South Sea Bubble: Poof!

We've heard it over and over again. Stock markets are volatile. Sometimes investor excitement gets the better of rational judgment and sucks in the most intelligent of people. Companies, either fooled by nationalism (as it was with the South Sea bubble) or their own confidence, shoot for the stars and hit nothing - not even a cloud.

Markets are a mirror into a particular era. When times are good we can't possibly see why and how it can end. In the late 20th and early 21st centuries, we were convinced we were rewriting a new financial paradigm. Technology companies were going to change everything. Ties were out, casual was in.

Earnings? Cash flow? High PE multiples? All were ignored. Those who cautioned against converting portfolios into tech stock or borrowing on margin (including my former team) were ridiculed for being dinosaurs. We know the rest. In case my presumptuousness is too forward, the market burst.

And since then? The internet was and remains an ungoverned wild west. Many sites masking as companies are fakes and frauds. They merely prey on unsuspecting people and make a killing under various "affiliate marketing" schemes. Be aware!

The day Lehman Brothers died, along with the Enron catastrophe (and more recently with the bizarre madness of Bernard Madoff), was the day the free market system took a massive hit on the public imagination. This has, naturally, emboldened every left-wing, anti-capitalist to come out of the dark forest spewing the evils and greediness of our ways. Nonetheless, there's no way to regulate vice and virtue.

But none of this is new. Market are indeed subject to over confidence and under confidence. Yet, since the 18th century, despite some brutal intervals, the markets in reality continue to rise. Why? Because greed is governed by fear. This allows for some rational thought where the most number of people can profit. Hope and fear are components which race alongside greed.

One example of a stock market bubble in history was the South Sea Bubble. A bubble in which "every fool aspired to be a knave." It took place when the British Empire was the greatest on earth. So forgive the English for believing their pooh didn't smell.

However, as was soon discovered, they were subject to the universal laws of human nature.

At its root, the South Sea Company was a company based on high expectations run by inexperienced people. The British government allowed the SSC to assume its debt in hopes of turning it into a profit in South America. It didn't work for many reasons - read second hyper link for details.

As people irrationally (including one Edward Gibbon grandfather of the great historian) continued to buy stock in the company, there were some cautionary and sober reflections. The chief speaker for the bank, Robert Walpole warned against it. "...The dangerous practice of stockjobbing...would divert the genius of the nation from trade and industry..." He continued, "the great principle of the project was an evil of first-rate magnitude; it was to raise artificially the value of the stock , by exciting and keeping up a general infatuation."

Of course he was ignored.

The idea of pushing through an idea (every American must own a house for example) through government ordinances via the stock markets is not a good idea as we've learned.

The infatuation, as Walpole put it, had reached such a point so that "Bubble Cards" (or Globe Permits) were issued in the form of IPO's. The list of dubious companies coming out of the woodworks hoping to cash in was astonishing. Reminds me of the time when technology IPO's were issued amidst much hype. The demand was so great the price offering usually exploded once trading commenced. All before any profits were ever recorded! More often than not, the stock price would collapse. However, in the meantime, people traded on the volatility. The trick was not to buy to high, ride the wave, sell and move on.

As far as I know not too many people were able to sustain this game for too long and most portfolios were down by the time the smoke had cleared.

These are trying times for the investment community, free markets and confidence among the people. But if we subscribe to the notion that history repeats itself, if anything we've learned, humans have a special knack for getting back on track.