There is a “meme” going around the Traders on Wall Street. The meme is that the stock markets always have a bubble during the second decade of a new century. It's the “Roaring 20's.”
The most famous of the Roaring '20s, was, of course, in the United States, 1920s. Time of the tin Lizzy, flappers and a stock market that just wouldn't quit. When everyone became a speculator in stocks.
There is a famous story of Bernard Baruch, perhaps the most famous investor of his time. The man whom Baruch College at City University of New York, is named after. In this story, Baruch goes to get his shoes shined. And while they're being shined, the shoeshine person starts touting his favorite stock. Telling Baruch that it's a “can't miss” opportunity, and that Baruch should but some shares.
According to the story, Baruch knew at that moment that it was time to sell the market. Which he did. And shortly thereafter came the Great Crash of 1929.
But we're getting a little ahead of ourselves, and we'll deal with that more in Part II tomorrow.
For today, let's look at what those traders see in this historic pattern of the Roaring '20s. Indeed, there does seem to be something about this second decade of a new century. It is often a time when emotions are running high. When it looks like just about anything is possible in the financial world.
The first time we saw this euphoria was in the opening decades of the 18th century. In 1711 a new company was formed that was destined to have a dramatic impact on the English Financial System. That company was: the South Sea Company. And its objective was to help Great Britain pay down its war debt. Certainly a noble cause. And even better: the British government created a public-private partnership with the South Sea Company, granting them a complete monopoly over all trade between Great Britain and South America, including the Caribbean Islands.
Thus investors in the South Sea Company were assured of participating in this trading monopoly, while at the same time helping their country. It sounded like a win-win.
The trouble was, that there was never any significant English trade taking place with South America or the Caribbean. And there never would be.
But speculators paid no attention to those realities, it was a story that was just too good to pass up. And so the stock was driven to ever new highs. That is until 1720 when word began to leak out (doesn't it always?) that the South Sea company really wasn't doing any business with South America at all.
This result: an unprecedented stock crash, which ruined many of those unhappy speculators.
Flash forward a hundred years to the beginning of the 19th century. Again Great Britain, again South America. This time an unscrupulous stock promoter, by the name of Gregor MacGregor, was touting his operation in South America.
MacGregor, who really was the Bernie Madoff of his time reported that he had developed a mini country in South America. Complete with plantations, and small communities. A place where the living was easy and the weather was wonderful.
None of it was true.
Again, loose money and dreams of incredible returns enticed many speculators to plunge. And in a particularly tragic note: about 500 actually sailed across the ocean to live at his development. Upon arrival, they found only a wild and undeveloped jungle. In the end, fully half of them perished.
Again, a financial bubble followed by a crash.
But this time the market crash was even worse. There were essentially no assets in this scheme. For investors, this was a total loss.
Flash forward, yet another century, and we come to the American Great Stock Market Crash of 1929.
I'm of the age, that both my parents and grandparents lived through the depression that followed. I can relate to the profound effect that this series of events had on Americans. For at least the next two generations the memory of the Crash was seared into investors' minds. L
ike the two bubbles which preceded it, leverage was a primary cause of this bubble. Loose money, easily obtained caused many to plunge into the stock market. What you may not realize is that back in the '20s, you only put about 1/10th down to buy stock. 90% of your stock purchase was loaned to you by the broker. Incidentally: this incredible amount of leverage is currently being enjoyed by many hedge funds.
But this means that even a minor move in the stock market, you would be left with absolutely no equity.
And in a major market move, like the crash of '29, you would be seriously underwater. You would have incurred a debt that would take years to pay back. If, it was ever paid back.
Speculators went bankrupt, brokers went out of business.
So, knowing the potentially devastating power of leverage when markets decline. And realizing the danger that comes when no one recognizes the risk, Bernard Baruch knew that it was time for him sell. When the person shining his shoes, thought no one can loose, then it was time to head for the exits.
Tomorrow Part II of the Roaring '20s.