Are stock markets ‘tulip heavy’?

Posted by Peter McGahan

Peter McGahan recalls the Fanny Kemble bulb while considering how to get vlue from an over-priced stock market.

tulips

It’s a daily question when you are protecting your pensions and investments: ‘Do you think the stock market is overpriced?’

For sure it is, but that doesn’t mean it can’t become more overpriced, and it doesn’t mean it has to crash in price. It also doesn’t mean you won’t be able to make a lot more out of it before it does falter.

Similarly, from the amount of questions asked after last week’s column on bitcoin, we need to fully appreciate the impact of sentiment on stock markets or the value of anything. More on bitcoins to come, however, from all my research, its value is no more than $1,200. Today, it’s trading at over $7,000. It doesn’t mean it has to fall below $7,000 nor does it mean it has to stop at $20,000.

Sentiment has a great part to play in the stages of investing which create bubbles, or even make a bubble real. Whether its negative or positive sentiment, it has a large part to play in the value of your funds, in particular at the last stage of the aforementioned bubble.

It has long been communicated that bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria.

The data coming through on Trump’s first year can easily be used to create optimism that even his harshest critics wouldn’t observe, which in turn may start to play into reality. Even if you don’t like him, nobody wants to be left on the sidelines in a soaring market.

Small snippets of hope that surprise markets, will ignite that optimism which can turn into blind euphoria, with people ignoring all fundamentals and piling into markets at an extraordinary rate. Remember when people were taking out mortgages to invest into the stock market, or even buying complex financial instruments they didn’t understand to borrow into the stock market.

Are we in the optimism stage – possibly, but we aren’t at euphoria, the point when people like me are seen as miserable for pointing out the glass half empty - when it is.

If you haven’t read ‘extraordinary popular delusions and the madness of crowds’, please feel free to. In there, you will read about tulip mania, where in 1634, you had to have Tulips to be a ‘somebody’. The euphoria became so extreme that Dutch people neglected their jobs and industry to source and buy tulips.

One trader offered 12 acres of building ground for one tulip root, and another offered four tonnes of beer, two tonnes of butter, a thousand pounds of cheese, twelve fat sheep, eight fat swine, four fat oxen and many other parts to the bargain … for one single root of the viceroy tulip. (1)

And so people sold their houses, even for knockdown prices, just to get into the tulip. Yes, a tulip.

As the euphoria peaked, and the ‘little people’ came in, the rich decided it could go on no longer, and that sentiment encouraged them not to keep their tulips like we do our wines, but now to sell at profit.

Selling caught hold, and all the contracts that were in place became a disaster, with buyers defaulting on the suppliers as prices had nosedived after the contract. Prices fell 90% immediately, and only with government intervention, who stated that contracts had to be settled at 10% of the original value. (2)

Contracts pre 1636 were declared null and void. Debts contracted in ‘gambling’ were deemed not to be debts in law. Gambling or investing? That’s the eye of the beholder ... and everyone pointed their fingers at each other.

Later, and not to be done out, in 1835, in London, the Fanny Kemble bulb was sold for £75 – over £8,740 in today’s money. (3). And so history doesn’t repeat itself but it often rhymes.

You are unlikely to predict a stock market, but you should feel euphoria, and when something looks and smells like a hamster, you know that it probably is. A steady hand, and mind, at the helm of your investment wheel mightn’t appear necessary on a calm and sunny day, but it is.

About the author

Peter McGahan is the owner of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.

Have a question on investments or pensions, please call Worldwide Financial Planning on 0800 011 2825, email info@wwfp.net or visit us on www.wwfp.net.
 

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