Jim Cramer warns, “Every once in a while, the market does something so stupid it takes your breath away.”
But what are those moments? And what lessons can they teach investors?
Take a deep breath as we dive into some of the maddest moments in financial history.
Tulip Mania — 1637
Around 1600, Turkish tulips arrived in Holland. They were rare, and so traded for big money. Prices spiked 60x, driven by people who weren’t even buying the flowers. Rather, they were betting their money on financial contracts — called derivatives — in the hope that tulip prices would keep rising. Traders were selling tulips for the same price that you could buy a large house!
As with all bubbles, it was too good to be true. Having peaked, sellers panicked, began selling their tulips and their derivative contracts and prices fell by 100x. Investors lost it all and the Dutch economy fell into a depression.
Lesson Learned — From tulips to tech stocks, bubbles always burst.
South Sea Insanity — 1720
As the saying goes, the sun never sets on the Empire, such was the amount of land that the British governed in the 1700s. In spite of this power, they didn’t make great financial managers.
In 1711, the South Sea Company, a British trading company, was granted a monopoly on trade with Spain’s colonies in South America. In return, it took on most of England’s war debt — about $9,000,000.
Noting the profit that could be made via this exclusive trade route from commodity-rich South America, and hearing claims (mostly fraudulent) of successful dealings in faraway lands, speculators bought shares in the South Sea Company. Boosted by reassurances from the government (many from bribed politicians), the stock rose over 1,000% from £100 to £1,050 in one year — that’s almost as much as last year’s crypto mania!.
But it was too good to be true. As the South Sea Company failed to generate paper returns, investor get-rich-quick confidence waned. The bubble popped, the stock collapsed and investors were ruined. In 1721, Parliament exposed the corruption and bribery at the heart of the company. But by then, many honest investors, including Sir Isaac Newton, had lost money they’d never get back.
Lesson Learned — As Newton said, “I can calculate the movement of the stars, but not the madness of men.”
Mortgage catastrophe — 2007
In America in ’07, NINJA loans (NINJA = “No Income, No Job, no Assets”) meant almost anyone could buy a house. But when mortgage rates went up and house prices went down, defaults rocketed as people couldn’t pay. Houses were repossessed throughout America.
The knock on effects of these defaults were felt all around the world as global banks and financial institutions, who owned the mortgages and were now no longer being repaid, lost a massive amount of money and began to fall bankrupt, causing millions of people to lose their jobs as the global economy ground to a halt. We’re still climbing out of this depression today.
Lesson Learned — One domino can bring the world crashing down.
Pokemon Crazy — 2016
Pokemon Go’s incredible popularity sent Nintendo stock soaring by 50%. One small problem… Nintendo didn’t make Pokemon GO. The Pokemon Company and Niantic did.
When Nintendo announced they only owned a portion of the game, panic hit and the stock fell by 30%, bizarrely staying 20% over starting value. In spite of the rise being NOTHING to do with Nintendo, investors let them keep $4 billion. Markets are like that sometimes. They can be mad.
Lesson Learned — Do your homework or get burnt in mad markets.
Crypto Crazy — 2017
You could almost feel the hype and hysteria building around cryptocurrencies in 2017.
All of a sudden, Bitcoin, Ethereum and Ripple were on the front pages of newspapers and talked about as the future of money. Bitcoin rose 1,000% in 2017. Urged on by a fear that they were missing out on the latest ‘get rich quick’ asset, dived in, speculators pushed the price of one Bitcoin to $19,783.06. Early investors got incredibly rich.
In January ’17, the bubble burst , as regulators clamped down on the unregulated technology and investors took profits. Bitcoin lost over 50% of its value, dragging other cryptos down with it.
Today, Bitcoin trades around $7,000 dollars, 65% down from its highs. Until we find a real-world use for crypto, the currencies will always be subject to massive volatility as the sector will continue to be dominated by speculators and gamblers. The events of 2017 and 2018 in crypto aren’t really mad — they’re just the new normal.
Lesson Learned — Some asset classes are mad and always will be.
History shows that markets can do crazy things and there’s no way to know when things are going to turn bad.
All you can do is invest sensibly and protect your portfolio. One way to do this is by diversifying your portfolio, which you can learn more about here.
Related: Diversification Part 1