In the early 1720’s, exactly 300 years ago, all of England was overtaken by a surge of stock market speculation which we now know as the “South Sea Bubble”. Ignited by a monopoly granted by Parliament to a company to trade in South America, all manner of companies suddenly were brought to the market, and their shares were purchased with wild abandon by all and sundry. Two strong emotions ruled; today we call them “FOMO – fear of missing out” and “YOLO – you only live once”. No idea was too bizarre and no scheme too outlandish. At the height of the boom a company was floated “For carrying-on an undertaking of great advantage but no-one to know what it is!!” It raised the equivalent of over $1 million, a lot of money 300 years ago. Naturally it all ended in tears. Here is a brief description of what happened:
The stocks crashed and people all over the country lost all of their money. Porters and ladies’ maids who had bought their own carriages became destitute almost overnight. The Clergy, Bishops and the Gentry lost their life savings; the whole country suffered a catastrophic loss of money and property.
Suicides became a daily occurrence. The gullible mob whose innate greed had lain behind this mass hysteria for wealth, demanded vengeance. The Postmaster General took poison and his son, who was the Secretary of State, avoided disaster by fortuitously contracting smallpox and died!
The South Sea Company Directors were arrested and their estates forfeited.
(The South Sea Bubble, E. Castelow).
It would be nice to think that we are more sophisticated than our distant forbearers, that capital markets are more rational and better regulated, and that something like this could never happen now. If only. Let me bring some examples to your attention that remind any reader of history of the original stock market bubble:
- Tesla is now valued at much more than all the other auto companies in the world combined although it has never made much money selling cars and is now faced with fierce competition in all markets.
- Special Acquisition Companies, which raise money to be used for an unknown purpose (presumably of great advantage) are trading at prices that value their only asset, cash, at $1.50 per $1.
- A previously little-known fund manager. ARK, has gone from $5 billion under management to more than $60 billion by piling cash into new high-tech market entrants, forcing up prices and making early investors (and the fund managers) rich, at least for the moment – see above!).
- And last, but not least, crypto currencies, a clever idea now used to launder money, avoid taxes and foster crime, are now valued at $1 trillion.
Our belief is that all this speculation will end badly, as has been the case with all speculative bubbles, most recently in 1999-2001, when the NASDAQ index fell by more than 80%. We believe this because we believe that value still matters.
The value of a stock has to do with its earning power over time. Early-stage companies are hard to value as they have not yet demonstrated what that earning power might be, and it is not surprising that many, if not most, are overvalued for a time. Ultimately, however, every company must pay its way. It must demonstrate the ability to make earnings on a sustained basis. Then it can be valued with some degree of certainty. For this reason, time is the great leveller for speculative companies. If prospects and projections do not eventually turn to profits, buyers lose interest and sellers start to predominate. As soon as there are more sceptics than believers, values evaporate quickly. Suddenly no one wants to own Tesla at $900, and it falls below $600 in a few days, as it did last week. Some commentators reference the “greater fool theory”: speculative stocks fall when there are no buyers left who are more foolish than the last buyer.
Of course, it is true that a lot of money can be made very quickly by speculators. Somebody bought bitcoin at $10 and sold it at $40,000. Fabulous! But history shows that most who gamble end up losing.
When the current bubble bursts, as we believe it must, what will be the impact on the 40 or so companies whose stock we have purchased for our clients? All our portfolio companies are profitable, high quality firms; most pay dividends and many raise dividends annually. They have proven themselves over years in the crucible of the public markets. These securities have value for precisely those reasons. Most are heavily owned by smart institutions which, like us, have long time horizons. Will our stocks fall along with the low quality over-hyped and over-priced issues crash? Likely they will, but not very far, and not for very long. When the dust clears there will be a rush to quality names and the companies that have measurable value will trade at a premium.
One of the most famous and widely quoted aphorisms about the stock market, attributed to John Maynard Lord Keynes, is that “the market can stay irrational longer than you can stay solvent”. Our clients, who are not margined, are not short sellers and who have not speculated, can stay solvent indefinitely. Eventually the markets will become more rational, as they always do. In the meantime, we hope our clients can suppress any FOMO or YOLO they may be feeling and take comfort in the knowledge that value is always, eventually, recognized.