Archive for the ‘WHY TULIPS MATTER???’ Category

WHY TULIPS MATTER!!!! (in progress) Sunday, May 17th, 2015

 

 

Probably the best known work on manias, bubbles and crashes is Charles MacKay’s work, “Extraordinary Popular Delusions and the Madness of Crowds” written in 1841. The first F043-22[1]hundred pages deal with the tulip mania of Holland in the early seventeenth century. The tulip phenomenon captures everyone’s fancy as it elucidates the foolishness that can be espoused by crowd behavior in the pursuit of easy wealth. This is a collective human phenomenon which most rational people sitting calmly in their homes say….’this insanity could never happen to me’. Well, that may be true and you may be an unusual individual…say, a Donald Trump or a Warren Buffet or a Peter Lynch….but, unfortunately the masses tend to fall in line and repeat the same folly. Usually there is a period of time that passes and a new set of lemmings formed but the behavior of the crowds is the same. And…the bubbles that are inflated by their collective action have a commonality. Ron Insana, analyst and CNBC commentator has written books on the formation of bubbles. Their profiles are amazingly simple: a dislocated asset, cheap money or credit to inflate and widespread conviction that prices will never go down. To those that point out bubbles as they are forming the gurus retort, ‘this time it’s different’ or ‘it’s a new paradigm or ‘the old rules no longer apply’. To the objective observer those phrases should bring instant sobriety.  But….it usually does not. The other phenomenon of bubbles is that they can last for a significant time. Sober minded and careful people watch others making substantial monies. Their skepticism is challenged when they see their friends and associates herald their success. Eventually most fall in line before the final phase of exponential price explosion and catastrophic collapse.

I am a lifetime student of markets. All markets! I contend that all markets behave the same. Whether they be the stock market, pork bellies, gold, real estate, derivatives or collectibles….all markets  behave the same! Why? Cuz the driving force is the collective action of the masses. Sure, some markets are more sophisticated than others but in the aggregate their behavior spans the two peaks of emotions driven by the masses. Those peaks are greed and fear. Wonderfully sophisticated folks with fancy degrees and sane lifestyles are wont to do crazy things when meshed with easy money and crowd mania behavior. If you don’t believe me…just look at history.

During the recent ‘dot com bubble’ bizarre metrics were used to justify those nosebleed type of valuations in the stock market. I say ‘recent’ although it was fifteen years ago. And…now…those lemmings that were butchered on a wholesale basis faded into the background and a new set resurfaced just a few years later only to form the ‘derivative/real estate bubble of 2008. Again….those hordes were massacred for a number of years this time both in the stock market and the real estate market. Many vowing to never to invest in financial asset and even housing again. But…going back to the metrics of 2000 brings to light the absurdity of the ‘extraordinary popular delusions and the madness of crowds’. Companies with earnings were trading at 80 to 100 times earnings while new issues or IPO’s came to market just with a business plan. No earnings or sales. And….on the first day of trading they were doubling in price and going higher. One of the metrics used was the number of clicks generated by their websites. I remember Cramer coming on Sqwack Box in the early mornings and heralding tis or that company whose site had scored millions of hits. One commentator even stated that it was advantageous for companies ‘not to have earnings’. Most principles would describe their company’s financials in terms of Pro Forma. When these ‘new gurus’ could not mark their holdings to market….they simply initiated a new concept. Mark to model. Why not? Now they were deep in fantasyland and the lemmings believed as stocks assumed the exponential climb. Then, of course, just as Wyl-e-Coyote having run a step too far over the cliff……straight down.

In the mid seventies I was working for Varian Associates as a marketing engineer in Palo Alto. Talk about a ‘fish out of water’.  And…I made friends with a production engineer. We became friends as we did business over the cubicles. Gold had recently been taken off the fixed rate of $36 an ounce and promptly shot up. Eventually hitting $800. The mania was raging. My engineer friend was sure that it would continue. He took a mortgage out on his house and invested in gold. He sadly commented later….it’s tough making those monthly payments and having nothing to show for it.

Remember Michael Milken in the 90’s? He was the junk bond king. He put together those wonderful deals financed with junk bonds paying 15 to 20%. One of the first things any student learns in any business school is that higher interest rates imply higher risk. Hmmm!!! So, you know the story. These bonds became popular and made regular payments…till they didn’t. A retired friend from Lockheed put a substantial amount in these junk bonds. And…having a drink one day after it was over…..he kept mumbling….’yeah! but, the 15% interest was awfully good’!

The aspect that I find interesting about the tulip episode is the mechanism that it created. During the build up stage as prices began to inflate and prices of the most prized and rare bulbs achieved astronomical heights they tended to bring the prices of lesser bulbs along. Eventually…as the demand continued to grow….as the pyramid of investor/speculator spread to an ever lower base….producers began to offer for sale baskets of lower quality bulbs. ETF’s, Mutual Funds…sound familiar. They would meet in back rooms of pubs, restaurants and such public places at established times to execute trades. The prices of these lower quality baskets continued to rise along with the rest.

What was is that cracked the market? And…this I find interesting as it has applications today in many and all markets. On one preset meeting a basket of low quality bulbs was offered at a price. There were no takers. It was offered again…still no takers.The news of this event spread like wildfire throughout. It was like a lightening rod of sanity that revealed to all the insanity of the prices. All markets collapsed. The very rare bulbs retained some of their values but the rest became worthless. I think that this is a universal which can be transmuted to all markets. Low quality is the last to rise and the first to fall.

Pro Forma

1) Froth of bubbles….how quickly they end. multiple offers ….where did all those buyers go

2) Apple Campus syndrome

3) Apple campus coming…..glazed eyes

4) low quality vs. high quality……peninsula counties vs. outlying counties

5) crowd or herding behavior  yelp…. greed….. fear…. ask someone you know….familiarity….broad experience in restaurant business with crowds….healthy disregard for common opinion or conventional wisdom….view doesn’t matter unless you’re the lead dog. bottom and broad base of the pyramid. CONVENTIONAL WISDOM

6) Silicon Valley 10 year tech. cycle Began Easter 2012.

7) Current forming bubbles…….silicon valley…….0 interest rates and QE people do foolish things to get yield…..RISK  CARLO, JOE KENNEDY & SHOE SHINE,  THE BAR MONTECATINI AT HEIGHT OF R/E BUBBLE

Does history repeat? Is the human animal doomed to continually repeat the mistakes of the past?

Deal with the notion of value. What broke the tulip mania. It was the failure to sell the basket of second rate bulbs……