It is hard to read a newspaper today without being told about suburbs where everyone is a millionaire, or a 9 year old who has just sold an app for billions.  The world, it seems, is sitting back and the good times are rolling.

Marketwatch’s eye was caught by an article in the Wall Street Journal titled “Persistent Advance in Stocks and Commodities Shows Investor Confidence”.  And certainly the American market has been growing steadily.  The chart below shows the 5-year trend for the Standard & Poors 500 index for the past 5 years.

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A quote from a major investment advisory firm was particularly telling, “There’s nowhere else to go in our view,” said Jeff Garden, chief investment officer at Lido Advisors. “You’re not going to be able to find what you’re looking for in the safer investment spaces.” 

The story is similar with the Australian share market although the COVID hit in March 2020 was more pronounced, and the subsequent growth less strong.

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But that doesn’t mean that the risk is less.  Figures for margin lending in Australia show that lending for investment continues to grow.

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We have an environment where interest rates are low, traditional forms of safer investments such as bonds are giving low rates of return, and the chase for better yields has started.  Share markets around the world are booming, why wouldn’t you join in.  What can go wrong?

So, settle down, pour yourself a drink and join me in a trip down memory lane.

Our first stop is in the year 1715.  Yes, that far back.  The British government faced an issue in that they had incurred significant debts acquired from financing the War of Spanish Succession.  A company called the South Sea Company, which had helped the government with previous re-financing efforts, came up with a scheme where it would offer its shares to the public in return for government debt at a reduced rate.  The mechanics of the scheme meant that a higher market price could result in higher profits for shareholders.  Money was lent directly to investors to buy shares, and the shares were highly leveraged by only requiring a deposit, a variation on margin lending.  Calls on the remainder of the capital were scheduled over long periods of time, so investors had the opportunity to re-sell at any time.  And you could borrow from the company to make the payments on the calls.

And there were winners.  The composer, George Frederic Handel (of Water Music and Messiah fame) invested £440 in shares and sold them in 1719 for a £145 profit, a significant return.  But others were less fortunate.

The problem was that the company was a slave trader with few assets.  Although the newspapers largely cheered on the share growth, one analyst, using cash-flow analysis, concluded that the shares were being offered at a price well above their value.  A bubble had formed.  The shares rose from £126 at the beginning of 1720 to £1,100 in mid-July.  The crash was just as dramatic as the reality of the over-valuation sank in, and by December was back to £126.  A lot of people lost an awful lot of money.

Fast forward a century or so to the 1840’s, and it was railway boom time in Great Britain.  New railways were being built all over the country thanks to the passing of the Railway Act in 1844.  Share prospectuses made wild claims of future profitability.  Interest rates were the lowest in 150 years at 2.5%.  Investors were hungry for better returns as a result because traditional yields were low.  This time they didn’t need to worry about borrowing money, the shares were part-paid and only a very low 10% deposit was required to acquire them.  Many investors didn’t understand that this still made them liable for the other 90%.  Never mind that the companies had not started construction, money was cheap and credit was easy, what could go wrong?

Well, for a start, the media were better at being critical.  The Times wrote editorials citing “excessive speculation”.  The weekend before the crash it wrote “the mania for railway speculation has reached that height at which all follies, however absurd in themselves, cease to be ludicrous, and become, by reason of their universality, fit subjects for the politician to consider as well as the moralist.”

Other economic events took their toll.  De-regulation of the railways caused companies to compete wastefully.  A harvest failure in England and Scotland, and, disastrously in Ireland, put pressure on prices.  The outflow of gold due to the economic problems caused the Bank of England to increase interest rates.  This occurred at the same time as railway companies made calls to pay additional capital over and above the original 10%.  The party was over.  Investors struggled to find additional funds in a tighter credit market.  By April 1850, shares had fallen by 66%.

Then in the 1880’s we had the Australian land boom.  An increase in marriage and a rising population increased demand for land in Melbourne and Sydney.  Land prices skyrocketed.  In 1887, land in Burwood, about 15 kms from the centre of Melbourne had risen from £70 an acre to £300.  Attracted by the high level of economic growth foreign capital poured into the country, mostly into the share market but spilled over into land investment.  In 1887, a coalition of Australian banks commenced a programme of interest rate cuts.  This caused a reduction of yields on safe assets and investors began to look for higher yields elsewhere.  The formation of land and property companies offering huge gains as property prices increased saw investors flock to invest.  Building societies, which had been formed to provide finance for homebuyers, changed their model to include lending to builders and developers.

Such was the demand for shares of land companies that when they came to the market, they were vastly oversubscribed and immediately sold at a premium.  This was a market on steroids.

Banks came to realise that cheap money had contributed to an unhealthy boom which had turned into a bubble.  So, they took several steps including the raising of interest rates and putting restrictions on credit.

Because the rest of the economy, agriculture, wool and silver were doing well, the gradual decline in property caused by interest rate rises was masked.  It wasn’t until 1891 that building societies, which had borrowed from banks which now wanted repayment, started to fail.  Land companies and banks followed and failed in such numbers that foreign investors started to pull out of the country.  The resultant bust plunged Australia into the longest and deepest recession in its history.

We can go on like this and talk about the Wall Street Crash in the late 1929 which heralded a worldwide depression but was particularly severe in the US.  Generally, easy credit and a loose market were the cause.  Or there was the Japanese property crash of the 1980’s and 90’s mostly due to an overheating economy, and an uncontrolled credit expansion, and which led to the “lost decade”.  Or there was the dot.com bubble of the 2000’s.  And, of course, we must not forget the Global Financial Crisis from 2008 onwards.  And that is by no means all of them.  But they all had similar characteristics of low interest rates, plenty of credit, soaring asset prices, and investors hunting for better yields.

So, here we are today.  We have the lowest interest rates on record.  Credit availability is not necessarily easy but there is plenty of it and with interest rates low, investors are willing to leverage themselves.  Asset prices, such as shares and housing are increasing in price.  Conventional investment returns are delivering lower yields so investors are looking for better returns elsewhere even if it means increasing their risk profile.

Before the Global Financial Crisis unfolded, a few brave economists and commentators started to sound warning bells.  You are wrong, they were told, this time is different. In 2009, two eminent economists, Carmen Reinhart and Kenneth Rogoff, published a study of financial crises over the past 800 years.  And their conclusion was, it never is different, it’s always the same.

And the final thought comes from the Spanish philosopher Jorge Santayana who wrote in 1905, “those who cannot remember the past are condemned to repeat it”.

Amen.

To cheer himself up in these months of winter, Marketwatch is grateful to a dinner guest who visited several days ago and kindly donated a bottle of Penfolds Bin 28, the Kalimna Shiraz 2013.  A very nice warm wine, most enjoyable.  Go on, treat yourself.