips were not purchased with a view to resale, but were typically kept in the owner’s conservatory for his own pleasure and the admiration of his friends. Nevertheless the persistent demand for the bulbs over many years gained for them the reputation of being excellent long-term investments, steadily growing in value year after year.
Was there any intrinsic virtue in the tulip which could justify the extravagant value placed upon it by otherwise prudent Dutchmen? In 1634 nobody asked this question, as the tulip mania spread to virtually the whole population, and prices rose higher and higher. In 1635 a particularly well-regarded species, the Semper Augustus, was considered cheap at 5,500 florins – about £500 or £25,000 in today’s money – for a single bulb!
At this stage tulips were still being bought for the gratification of the purchaser and his friends, rather as Old Masters are often bought today. It was in 1636 that the real speculation began; regular markets for trading in the bulbs were established on the Amsterdam and other Dutch stock exchanges. Now the mania quickly reached its final phase; tulips were bought, not for their own intrinsic attractions, such as they were, but simply so that they could be resold at higher prices to the ‘bigger fool’ who would always be at hand.
Prices continued to soar, and dealing became more and more frantic. If we listen carefully, perhaps we may hear some faint echoes from those far-off days, when investors began to believe that demand for the fragile flowers would never diminish. They thought that they only had to invest, regardless of fundamentals, to be certain of making large profits. In the 1980s, we have seen privatisation issues attracting first-time investors who look on them purely as opportunities to make windfall capital gains.
The tulip brokers of the 1630s published optimistic analysis explaining that the weight of money flowing in from every part of the world would ensure that prices would go on rising for ever. In the 1980s we have constantly been told that the high level of stock markets, particularly in Japan, would surely be sustained by the massive liquid funds available for investment.
The machinations of those involved in the tulip trade became so complicated that it was found necessary to introduce new laws to regulate the trade, and ‘tulip notaries’ were appointed to administer them. In 1986 a Financial Services Act was introduced in the United Kingdom, and a Securities and Investments Board was set up to regulate the securities business.
Tulip mania pervaded every aspect of life in Holland, and took hold to such an extent that the ordinary business of the country was neglected as everyone concentrated on the latest news from the trade. In the 1980s we can hardly listen to the wireless or watch television without hearing in detail up-to-date stock market reports and business news.
At last the perception grew, very slowly at first, that it was folly to pay such enormous prices for tulip bulbs. Some minor setback, which earlier would have been shrugged off as unimportant, served as the trigger for a sharp fall in prices; and although desperate efforts were made by those interested in its continuation to reinstate the boom, the conviction took hold that it was over. Defaulters now appeared in increasing numbers, and there were cries of distress from those who stood to lose money as a result of transactions which they had long assumed to be automatically profitable. More recently, did we not hear a few cries of distress from the BP underwriters, who suddenly found that easy money was being replaced by heavy losses?
The typical bull market in equities, such as we have seen in the last thirteen years, follows much the same pattern as the tulip mania, although thankfully in a much less extreme form. The trouble really starts when the belief takes hold among the public generally that automatic profits can always be made from investing in shares. All you have to do is get on the escalator at point ‘A’ and get off at point ‘B’ a bit higher up. You do not need to know anything about the companies you invest in, or how much you are paying for profits which are growing at what rate!
As in the story of the tulip mania, the point is reached when too many people realise that things have gone too far. The market suffers a sharp fall, and the experts search around for a plausible reason for it. Thus the American budget deficit was proposed as the reason for last October’s crash. It was in truth nothing of the kind; the reason was simply that prices had advanced so far and so fast that they had lost touch with reality. In a nutshell, it was a crash waiting to happen.
Can we recognise any rare blooms which flourished briefly in the later stages of the bull market? Here is an example, described in the Financial Times within the last year.
“The silly face of capitalism was on view yesterday, waiting impatiently in the rain for the chance to gamble on the latest hot new issue. For the record the market capitalisation of £49.7 million at the offer price compares with net assets last reported at £3.5 million, and offers a notional yield and price-earnings ratio of 1% and 31.5 respectively; the company has been making profits for all of three years. The chances are that the issue will open at a fat premium and that lots of people will make a little pin money. (It did). But yesterday’s crowds were in reality no more than a reflection of the casino mentality which emerges in a ripe bull market.”
All this does not mean that good equities (and, indeed, tulips) are not excellent investments in normal times and at sensible prices. The American financier Bernard Baruch observed of the 1929 Wall Street crash “if we had all continuously repeated to ourselves ‘two and two still make four’ much of the evil might have been avoided.” More optimistically, he also said, when asked if declines would never end, “they always did!”
A good party is of course a very enjoyable experience, but it is usually wise to go home before it deteriorates into an orgy. You may miss some of the fun, but you are likely also to miss the worst of the hangover! In due course there will be another party; why not make sure that you are in good shape to enjoy it when it comes – as it surely will?