“You know, people talk about this being an uncertain time. You know, all time is uncertain. I mean, it was uncertain back in – in 2007, we just didn’t know it was uncertain. It was – uncertain on September 10th, 2001. It was uncertain on October 18th, 1987. You just didn’t know it.” — Warren Buffett
The Stock Market is NOT the Economy.
There is a fundamental difference between Economic Indicators like the labor market (unemployment rate / wage data) and the Stock Market. The Economic Indicators are backwards looking (lagging indicators); they tell us what the labor market was in the last few weeks or months. The Stock Market, in contrast, is forward looking (leading indicators); investors are always trying to guess what is going to happen next and how it might affect a company’s earnings and its profitability.
As a result of market cycles, Stock Market crashes and downtrends are an inherent risk of investing.
Looking back, it is easy to think of Stock Market crashes as abrupt shocks. But in the long run it’s just a blip ... tomorrow or next year ultimately won't matter much over the decades.
History is not the market's friend in the near term, but it's a big-time ally of long-term investors.
TULIPMANIA
Dutch Tulip Bulb Market Bubble, also known as Tulipmania, is the earliest-known Stock Market crash. During the mid-1630s, tulips became widely popular as a status symbol in Holland and, as a result, speculation caused the value of tulip bulbs to increase. By 1636, the demand for tulips became so large that speculators began to trade in what were essentially tulip futures.
Tulipmania
A tulip, known as "the Viceroy" (viseroij), displayed in the 1637 Dutch catalogue Verzameling van een Meenigte Tulipaanen. Its bulb was offered for sale for between 3,000 and 4,200 guilders (florins) depending on weight.
At the market’s peak, the rarest tulip bulbs traded for as much as six times the average person’s annual salary. A single bulb could be worth as much as 4,000 or even 5,500 florins (gold coins). This means that the best and rarest of tulips could cost upwards in the range of $750k - $1 million in today’s money (but with many bulbs trading in the $50,000–$150,000 range).
It was at that time that traders got in on the action, and everybody appeared to be making money simply by possessing some of these rare bulbs. Indeed, it seemed at the time that the price could only go up, that “the passion for tulips would last forever”.
In February 1637, however, the tulip bubble burst as the market fell apart. A large part of this rapid decline was driven by the fact that traders had purchased bulbs on credit, hoping to repay their loans when they sold their bulbs for a profit. But once prices started to drop, holders were forced to sell their bulbs at any price and to declare bankruptcy in the process.
... just like THE CRYPTO PHENOMENON we are witnessing today.
“Bitcoin —> The 21st Century Dutch Tulip Mania ! ”
The classic word for these kinds of phenomena is BUBBLE ... and ... The Bubble Bursts !
Economic Bubbles occur when too much money is chasing too few assets. This causes both good assets and bad assets to appreciate beyond their intrinsic value, or fundamentals, to an unsustainable level. Once the bubble bursts, and they all do, the fall in prices causes a crisis of investor and consumer confidence that leads to a shock causing a financial crisis. Euphoria turns to despair as the mandatory readjustment that takes place in the economy creates massive worker dislocation, and great numbers of bankruptcies.
“Oct. 19, 1987 (also famously referred as BLACK MONDAY), marks the largest one-day stock market decline in history. This day Dow fell by 22.6% in a single trading session. To put that into context, a drop of that magnitude would be a nearly 7,000-point slide based on the Dow’s current levels. In 1987, that was about a 508-point drop. Black Monday prompted the development of “trading curbs” aimed to reduce market volatility – rules that allow regulators to halt trading, including electronic trading, in the event of extreme pricing swings.”
BOOMS AND BUSTS
Extraordinary popular delusions and the madness of crowds often leads to Stock Market Booms and Busts ... followed by a LIFEBOAT OPERATION.
Booms and Busts as outlined by Antoin Murphy (1986).
The MARKET rise starts off because of some exogenous shock such as war, the end of a war, a technological or natural resource discovery, or 'a debt conversion that precipitously lowers interest rates'. The shock creates new opportunities for profit and a boom is engendered.
The BOOM is nurtured by an expansion of bank credit which expands the money supply. Alternatively the velocity of circulation increases.
As INCREASED DEMAND pushes up the prices of goods and financial assets, new profit opportunities are found and confidence grows in the economy. Multiplier and accelerator effects interact and the economy enters into a 'boom or euphoric state.' At this point overtrading may take place.
OVERTRADING may involve:
Pure speculation, that is over emphasis on the acquisition of assets for capital gain rather than income return
Overestimation of prospective returns by companies
Excessive gearing involving the imposition of low cash requirements on the acquisition of financial assets through buying on margin, by instalment purchases, and so on.
When the NEOPHYTES, attracted by the prospect of large capital gains for a small outlay, become numerous in the market, the activity assumes a separate abnormal momentum of its own. Insiders recognize the danger signals and move out of securities into money.
A FINANCIAL DISTRESS period sets in as the neophytes become aware that if there is a rush for liquidity prices will collapse. The race to move out of securities gathers pace.
REVULSION against securities develops as banks start calling in loans and selling collateral.
Panic sets in as THE MARKET COLLAPSES and the question arises as to whether the government or Central Bank should come in and act as a lender of last resort in what has been recently described as a “LIFEBOAT OPERATION”.
Today, the story of Tulipmania serves as a parable for the pitfalls that excessive greed & speculation in investing can lead to.
But here's the good news:
Despite all the stock market crashes and corrections, if you invested $100 in the S&P 500 at the beginning of 1926, you would have about $1,112,195.58 at the end of 2022, assuming you reinvested all dividends. This is a return on investment of 1,112,095.58%, or 10.08% per year (excluding fees and taxes). This lump-sum investment beats inflation during this period for an inflation-adjusted return of about 67,166.25% cumulatively, or 6.94% per year.
