Bogleheads® on Investing Podcast 031 – Jamie Catherwood, host Rick Ferri (audio only)

00:00:00.000 | [MUSIC PLAYING]

00:00:10.080 | Welcome, everyone, to the 31st episode

00:00:12.440 | of Bogle Heads on Investing.

00:00:14.480 | Today, our special guest is Jamie Catherwood,

00:00:17.240 | a bona fide financial history nerd.

00:00:20.160 | Jamie's research that he publishes weekly

00:00:22.280 | on his Investor Amnesia website show

00:00:25.120 | that we make the same mistakes as investors

00:00:27.400 | over and over again.

00:00:28.920 | [MUSIC PLAYING]

00:00:37.680 | Hi, everyone.

00:00:38.440 | My name is Rick Ferry, and I'm the host

00:00:40.360 | of Bogle Heads on Investing.

00:00:42.320 | This episode, as with all episodes,

00:00:44.520 | is brought to you by the John C. Bogle Center

00:00:47.440 | for Financial Literacy, a 501(c)(3) nonprofit organization.

00:00:53.040 | Donations can be made at boglecenter.net.

00:00:56.240 | Today, we have a special guest, Jamie Catherwood.

00:00:59.600 | I first met Jamie at a quantitative analyst meeting

00:01:02.760 | that was full of PhDs and people a lot smarter than me.

00:01:06.760 | And there was this young man captivating all these PhDs,

00:01:10.320 | just coming up with all of this information

00:01:12.600 | that I'd never heard of.

00:01:14.440 | And as I listened to him talk, I came quickly to the conclusion

00:01:17.360 | that he was one of the smartest people in the room.

00:01:19.840 | And I actually got a little bit nervous when somebody said

00:01:22.300 | my name, and he looked at me and said, you're Rick Ferry?

00:01:25.760 | That scared me a little bit.

00:01:26.960 | I said to myself, how am I going to keep up with this guy?

00:01:29.520 | But it turned out great.

00:01:31.040 | It was a real pleasure getting to know Jamie,

00:01:33.100 | and it's a real pleasure having him on the show today.

00:01:35.720 | I'm sure you're going to enjoy this.

00:01:38.040 | So with no further ado, let me introduce Jamie Catherwood.

00:01:42.320 | Welcome to the podcast, Jamie.

00:01:44.640 | Thank you so much for having me.

00:01:45.960 | It's an honor to be here.

00:01:47.560 | I wanted to have you on the show to dig into all of the work

00:01:51.960 | that you've done, even though you don't have your PhD.

00:01:54.480 | I mean, you have done a PhD volume worth of work

00:01:58.800 | on financial history, and have developed a website called

00:02:02.640 | Investor Amnesia, and a course, and really have become quite

00:02:07.840 | a widely known expert on financial history

00:02:12.720 | at the young age of 26 years old.

00:02:15.320 | So before I jump into our discussion

00:02:17.960 | about financial history, could you

00:02:19.580 | tell us a little bit about your background

00:02:21.280 | and what got you to this point?

00:02:23.400 | It actually kind of goes all the way down the line

00:02:25.560 | in my ancestry, particularly on my father's side.

00:02:29.160 | I don't know how many greats it is, but great, great, great

00:02:31.920 | something grandfather was a guy named Frederick Catherwood.

00:02:35.000 | And he is known for helping rediscover the Mayan civilization

00:02:41.400 | with his colleague John Lloyd Stevens.

00:02:44.320 | And this is in the mid to late 19th century.

00:02:47.400 | They went through the jungles of, I think,

00:02:50.320 | modern day Guatemala, and found these ancient ruins

00:02:54.000 | that they had heard about.

00:02:55.040 | And what my ancestor did, his role

00:02:57.920 | was painting these really elaborate lithographs.

00:03:00.880 | And if you just Google Frederick Catherwood,

00:03:02.720 | you'll see some of these beautiful illustrations.

00:03:06.160 | And it was those illustrations that were actually

00:03:09.440 | used to help decipher the Mayan language,

00:03:12.840 | and figure out what these monuments and statues were

00:03:15.960 | talking about and representing.

00:03:17.240 | And we could decipher the history

00:03:18.600 | of the Mayan civilization.

00:03:20.600 | Edgar Allan Poe said the book that Frederick Catherwood

00:03:24.320 | and his colleague John Lloyd Stevens

00:03:26.480 | put out about their adventures was the most important book

00:03:30.880 | on travel written in the 19th century.

00:03:34.080 | And then there's actually another Frederick Catherwood

00:03:36.760 | who is my direct grandfather, much more recent.

00:03:40.080 | He sadly passed away in 2014.

00:03:43.000 | But he has also always been an avid historian

00:03:46.040 | and passionate history buff.

00:03:47.840 | And he had a fascinating career in both business and politics,

00:03:51.760 | to the point where he was actually knighted formally

00:03:54.520 | by the queen in 1971, I believe.

00:03:58.000 | And so he is technically Sir Frederick Catherwood.

00:04:00.960 | Does that roll down generations?

00:04:03.360 | Are you a Sir also?

00:04:04.680 | I wish.

00:04:06.360 | I wish.

00:04:06.920 | If it did, I would have a full suit of armor in my apartment.

00:04:11.240 | I would definitely be showing that off all the time.

00:04:13.640 | But no, it does not, unfortunately, roll down.

00:04:16.280 | He, from there, went on to be a founding

00:04:21.520 | member of the European Parliament and European Union.

00:04:25.400 | And he was elected at first in 1974

00:04:28.440 | to be a representative from Cambridgeshire.

00:04:31.600 | And from there, he kept serving for decades

00:04:34.600 | and eventually ended up being the vice president

00:04:37.200 | of the entire European Parliament in the late '90s

00:04:39.960 | into the early 2000s, before then retiring afterwards.

00:04:43.680 | But he and the greater ancestor have definitely

00:04:47.600 | had an influence in my interest in history and business,

00:04:50.800 | politics, et cetera.

00:04:52.200 | Well, that's incredible pedigree,

00:04:54.440 | to actually do what you are now doing,

00:04:56.840 | history and economics and politics,

00:04:58.920 | tying those things together.

00:05:00.320 | I mean, it's really your work.

00:05:02.560 | Can you tell us about your work?

00:05:04.840 | My work stems more from immediate interest

00:05:07.600 | from college as a history major with my now

00:05:10.240 | professional interest as someone who

00:05:12.000 | works in the financial services industry at an asset

00:05:14.880 | manager, O'Shaughnessy Asset Management.

00:05:17.160 | And I really wanted to marry my two interests.

00:05:20.640 | And I began writing after the recommendation

00:05:24.360 | of a friend of mine to join Twitter

00:05:26.400 | as a way for networking.

00:05:27.960 | And then after I joined Twitter, I

00:05:29.400 | saw that there were a bunch of people

00:05:30.520 | like yourself who were putting out

00:05:31.920 | great podcasts, blogs, et cetera.

00:05:34.240 | And I missed the process of researching and writing

00:05:37.200 | that was basically my entire undergrad degree

00:05:40.120 | at King's College London doing history papers.

00:05:42.560 | And so I figured maybe I'll put together

00:05:45.040 | a short series on interesting moments or characters

00:05:48.160 | in financial history.

00:05:49.640 | And to my great surprise, they were very well received.

00:05:52.600 | And it turned out that there is a quite large base of people

00:05:56.600 | that were working in this industry that

00:05:58.520 | had an interest in history.

00:06:00.640 | And so from there, it's gone from just posting

00:06:03.040 | some articles on Medium to developing my own website

00:06:07.360 | and starting a newsletter that now goes out to, I think,

00:06:11.840 | over 11,000 people each Sunday.

00:06:14.480 | And in those posts, I'm taking together

00:06:17.760 | five different scholarly articles on financial history

00:06:21.440 | all wrapped around one theme that

00:06:24.280 | is relevant to whatever is going on in the markets that week.

00:06:26.920 | So recently, I've had posts on the history of short selling

00:06:31.320 | and market corners, et cetera, after the whole GameStop

00:06:34.960 | mania.

00:06:35.720 | I definitely feel that history is

00:06:37.800 | helpful for putting everything into context.

00:06:39.720 | And you can avoid getting swept up

00:06:41.800 | by whatever the latest fad is.

00:06:44.160 | And to my surprise, there are a lot of other people out there

00:06:46.720 | who share my nerddom for financial history.

00:06:49.960 | Your newsletter that you send out every Sunday,

00:06:52.800 | that's a lot of work.

00:06:54.240 | Is there a cost to that if I wanted to sign up?

00:06:57.280 | How does that work?

00:06:58.040 | No, it's completely free.

00:06:59.600 | If you just go to InvestorAmnesia.com,

00:07:02.440 | there is a section just right there

00:07:04.400 | on the home page for you to enter in your name and email.

00:07:07.560 | And then you're good to go, and you'll

00:07:09.600 | start receiving that newsletter into your inbox every Sunday.

00:07:12.640 | And the pictures that you come up with,

00:07:14.480 | and the charts, and the books that you photograph,

00:07:18.160 | and the pamphlets, and everything

00:07:20.160 | from 100, 200 years ago, it's just amazing where

00:07:23.400 | you get this information from.

00:07:24.880 | It's really a great resource for people

00:07:28.320 | who are interested in financial history, economic history,

00:07:31.800 | market history, and so forth.

00:07:33.680 | One of the things that you make a point of in everything

00:07:37.080 | you do, including your course and your lectures

00:07:40.520 | that you're giving-- you've given lectures even at Yale

00:07:42.720 | University, correct?

00:07:43.680 | I mean, you've been out there quite a bit.

00:07:46.680 | Is that what history is and isn't?

00:07:51.320 | So all of this work that you've done on financial histories,

00:07:54.040 | and manias, and booms, and busts,

00:07:55.840 | and tell us what history is, or what it is and what it isn't.

00:07:59.960 | I mean, how does it help, and how does it not help?

00:08:02.360 | Yeah, so I guess to allude back to my more great ancestor who

00:08:08.160 | discovered the Mayan civilization by backpacking

00:08:10.440 | through the mountains, the analogy I like to use

00:08:12.560 | is history is a compass rather than a roadmap.

00:08:17.920 | I think I do a good job of setting out

00:08:20.080 | what history is and isn't.

00:08:21.400 | But I feel like some people might read either my site

00:08:24.200 | or just financial and economic history in general

00:08:26.480 | and think that, oh, I can see that something similar

00:08:29.800 | happened before, so now I know exactly what's

00:08:33.200 | going to happen in the future.

00:08:34.680 | And so it's not a roadmap where there's previous laid out

00:08:40.040 | paths that you can just follow again,

00:08:41.960 | and you'll end up at the same destination.

00:08:44.240 | There's no clear route for you to take just

00:08:48.160 | by understanding history.

00:08:49.680 | But what you can do with history is

00:08:51.600 | that there are some kind of high level and overarching themes

00:08:55.120 | that repeat themselves over and over throughout history, which

00:08:58.040 | is why I named my site Investor Amnesia because we never

00:09:01.120 | learn as investors.

00:09:02.440 | Some of these same things continually

00:09:04.000 | happen, especially related to investor behavior.

00:09:07.000 | That's why there's always booms and busts and bubbles.

00:09:09.880 | So history as a compass, I think,

00:09:12.200 | is a better analogy because, again, you

00:09:14.720 | won't know exactly how things are going

00:09:16.800 | to play out moving forward.

00:09:18.480 | But by understanding and reading history,

00:09:20.880 | you can see, OK, well, when these kind of forces

00:09:23.680 | have combined throughout centuries in the past,

00:09:27.400 | this has been the general direction

00:09:29.280 | that markets have gone moving forward.

00:09:31.680 | And it just becomes easier to, at the very least,

00:09:34.120 | orient yourself in the right direction

00:09:36.080 | and put things within a broader historical context

00:09:39.280 | and not get maybe swept up by short-term thinking

00:09:42.400 | and getting sidetracked in the latest fad or innovation that

00:09:46.640 | will supposedly revolutionize markets and change society

00:09:50.200 | forever.

00:09:51.080 | Well, let's go ahead and start looking

00:09:52.360 | into some of your research.

00:09:53.480 | And it covers many centuries.

00:09:57.280 | We hear about tulip mania in Holland.

00:10:00.240 | I mean, with your research, where does this all start?

00:10:04.680 | Yeah, so tulip mania is kind of my pet peeve

00:10:07.440 | because it's not actually what 90% of market commentators

00:10:12.600 | think it is.

00:10:13.480 | There's a great book by Ann Goldgar,

00:10:15.880 | who was actually at my alma mater, King's College London,

00:10:18.400 | called Tulip Mania.

00:10:19.680 | But it's not what market pundits think it is.

00:10:22.560 | It's the result of some very shoddy historical sourcing

00:10:26.960 | by everyone's favorite author, Charles Mackay,

00:10:29.960 | in his Madness of Crowds book.

00:10:32.280 | Basically, the quick story is that he

00:10:34.280 | based all of his source work for the tulip mania

00:10:37.520 | section of his book on a German author from the 18th century.

00:10:43.480 | And that German author got everything

00:10:46.440 | that he knew about tulip mania from these pamphlets that

00:10:50.200 | were highly sensationalized and just pure propaganda and false,

00:10:54.320 | in many cases, talking about people committing suicide

00:10:57.760 | after losing all of their money day trading tulips and families

00:11:01.480 | going broke and children starving because their dads

00:11:04.680 | were getting drunk in the tavern trading tulips.

00:11:06.920 | And tulips were going for the cost of houses.

00:11:10.360 | And one tulip was traded 100 times.

00:11:13.120 | But what happened is that that guy, the German writer

00:11:16.200 | from the 18th century, wrote his book stating

00:11:20.080 | all those propaganda sources and satirical pamphlets as fact,

00:11:23.880 | as if they actually occurred.

00:11:25.480 | And then that got passed into Charles Mackay's book.

00:11:27.680 | And now we all use Charles Mackay's book

00:11:29.600 | as saying this is what happened to tulip mania.

00:11:31.520 | But it's all based on satire and propaganda.

00:11:35.760 | So there was a tulip--

00:11:36.880 | Stop, stop.

00:11:37.400 | So are you telling me that it didn't happen?

00:11:39.800 | So there were people who were trading tulips.

00:11:42.680 | But the narrative that, one, that it crashed the Dutch

00:11:46.480 | economy is just false.

00:11:47.720 | It was a very small, siloed section of society.

00:11:53.640 | So Anne Goldgarmi, she spent years in Dutch archives

00:11:56.520 | looking through all of these original sources,

00:11:59.520 | original paper contracts that have carried on or lasted

00:12:03.840 | these few centuries.

00:12:05.320 | And the most she ever found a tulip traded,

00:12:09.400 | like one single tulip, was five times.

00:12:11.360 | But we always hear stories of the same tulip changing hands

00:12:14.000 | hundreds of times.

00:12:15.280 | And the other thing is that the way that they worked,

00:12:17.480 | the contracts was I would agree to buy a tulip from you

00:12:21.800 | in the fall.

00:12:22.720 | And then I would receive the tulip in the spring.

00:12:25.960 | And so we would agree on a price.

00:12:27.400 | But what happened was that a lot of those high prices,

00:12:29.600 | once spring came around, those contracts

00:12:31.400 | were never actually completed or executed.

00:12:34.840 | And so there might have been high prices written somewhere.

00:12:37.920 | But they weren't actually executed.

00:12:40.160 | And so one, the prices weren't nearly as high

00:12:43.440 | as everyone says they are.

00:12:44.480 | Because again, they're being taken

00:12:46.120 | from these satirical and propaganda sources.

00:12:48.720 | But also, a lot of those higher prices

00:12:50.560 | weren't actually ever completed.

00:12:52.360 | So no one actually ever paid those prices.

00:12:54.800 | Tulip mania never really happened.

00:12:56.360 | But it was sort of like a Hollywood movie, in a way.

00:12:59.240 | Yeah.

00:13:00.000 | So let's look at real actual history, real facts.

00:13:03.120 | I mean, where does it begin?

00:13:04.760 | A little bit earlier in Holland, in 1602,

00:13:08.200 | the founding of the East India Company and the stock

00:13:11.640 | market in Amsterdam, the first modern stock market,

00:13:15.760 | was founded in 1609.

00:13:17.880 | And the Amsterdam Stock Exchange is the first modern exchange.

00:13:22.520 | And really, though, for the first good chunk

00:13:25.360 | of its existence, what's interesting to think about

00:13:28.120 | today is that really the only stock that was being traded

00:13:30.560 | was the East India Company.

00:13:32.200 | So it's just bizarre to think about today

00:13:34.560 | if the entire stock exchange was just Apple.

00:13:38.560 | It was really just this one stock.

00:13:40.040 | And then from there, you had the London Stock Exchange

00:13:43.880 | opened in the later 17th century at around the 1690s.

00:13:47.920 | And that was the first tech IPO bubble.

00:13:50.880 | And then from there, you had exchanges pop up

00:13:52.880 | around Europe for the rest of the 18th and 19th centuries.

00:13:56.920 | But the Amsterdam Stock Exchange in the first decade

00:13:59.920 | of the 1600s is where it all begins.

00:14:03.080 | The first big tech bubble occurred

00:14:05.960 | in London in the 1690s.

00:14:08.880 | Can you talk about this tech bubble?

00:14:11.440 | Yeah.

00:14:11.920 | So this is a really bizarre bubble

00:14:15.560 | in that it was prompted by a treasure hunt of all things.

00:14:20.920 | Almost all of financial history, especially

00:14:23.040 | for the 17th and 18th and 19th centuries,

00:14:27.320 | basically follows a pattern of huge war,

00:14:30.040 | government has a lot of debt afterwards,

00:14:32.080 | lowers rates, and then speculation abounds.

00:14:34.600 | And so this was kind of the first major example of that,

00:14:37.320 | where after the Nine Years' War, Britain had all of this debt,

00:14:41.440 | and they lowered rates massively and tried to refinance the debt.

00:14:46.560 | So during the 1690s, there was money to invest,

00:14:50.440 | but people did not want to put it into government assets

00:14:55.600 | because the rates were low.

00:14:57.240 | Then what happened was Sir William Phipps,

00:14:59.960 | he went on a treasure hunt because he

00:15:01.520 | had heard that there were rumors of a sunken Spanish treasure

00:15:05.120 | ship off the coast of, I think it's Honduras,

00:15:07.760 | modern-day Honduras.

00:15:09.520 | And it was essentially the ship that

00:15:11.680 | was going back to Spain to bring all this gold back,

00:15:13.840 | and then it sunk.

00:15:15.040 | And so he went to London and got some--

00:15:19.480 | I called them in the article I wrote,

00:15:21.000 | kind of early venture capital investors.

00:15:22.880 | And he basically got them to form a joint stock

00:15:26.360 | company to finance his voyage, pay for the crew,

00:15:29.760 | the ship, supplies, et cetera.

00:15:32.160 | And then they agreed what the splitting of the profits

00:15:36.240 | would be if he was successful in finding this treasure.

00:15:38.960 | And boy, was he successful.

00:15:40.760 | He eventually found the ship, and they hauled up

00:15:43.560 | 32 tons of treasure, which is almost hard to even picture

00:15:47.680 | how much treasure that is.

00:15:49.080 | And this small group of investors in the joint stock

00:15:51.960 | company that financed it each received a 10,000% return

00:15:56.440 | on their investment.

00:15:57.920 | And so once news of this wildly successful treasure

00:16:01.920 | hunt and investment spread around London,

00:16:05.040 | suddenly there was a boom in these new diving technology

00:16:09.000 | companies, which were basically predicated

00:16:11.720 | on the very simple thesis that they're all

00:16:14.040 | kind of diving apparatuses that would allow a treasure

00:16:16.480 | hunter to breathe longer.

00:16:18.000 | And the thesis was, if you can breathe longer underwater,

00:16:21.200 | you can look for treasure longer and then increase the odds

00:16:24.360 | of you finding treasure.

00:16:25.640 | And so you had this boom in companies

00:16:27.640 | called very straightforward and boring names

00:16:30.040 | like the John Williams Company for Treasure Hunting

00:16:33.680 | or the Williams Apparatus Diving Technology Engine.

00:16:37.880 | And they were all just trying to replicate

00:16:40.120 | the success of the original treasure hunter

00:16:43.720 | and trying to lure early British investors

00:16:47.080 | into these speculative ventures.

00:16:49.280 | And none of them worked out.

00:16:50.480 | There was never any instance of treasure being found again.

00:16:54.320 | Of the companies that were in operation in 1694, by 1697,

00:17:00.040 | 70% of them had been wiped out.

00:17:01.960 | So it was not a good time to be chasing returns

00:17:05.920 | in new technology companies.

00:17:07.680 | Sounds like some of the dot-com companies in the 1990s.

00:17:10.480 | Yeah, exactly.

00:17:11.440 | It's such a great parallel, because we're both in the '90s.

00:17:14.720 | Well, after that then came the next bubble,

00:17:17.000 | which was the South Sea Bubble.

00:17:18.960 | And this did happen, correct?

00:17:20.680 | And could you talk about that?

00:17:21.920 | Yes, yes, this one did happen, very much so.

00:17:24.840 | So first there was the Mississippi Company Bubble

00:17:27.720 | in late 1719 and then going into 1720.

00:17:31.440 | And essentially, both the South Sea Company Bubble

00:17:34.840 | and the Mississippi Company Bubble

00:17:36.800 | were rooted in the same idea.

00:17:39.680 | Based on John Law, who was master of the Mississippi

00:17:42.720 | Company Bubble, he came up with this theory

00:17:44.920 | that while the French government had so much debt

00:17:47.760 | and needed to figure out a way to reduce their debt

00:17:50.240 | burden and lower their debt expenses, their interest

00:17:53.440 | payments, he devised a scheme where he set up a company,

00:17:58.400 | the Mississippi Company, that was

00:18:00.120 | going to have exclusive trading rights with the Mississippi

00:18:03.760 | Territory in the United States.

00:18:06.320 | And the idea was if the French government could convince

00:18:12.000 | its debt holders to exchange their existing government

00:18:16.040 | depositions for equity in this Mississippi Company,

00:18:19.560 | then they could reduce their debt obligations

00:18:22.440 | because debt holders were retiring their debt in exchange

00:18:25.520 | for equity shares in this Mississippi venture.

00:18:28.600 | So you can see how the kind of incentives

00:18:30.760 | quickly became misaligned because the government basically

00:18:34.680 | had to keep figuring out ways to pump up the Mississippi Company

00:18:38.200 | stock price in order to entice investors

00:18:40.920 | to part with their existing government debt positions

00:18:44.520 | and exchange it for equity.

00:18:46.280 | And so there was a mania because they

00:18:48.680 | were doing so much to pump up the price of this company.

00:18:51.400 | Then you had some investors pouring

00:18:53.640 | in to try and get a piece of the Mississippi Company.

00:18:56.280 | And inevitably, it blew up spectacularly.

00:18:58.880 | But what was really funny and kind of a testament to, again,

00:19:01.720 | investor amnesia and how investor psychology is just

00:19:05.000 | so brutal, that the whole time the Mississippi Company

00:19:08.480 | affair was going on, the British were pointing at the French

00:19:11.520 | and saying, these idiots in Paris,

00:19:14.800 | can't they see that this is going to blow up spectacularly

00:19:17.440 | and this is going to fail?

00:19:18.520 | How could they be so stupid to adopt

00:19:20.680 | this system of government debt for equity swaps?

00:19:24.080 | And then they did the exact same thing six months later

00:19:26.600 | with the South Sea Company.

00:19:27.760 | It was literally the same.

00:19:29.240 | Again, the British government tried

00:19:31.240 | to retire its debt by getting government bondholders

00:19:34.600 | to exchange their debt for equity in the South Sea

00:19:37.360 | Company, which was going to have exclusive trading

00:19:39.520 | rights with the new Spanish territories that had won

00:19:43.520 | independence from Spain.

00:19:45.480 | And again, it ended up failing spectacularly.

00:19:49.080 | But it was still the second time in 30 years

00:19:52.520 | theme of government lowering rates

00:19:55.000 | or coming up with some scheme to try and address

00:19:57.640 | the massive debt burden and that fueling speculation,

00:20:01.400 | in this case, with direct government involvement.

00:20:04.280 | But there's also bubbles that occur in everyday common thing,

00:20:06.840 | like beer, for example.

00:20:08.520 | Beer has been around for thousands of years.

00:20:10.480 | And yet, in the late 1880s, there was a beer stock bubble

00:20:16.920 | in Europe.

00:20:18.080 | And so something as common as, say,

00:20:20.280 | beer, which had been around forever,

00:20:22.640 | even that can create a bubble.

00:20:24.680 | Yeah.

00:20:25.320 | For the brewery stock bubble, it was set off by the Guinness

00:20:29.640 | IPO.

00:20:30.920 | It formed as a joint stock company

00:20:32.560 | and began issuing shares in 1886.

00:20:35.880 | And that was a really speculative mania

00:20:38.880 | when that IPO happened.

00:20:40.240 | Because in those days, obviously, you

00:20:41.840 | had to go hand-submit your order for shares.

00:20:45.120 | And the day that the Guinness company IPO-ed,

00:20:49.840 | the scene outside Barings Bank, who was underwriting the IPO,

00:20:53.880 | were just pure chaos.

00:20:55.600 | And I think the IPO, the shares were oversubscribed something

00:20:58.120 | like by 30 times.

00:20:59.400 | And there was such a mad sea of investors

00:21:03.320 | rushing to submit their order forms

00:21:06.680 | that Barings Bank had to order in a special police

00:21:10.280 | unit to barricade and block the doors.

00:21:13.120 | And then what the investors did, they

00:21:14.680 | began tying their order applications,

00:21:18.280 | like their buy orders, to rocks and hurling the rocks

00:21:22.040 | through the windows of Barings Bank

00:21:23.560 | in attempts to get their orders filled

00:21:25.920 | so that they can invest in the Guinness company.

00:21:28.400 | So that kind of set off this whole boom in brewery stocks

00:21:31.880 | as a bunch of other domestic brewing companies

00:21:34.720 | started to issue shares as well and take

00:21:36.760 | advantage of the speculation.

00:21:39.760 | Warren Buffett once called it the three I's,

00:21:42.320 | which is the innovator, then the imitators, and then the idiot.

00:21:45.720 | And a lot of bubbles in history follow that exact progression.

00:21:49.400 | After beer came bicycles.

00:21:52.520 | Coinciding with the brewery bubble of the 1890s,

00:21:55.840 | there was actually a shortened and more intense bubble

00:21:59.480 | that was running alongside it in the form

00:22:02.400 | of a different transportation mania

00:22:04.720 | than we would recognize today with the electric vehicle

00:22:08.240 | speculation going on.

00:22:09.440 | It's actually the bicycle that was really captivating

00:22:12.640 | investors back in the 1890s.

00:22:14.920 | And what was happening there was before the kind

00:22:18.400 | of modern bicycle frame we would recognize now,

00:22:21.360 | that kind of diamond frame, there

00:22:23.040 | were the penny farthings, which if people don't know by name,

00:22:26.320 | those are the bicycles that you see in old movies

00:22:29.600 | where there's the massive front tire and then

00:22:31.800 | the tiny back tire.

00:22:34.520 | And essentially what happened in the 1890s

00:22:36.920 | was there was few technological innovations

00:22:39.880 | in the bicycle industry that led to the creation

00:22:43.840 | of the modern frame we recognize now

00:22:45.960 | with the two equally sized tires.

00:22:47.720 | And basically exactly what the bicycle frame looks like today

00:22:50.680 | is what it looked like 100 plus years ago.

00:22:53.280 | And there were some innovations around the tires,

00:22:56.000 | the welding of tubes to create the frame,

00:23:00.320 | and there were some innovations in the ball bearings

00:23:03.240 | that were used.

00:23:03.840 | The reality was that bicycles kind of took over the UK

00:23:07.080 | population by storm and really had

00:23:09.440 | some far reaching implications for society

00:23:12.520 | outside of financial markets in terms of, believe it or not,

00:23:15.560 | progressing women's rights.

00:23:17.120 | Because females were buying the bicycles as well,

00:23:19.640 | but they at that time were wearing very formal clothing.

00:23:22.280 | It actually modernized women's wear

00:23:24.840 | because they couldn't ride a bicycle while wearing

00:23:27.000 | those huge like fluffy dresses with all the frills

00:23:29.920 | because they'd get caught in the spokes, et cetera.

00:23:32.200 | But for financial markets, as people around the UK

00:23:36.640 | started going crazy about the bicycle and buying them

00:23:41.040 | en masse, the returns for the initial bicycle companies

00:23:44.560 | were fantastic.

00:23:45.880 | And as usually happens in history,

00:23:47.640 | that led to an explosion in copycat companies

00:23:51.360 | starting up trying to capitalize on the latest fad.

00:23:55.680 | And so you ended up having in 2 and 1/2 years,

00:23:59.200 | 671 bicycle companies IPO, which is just absolutely insane.

00:24:07.520 | I think in the fourth quarter of 1896,

00:24:10.400 | there was 156 bicycle companies that went public.

00:24:14.720 | Let's get into another bubble.

00:24:15.960 | And this happened in the US also.

00:24:17.640 | And this is the railway bubble.

00:24:20.720 | I think it was Jack Kenneth Galbraith who

00:24:22.880 | said that nothing was more fascinating than watching

00:24:28.160 | men quickly forget the previous railway mania

00:24:32.040 | and go like head first into the next one.

00:24:33.920 | Because during the 19th century, there

00:24:36.120 | were three railway manias in the US and the UK.

00:24:39.160 | The first one was in the UK in the 1840s.

00:24:44.160 | And that was its own spectacular mania and bust.

00:24:47.000 | And then in the US, there was one in the 1850s

00:24:51.080 | and one in the 1870s.

00:24:53.640 | And what's interesting is that the first railway mania

00:24:56.120 | in the US was less catastrophic and not even widely recognized

00:25:01.200 | in the historical literature.

00:25:02.480 | Most people just focus on the second railway mania.

00:25:04.680 | But the first one was almost as big.

00:25:07.840 | And it was not as spectacular or bust

00:25:10.840 | as it was for the second railway mania.

00:25:13.280 | And there was a lot more money made in the first railway

00:25:16.800 | mania without as much of the catastrophic losses.

00:25:20.240 | But in both periods, from 1865 to 1873,

00:25:24.840 | there was 30,000 miles of railway track laid.

00:25:27.880 | And by the late 1890s, especially

00:25:31.440 | in the panic of 1893 when the financial markets contracted

00:25:35.600 | and credit got tight, there was a massive wave

00:25:38.760 | of bankruptcies for these railroad companies

00:25:41.280 | that suddenly could not get financing

00:25:44.160 | for their operations any longer.

00:25:45.600 | And there was spectacular bust.

00:25:47.080 | But one of the interesting points about railway mania,

00:25:49.800 | even though there was this spectacular boom and bust,

00:25:52.840 | there was actually a benefit to society afterwards

00:25:55.920 | because during that speculative period,

00:25:58.960 | we laid the groundwork for the railway

00:26:01.680 | system in the United States.

00:26:03.120 | So even though speculators and other financiers

00:26:06.760 | might have been left holding the bag,

00:26:09.320 | afterwards, they still benefited society

00:26:12.240 | because we got to benefit from the railway

00:26:15.000 | track that had been laid.

00:26:16.440 | Now, that's an interesting point.

00:26:17.880 | And you bring this up in one of your lectures,

00:26:20.960 | is that a disaster for investors is often

00:26:24.320 | a real positive for society and even the economy.

00:26:28.040 | But people lose money in all of these manias that take place.

00:26:32.200 | There's so much capital being thrown at a particular industry

00:26:35.880 | at one time that it causes innovation, which

00:26:38.040 | is good for society.

00:26:39.120 | But a lot of people lose money.

00:26:40.560 | I want to read you a quote from Warren Buffett.

00:26:44.560 | And Warren Buffett is famous for losing money

00:26:48.200 | in the airline industry.

00:26:50.200 | And this is what he said in his 2007 Berkshire Hathaway

00:26:54.680 | shareholder letter.

00:26:56.640 | "The worst sort of business is one

00:26:59.200 | that grows rapidly, requires significant capital

00:27:03.120 | to engender the growth, and then earns little or no money.

00:27:07.720 | Think airlines.

00:27:09.240 | Here, a durable competitive advantage

00:27:12.240 | has proven elusive ever since the days of the Wright

00:27:15.640 | brothers.

00:27:16.240 | Indeed, if a farsighted capitalist

00:27:19.320 | had been present at Kitty Hawk, he

00:27:21.520 | would have done his successors a huge favor

00:27:24.080 | by shooting Orville down."

00:27:27.320 | And he's right.

00:27:28.720 | I mean, look at how airlines have really

00:27:30.640 | benefited society and benefited the economy

00:27:33.200 | and have been a real positive for all of us

00:27:35.160 | to get all over the world.

00:27:36.440 | And yet, in aggregate, I don't think

00:27:38.600 | any money has ever been made in the airline industry.

00:27:42.480 | It's a great quote.

00:27:43.400 | Perfect way of illustrating the point we were just

00:27:45.480 | talking about, where the speculators and Wall Street

00:27:48.480 | investors might be the ones that suffer in the crash,

00:27:51.200 | but society as a whole, outside of that small group,

00:27:54.160 | speculating in the industry, benefit from the aftermath.

00:27:58.920 | It's like in the tech bubble, when most companies went bust

00:28:03.280 | in the tech sector, there was still

00:28:04.920 | the groundwork laid with fiber optic cables, et cetera,

00:28:08.120 | that later was built upon.

00:28:10.120 | The companies that survived and new companies

00:28:13.400 | used that groundwork to build more durable companies

00:28:17.520 | on top of it.

00:28:18.440 | Right place, wrong time.

00:28:20.200 | Yeah, the fiber optic--

00:28:21.640 | we've got WorldCom, Exo Communications.

00:28:23.760 | I mean, the list goes on and on of these companies

00:28:25.800 | that are no longer around today.

00:28:27.120 | But they built out the fiber optic network

00:28:29.920 | that we currently have, that we all run our computers on.

00:28:32.800 | And we all can talk to each other.

00:28:34.240 | In fact, I'm talking to you now over fiber optic cable

00:28:37.200 | because I'm using voice over IP.

00:28:39.480 | Sorry you lost money, but it's an advantage to everybody

00:28:42.360 | that speculators did do this.

00:28:44.360 | And we could see it over and over.

00:28:45.920 | We probably see it right now in many different industries.

00:28:48.280 | We just sit back and we look at it.

00:28:49.760 | I mean, the space industry, right?

00:28:51.200 | I mean, this is like a big thing now.

00:28:53.000 | All these very wealthy people are putting money

00:28:56.120 | into the space industry, where--

00:28:58.040 | I mean, they can't all be profitable in the long term.

00:29:00.520 | But in the end, it's going to benefit everybody.

00:29:03.160 | It's the phoenixes that rise from the ashes.

00:29:05.280 | There's going to be the wipeout.

00:29:06.560 | But the companies that emerge and are still around

00:29:11.280 | are usually the ones that go on to be the dominant players

00:29:14.800 | in the industry.

00:29:15.520 | So at this point, I mean, I don't know anywhere near enough

00:29:18.760 | about space exploration to go into any of the companies.

00:29:22.080 | But like you said, you can imagine

00:29:24.040 | that they're not all going to be here in 15 years.

00:29:26.440 | But there will be some that remain

00:29:28.680 | as the dominant players that are probably already

00:29:31.440 | in operation today.

00:29:33.040 | There is also innovation when it comes to investing.

00:29:37.560 | First Mutual Fund was created back in 1774,

00:29:41.800 | where the creators of that fund realized

00:29:45.640 | that you need diversification.

00:29:47.680 | So they innovated products that looked like mutual funds

00:29:53.680 | back then.

00:29:54.200 | I know this is another part of your research.

00:29:57.000 | If you could talk about sort of the innovations

00:29:59.840 | to allow commoners, if you will, to invest in these companies,

00:30:04.720 | but do it in a diversified way.

00:30:07.520 | This first mutual fund in 1774 also came out of a crisis.

00:30:13.520 | So basically, what happened was there

00:30:15.040 | was a Dutch broker that was named Abraham van Ketwich.

00:30:19.800 | After the summer of 1773, he saw the East India Company,

00:30:27.080 | their share prices tanked.

00:30:28.760 | And there was a lot of financial ruin in London.

00:30:32.680 | But there were also a number of large Amsterdam

00:30:35.640 | financial institutions that have been heavily exposed

00:30:38.680 | to the East India Company.

00:30:40.280 | And so when the share prices tanked,

00:30:42.320 | it almost wiped out most of the Dutch major banking

00:30:46.880 | institutions.

00:30:48.000 | And people realized, oh, maybe it's not a good idea

00:30:51.760 | to just have everything riding on the price

00:30:54.760 | of one single stock.

00:30:56.400 | And so while the wealthy elite might

00:30:59.480 | have had the ability to buy and sell shares of other companies

00:31:03.640 | and so they could have a diversified portfolio,

00:31:05.960 | the average small investor didn't have a way in that time

00:31:09.600 | period to access the market without buying

00:31:12.720 | all the individual shares himself, which

00:31:15.000 | put that kind of access out of reach

00:31:17.240 | for many small investors.

00:31:19.440 | And so after the experience of watching this one stock almost

00:31:24.120 | take out the entire financial industry in Amsterdam,

00:31:28.000 | Abraham van Ketwich decided that he

00:31:30.120 | was going to come up with a fund that

00:31:33.320 | would be able to offer access to the broader

00:31:37.160 | market for smaller individuals who could just

00:31:40.480 | buy shares of the fund rather than buying the underlying

00:31:43.240 | shares individually.

00:31:44.680 | And so I'm not going to try and pronounce

00:31:46.960 | the Dutch name of the fund.

00:31:48.720 | But it translates to Unity Creates Strength,

00:31:52.000 | which I think is a fantastic name for the kind

00:31:54.600 | of first diversified mutual fund.

00:31:56.720 | Because again, unity, diversification,

00:31:58.800 | creates strength.

00:32:00.160 | And so what the fund was, it was, I believe,

00:32:04.080 | roughly 50 bonds split across 10 different sectors of bonds.

00:32:09.680 | So there was some plantation loans,

00:32:11.600 | which were kind of interesting because they're almost

00:32:13.800 | an early mortgage-backed security.

00:32:16.400 | But there are mortgage loans, kind of canal and turnpike

00:32:19.240 | bonds, and then various kind of local government bonds.

00:32:23.040 | But what was interesting is that it was equally

00:32:25.680 | weighted across all of these 10 categories.

00:32:28.960 | And I think specifically in the prospectus,

00:32:31.400 | it mentioned that, one, it said we

00:32:33.800 | will hold these investments as proportionate as possible

00:32:37.880 | to maximize the diversification benefits.

00:32:41.160 | Or we will not let any single position be more than, I think,

00:32:43.840 | 3% of the portfolio.

00:32:46.160 | But what was really crazy is, well, two things.

00:32:48.920 | The first is that it was very reminiscent

00:32:52.040 | of a modern kind of passive bond fund in the sense

00:32:54.800 | that even back then, the fees were relatively low,

00:32:57.880 | even by modern standards.

00:32:59.240 | It worked out to about 20 basis points a year, which, I mean,

00:33:03.000 | now you can get, probably for two basis points,

00:33:05.760 | a passive bond fund.

00:33:07.120 | But still, 20 basis points is fairly low.

00:33:09.800 | That's 0.2%.

00:33:11.160 | Yeah.

00:33:13.240 | But the craziest part about this fund

00:33:15.360 | was they recognized that active management--

00:33:19.440 | and again, this is all in the wake of watching banks

00:33:22.760 | get almost wiped out by one stock.

00:33:24.640 | So in response to that, this fund

00:33:26.640 | was heavily focused on no kind of active stock picking,

00:33:30.240 | or in this case, bond picking, and no real human element.

00:33:33.440 | And so to reduce the ability for the portfolio managers

00:33:37.800 | to make rash decisions, they bought the underlying shares

00:33:42.600 | or the bond certificates.

00:33:44.000 | And once they held these certificates

00:33:46.720 | to prevent themselves from being able to trade,

00:33:49.080 | they locked all of the certificates

00:33:51.160 | into an iron chest that had three locks.

00:33:53.720 | And there were three portfolio managers.

00:33:55.880 | So if there was ever a time where one of them

00:33:57.920 | wanted to trade, they would not be able to get access to it.

00:34:01.200 | And it was only if all three portfolio managers

00:34:03.800 | came with their special keys to unlock this iron chest

00:34:06.560 | that they would be able to make active investment decisions.

00:34:09.680 | So basically, you were talking about here

00:34:11.720 | is investment management by committee, which

00:34:14.360 | is quite popular nowadays.

00:34:16.680 | Yes, exactly.

00:34:17.840 | It's kind of a team exercise.

00:34:20.320 | And it was interesting.

00:34:22.000 | But it is well and truly, because it

00:34:23.600 | is low cost, diversified, and passive.

00:34:26.520 | It's really the first passive bond index fund.

00:34:29.920 | And how did it do?

00:34:30.880 | Was it accepted?

00:34:31.800 | This is a really novel innovation in 1774.

00:34:36.200 | Yeah, unfortunately, it didn't actually do that well.

00:34:39.360 | But it was a huge step forward for the industry

00:34:43.120 | and laid the foundation for future funds.

00:34:46.320 | What is kind of interesting is that even though he started

00:34:48.920 | with this passive bond fund, his next fund, Abraham Van Ketwich,

00:34:54.280 | was in 1779.

00:34:56.480 | This one was the world's first value fund.

00:34:59.200 | Because while the previous prospectus

00:35:01.520 | had been talking about how it was strictly

00:35:03.960 | going to be kind of passive, equally weighted, et cetera,

00:35:07.200 | in this prospectus for the 1779 fund,

00:35:09.760 | it explicitly stated that the fund would seek securities

00:35:12.920 | that you were able to buy below its intrinsic value.

00:35:16.480 | So it was explicitly stating that the fund would

00:35:20.160 | have a value bias.

00:35:21.480 | So this guy was really quite the innovator.

00:35:24.200 | But it's funny to me that he moved

00:35:26.040 | from passive to active in a five-year kind of time span.

00:35:30.280 | So quantitative analysis really began in 1779.

00:35:34.920 | Yeah, I guess so.

00:35:36.280 | Interesting.

00:35:38.040 | Let's fast forward to 1929, where you have isolated--

00:35:43.000 | this is the next innovation in mutual funds.

00:35:46.720 | Yeah, so in the same way that I described,

00:35:50.520 | where in the crisis of 1773, that

00:35:54.840 | spawned the kind of first passive bond fund in 1774.

00:35:59.520 | After the 1929 crash, there were a large group

00:36:04.200 | of investors who became disillusioned

00:36:06.800 | with the actively managed investment trusts

00:36:09.480 | that they had been putting their money in.

00:36:11.480 | Because in their minds, the reason

00:36:13.760 | that they were paying these managers the high fees

00:36:17.400 | was because they expected their expertise to pay off

00:36:21.320 | during a crash like 1929 and outperform the market

00:36:24.920 | and save them money.

00:36:26.480 | But in reality, most of these trusts

00:36:28.320 | were highly levered and did the exact opposite.

00:36:31.480 | So a lot of people lost their money

00:36:33.280 | despite paying these active fees.

00:36:34.880 | And so there was a growing frustration and disillusion

00:36:39.000 | with the actively managed trust industry.

00:36:41.840 | And it was, again, in that environment

00:36:43.880 | where the next iteration of passive funds

00:36:46.600 | was born in the form of fixed trusts, which

00:36:50.360 | is aptly named because what the fixed trust meant

00:36:53.640 | was once they launched the fund, they

00:36:56.640 | were beholden to those specific investments

00:36:59.000 | and were not able to make active decisions.

00:37:01.480 | And this was very popular because of the experience

00:37:04.920 | that investors had with active funds in the '29 crash.

00:37:08.320 | And so quickly, you had an explosion in these trusts

00:37:12.240 | as both asset managers realized that this was the movement

00:37:16.640 | that they should adopt.

00:37:17.560 | And so they started pumping out these trusts for people

00:37:20.720 | to put their money in.

00:37:22.440 | But like I mentioned with the progression of Abraham

00:37:26.320 | Van Ketwich from passive to active, what was interesting

00:37:29.320 | is that the fixed trusts quickly became

00:37:33.360 | what they called fixity trusts, where

00:37:36.280 | the line between active and passive

00:37:39.040 | started to get blurred a bit.

00:37:40.840 | Because what would happen is if you put out your fixed trust

00:37:45.800 | fund in 1930, but there was 50 securities,

00:37:50.040 | and then some of them ended up getting bought out

00:37:52.280 | or going bankrupt, et cetera, you still

00:37:54.640 | said that you're going to be invested in 50,

00:37:56.480 | so they had to be replaced.

00:37:57.840 | And so how do you replace them?

00:38:00.000 | Because you said you were going to be fixed and beholden

00:38:02.600 | to those set securities.

00:38:04.400 | And so the management teams started coming up

00:38:06.960 | with early factors for deciding what securities would

00:38:11.880 | be eligible for replacement.

00:38:13.760 | And from there, you had funds that

00:38:16.760 | were then using those replacement rules

00:38:19.480 | as their guiding rules for investment.

00:38:21.840 | So there was a fund that said if any security in our portfolio

00:38:26.600 | drops below their five-year earnings average,

00:38:29.400 | then it will be sold out of the portfolio.

00:38:32.040 | So right there, it's kind of like a earnings-based metric.

00:38:36.720 | And so it's interesting to see this, again,

00:38:38.760 | passive to active transition.

00:38:41.240 | But they were really the first, and it's

00:38:43.400 | so little talked about, which I find interesting,

00:38:46.400 | because it's not that long ago, and it's

00:38:48.400 | around one of the most famous crashes in US history.

00:38:51.080 | But they were really the first kind of modern index funds.

00:38:55.320 | And another bizarre example from one of these passive trusts

00:38:58.680 | was, in general, these trusts had a more set timeline, which

00:39:02.240 | is also interesting.

00:39:03.080 | So the fund would exist, but it had

00:39:05.640 | an end date of, say, 30 years out.

00:39:07.640 | So you couldn't necessarily hold it for 50 years.

00:39:10.120 | There was an end date.

00:39:11.440 | And you could roll it into the next fixed trust

00:39:14.160 | that they offered.

00:39:14.880 | But one trust and a couple of others

00:39:16.920 | followed suit, started saying, we're

00:39:19.280 | actually going to break up this fixed trust earlier,

00:39:22.520 | but we'll give you the option to roll over your money

00:39:24.960 | into one of our actively managed trusts with higher fees.

00:39:27.720 | And so you can see that the financial services

00:39:30.960 | industry wasted no time misaligning incentives

00:39:33.800 | with the smaller retail investors

00:39:36.600 | and trying to push them into higher fee funds.

00:39:40.200 | But the modern mutual fund, meaning the opened-end fund

00:39:43.560 | where the manager could just buy and sell at will,

00:39:47.200 | I believe the first one was created in 19--

00:39:51.240 | 1924.

00:39:52.560 | '24, right.

00:39:53.520 | Massachusetts Mutual Trust, I believe it was.

00:39:56.720 | And this was a little bit different

00:39:58.680 | in that it wasn't fixed.

00:40:00.320 | The managers had the ability to buy and sell within the trust.

00:40:04.120 | And then that became the popular vehicle

00:40:06.920 | for doing mutual funds for--

00:40:08.880 | well, all the way up until the ETF was innovated in 1993,

00:40:14.920 | at least in the United States, although the Canadians will

00:40:17.420 | argue that they had the first ETF out earlier than that.

00:40:22.080 | Before I forget, one interesting point left on this fixed trust

00:40:25.520 | is that Jason Zweig wrote an article.

00:40:27.640 | One of those fixed trusts, I think from 1935,

00:40:30.520 | is actually still in existence.

00:40:32.600 | If you just Google Jason Zweig fixed trust,

00:40:34.440 | I'm sure you'll find the article.

00:40:35.600 | But it's interesting.

00:40:36.440 | We can kind of see out of the original 50 stocks

00:40:40.240 | or whatever the trust chose in 1935, what's

00:40:44.080 | happened to those securities and how did they

00:40:46.520 | perform in the ensuing almost 100 years.

00:40:50.760 | In my view, the next big innovation

00:40:52.840 | occurred in the 1970s.

00:40:54.480 | And that was the innovation of index funds.

00:40:58.200 | And that happened for a lot of reasons.

00:41:01.200 | But I think there was a change in the securities industry that

00:41:05.240 | brought the brokerage firms a little bit to their knees

00:41:08.680 | and actually created discount brokers.

00:41:11.000 | That was the elimination, basically by law,

00:41:13.320 | of fixed commission rates, where you

00:41:15.400 | didn't have to pay an arm and a leg to buy shares of stock.

00:41:18.600 | So now, when that was eliminated,

00:41:20.640 | it gave fund companies the ability

00:41:22.960 | to have massive diversification in their mutual funds.

00:41:25.520 | And that really helped to create the first index fund, which

00:41:29.080 | Vanguard and Jack Bogle created.

00:41:31.320 | I did a podcast, by the way, with Jack Bogle.

00:41:33.800 | The very first podcast I did, Bogle Heads On Investment.

00:41:36.720 | Oh, really?

00:41:37.640 | Yeah.

00:41:38.120 | Starting strong.

00:41:39.040 | In fact, it was a few months before he passed away.

00:41:41.160 | So it was one of the last things he actually did publicly.

00:41:43.600 | And in there, that podcast, podcast number one

00:41:46.960 | of Bogle Heads On Investment, we go

00:41:48.440 | through that history of the creation of the first index

00:41:52.960 | fund and how it all came about.

00:41:54.240 | And it was really fascinating to listen to him talk about it.

00:41:57.440 | There's some stories there that you just wouldn't believe.

00:41:59.840 | It almost didn't happen.

00:42:01.400 | It's like a miracle that the first index fund actually

00:42:04.560 | happened.

00:42:05.600 | But let's go on to a different topic.

00:42:07.840 | And that is, in all of your studies of bubbles and busts,

00:42:14.600 | let's put together a laundry list of things

00:42:18.840 | that you have found help create a bubble

00:42:23.240 | or get a bubble going in anything-- beer, bicycles,

00:42:28.440 | railroads, whatever it is.

00:42:31.000 | What is the making of a bubble?

00:42:34.280 | So I'm going to divert your question to an excellent book

00:42:39.160 | by John Turner and William Quinn that just came out earlier

00:42:42.800 | this year-- or last year, I guess, at this point--

00:42:44.880 | called Boom and Bust.

00:42:46.960 | And I really like the framework that they put together.

00:42:49.720 | They used the fire triangle, which

00:42:52.920 | is typically the three sides of the fire triangle

00:42:55.880 | are oxygen, fuel, and heat.

00:42:58.120 | And then there's obviously the initial spark

00:43:00.200 | that sets it all off.

00:43:01.360 | But with those three sides of the triangle, oxygen, fuel,

00:43:04.760 | and heat, that's what keeps the fire going and spreading.

00:43:07.360 | But if you lose one of those, then the fire goes out.

00:43:10.800 | And so they replaced those sides of the triangle

00:43:14.280 | and made them more applicable to finance,

00:43:17.120 | where you have the first side of the bubble triangle is oxygen.

00:43:21.680 | And in this case, for finance, it's marketability.

00:43:25.360 | And by that, they don't mean marketing and advertising,

00:43:29.640 | but the ability to easily buy and sell shares in an asset.

00:43:33.840 | You mean like the securitization,

00:43:35.320 | like securitizing something.

00:43:37.240 | Exactly.

00:43:38.200 | And so after that, you then--

00:43:40.440 | I guess the grease that keeps it going

00:43:42.360 | or the fuel, which is money and credit.

00:43:44.920 | So in this case, low interest rates, access to cheap money

00:43:48.280 | and cheap credit, which helps sustain a boom

00:43:51.880 | and creates a bubble.

00:43:53.520 | And then on top of that, you have

00:43:56.560 | the heat, which keeps everything going,

00:43:58.240 | which is the speculation.

00:43:59.680 | So in addition to all this, you have

00:44:01.640 | to have the people that are actually going out

00:44:03.640 | and speculating in this and keeping it going.

00:44:06.240 | And so those three sides are what keep the bubble going.

00:44:10.080 | But Spark, that initially sets it off,

00:44:12.840 | these two authors posit that it's usually

00:44:16.000 | politics and/or technology that initiates the bubble.

00:44:20.000 | And so some examples from that in history,

00:44:22.200 | the technology ones are obvious.

00:44:23.880 | I mean, the tech bubble is some of the ones

00:44:25.360 | we've talked about already with the treasure hunting

00:44:28.000 | bubble and bicycle mania, et cetera.

00:44:30.120 | Those are technology-based.

00:44:31.880 | But then in terms of the government's involvement,

00:44:35.440 | the South Sea bubble, which we touched upon,

00:44:37.960 | is another great example where that was the government

00:44:41.000 | stepping in and really creating a bubble out of nothing

00:44:43.680 | by instituting this ridiculous government debt for equity

00:44:47.640 | swap, where you could exchange your government bond

00:44:51.160 | holdings for shares in a government-backed public equity

00:44:55.960 | venture in the form of the South Sea Company.

00:44:58.760 | So obviously, this doesn't apply to every bubble that's occurred.

00:45:02.080 | But I think it's a useful framework

00:45:03.640 | for figuring out when and why bubbles occur,

00:45:07.720 | because in almost all of them, you have these three sides.

00:45:11.280 | And the original Spark is usually

00:45:13.160 | related to politics or technology.

00:45:16.520 | So we have the oxygen, which is the securitization,

00:45:19.840 | if you will, I mean, the availability of the asset

00:45:23.640 | that eventually becomes a bubble,

00:45:25.080 | whether it's through the IPO market or some new innovation

00:45:28.440 | or in the financial industry.

00:45:30.440 | But you actually have the product

00:45:33.120 | that is going to become the bubble, the marketability

00:45:36.280 | of it, as you say.

00:45:37.040 | And then you've got the willingness of creditors

00:45:41.080 | to loan money on it or give you money

00:45:44.280 | to go out and buy this thing, access to cheap money,

00:45:47.720 | as you said.

00:45:48.240 | People would borrow to buy these things.

00:45:50.960 | And then finally, you've got interest,

00:45:53.160 | which is the speculation.

00:45:54.400 | I imagine that the speculation or the heat, if you will,

00:45:57.320 | is it starts out with a spark.

00:45:59.080 | I mean, somebody must make a lot of money

00:46:02.000 | doing one of these things.

00:46:03.600 | And then that's, in many ways, the spark

00:46:05.600 | that gets everybody going.

00:46:06.960 | Like, I recall we were talking about Guinness beer.

00:46:09.800 | Like, that was the first beer IPO that came out.

00:46:13.120 | And it was just--

00:46:14.440 | everybody was familiar with it.

00:46:16.360 | Now it was available.

00:46:17.360 | And people started making money right away.

00:46:19.160 | And that was a spark that caused the beer bubble.

00:46:22.040 | Yeah, exactly.

00:46:23.160 | And I think last year, actually, there

00:46:24.680 | was a great example of that, where I personally

00:46:27.880 | don't think that it was a coincidence

00:46:29.480 | that the kind of explosion in electric vehicle hype

00:46:33.400 | coincided with Tesla's original really impressive run

00:46:38.680 | earlier in the year, where by that point,

00:46:41.080 | I think by the time Nikola went public via its SPAC,

00:46:45.200 | I want to say it was either May 4 or June 4.

00:46:48.040 | Tesla was already up like a couple hundred percent

00:46:50.480 | for the year.

00:46:51.360 | And then coupled with stimulus checks and people

00:46:53.360 | working from home, there was already

00:46:54.860 | that kind of speculative presence.

00:46:57.000 | And with a name brand like Tesla and younger investors

00:47:01.080 | coming into the market and seeing the returns there,

00:47:04.480 | then the kind of natural progression

00:47:06.200 | was, where's the next Tesla?

00:47:08.400 | And then, ironically--

00:47:10.160 | The imitators, basically.

00:47:11.200 | --people turned to Tesla, which shares the name

00:47:14.000 | with the original company Tesla.

00:47:16.000 | It's just the guy's first name, Nikola.

00:47:18.520 | Right, there you go.

00:47:19.360 | And that ran up.

00:47:21.360 | However, I think it was up 80% at one point.

00:47:23.920 | And the company's first quarterly earnings

00:47:27.040 | had revenues of $36,000.

00:47:30.040 | And that was all derived from installing solar panels

00:47:34.120 | on the chairman's house.

00:47:35.240 | So there was no actual real product or earnings,

00:47:40.040 | let alone the meager revenues that were not even related

00:47:43.160 | to the company's main operations,

00:47:45.600 | but let alone the stock soared.

00:47:47.700 | And there are still a ton of electric vehicle companies

00:47:51.000 | going public via SPAC or announcing deals

00:47:53.920 | and having astronomical share price returns.

00:47:59.000 | Well, we're going to talk about special purpose acquisition

00:48:01.880 | companies in a minute, which are SPACs.

00:48:04.160 | But you hit on something, though,

00:48:05.760 | and it's something that Warren Buffett said.

00:48:07.640 | You start out with innovation, and then you go to imitation.

00:48:11.680 | And then the next step is idiocy.

00:48:14.120 | Is that what he said?

00:48:15.280 | Yeah.

00:48:17.120 | And here's where things get crazy.

00:48:19.080 | I was just reading yesterday about a special purpose

00:48:24.520 | acquisition company.

00:48:25.440 | And this came public.

00:48:26.640 | This is actual public.

00:48:29.040 | They raised $69 million.

00:48:30.920 | The ticker on this is J-A-A-C. So phonetically,

00:48:35.840 | it's Juliet Alpha Alpha Charlie.

00:48:39.160 | And it's called Just Another Acquisition Company.

00:48:43.060 | What's the name of the company?

00:48:45.240 | Management wrote in an S-1 that Just Another Acquisition

00:48:49.400 | Company may pursue an initial business combination

00:48:53.080 | target in any business, industry,

00:48:56.200 | or geographical location.

00:48:58.120 | This is the company.

00:48:59.720 | And this came public.

00:49:01.360 | It's like the famous story from the South Sea Bubble,

00:49:04.080 | where there was a prospectus for a company,

00:49:06.200 | but no one is to know what it is.

00:49:08.520 | That's right.

00:49:10.840 | Anyway, so again, getting back to Buffett,

00:49:13.720 | there's innovation, there's imitation,

00:49:16.000 | and then there's idiocy.

00:49:17.280 | And I have to look at that and say,

00:49:18.760 | this is kind of like pure idiocy.

00:49:20.960 | Who am I to know?

00:49:21.840 | Well, the problem is there are too many examples of idiocy

00:49:24.280 | with these facts.

00:49:25.400 | It's hard to pinpoint who the exact idiot is.

00:49:28.400 | Let's get into then the bust.

00:49:30.200 | So we've talked about what creates the bubble.

00:49:32.960 | What then creates the bust?

00:49:36.160 | So there are a lot of different ways

00:49:38.760 | that the bubble gets pricked throughout history.

00:49:41.200 | But again, in this boom and bust framework,

00:49:43.680 | the authors argue that by removing one of those sides,

00:49:47.560 | then that leads to the collapse of a bubble

00:49:49.960 | because you need all three of those to sustain it.

00:49:52.880 | And so in terms of cheap money and credit,

00:49:55.560 | if rates are suddenly hiked unexpectedly

00:49:58.400 | or maybe at a much faster and higher rate than expected,

00:50:01.960 | that can help prick the bubble because financing dries up

00:50:05.120 | and leads to a credit crunch.

00:50:07.800 | If, for whatever reason, speculation dies down,

00:50:11.080 | then there's the just feedback loop

00:50:13.280 | where those speculative stocks will drop in price

00:50:16.880 | and they'll continue to drop in price

00:50:18.680 | because then the people still speculating

00:50:20.640 | will be less inclined to keep buying it

00:50:23.360 | because it's going down.

00:50:24.960 | But then also with the marketability,

00:50:27.000 | if something happens and shares suddenly aren't as liquid

00:50:29.800 | as they were previously,

00:50:31.320 | that can lead to problems and bank runs

00:50:33.760 | if people suddenly aren't able to as easily buy

00:50:36.160 | and sell their investments.

00:50:38.480 | - I'll add a few things here under

00:50:40.840 | when people are not able to easily buy and sell investments.

00:50:43.440 | I mean, sometimes the government will get involved

00:50:45.680 | and they'll clamp down on margin,

00:50:48.400 | they'll clamp down on short selling,

00:50:50.960 | they'll do things that will cause the market to dry up

00:50:55.680 | and that can create catalyst for the bust.

00:51:00.680 | And then another thing, by the way,

00:51:02.400 | before we even get to the government stepped in,

00:51:04.560 | it seems like a lot of times fraud

00:51:07.520 | tends to get on top. - Yeah, yeah.

00:51:09.040 | So that's a great one that I usually mention.

00:51:13.040 | And going back to some of the lessons

00:51:16.120 | from the online course I put together,

00:51:18.880 | one of the lectures was done by Jim Chanos,

00:51:22.240 | the short seller.

00:51:23.560 | And he has what I find fascinating kind of framework

00:51:28.000 | for looking at fraud and the market cycle,

00:51:30.680 | where he has said that the fraud cycle

00:51:34.520 | operates at a slight lag to the market cycle.

00:51:37.840 | And you just think about it

00:51:38.720 | from an investor behavior standpoint,

00:51:40.360 | it makes total sense.

00:51:41.480 | And the evidence supports this where

00:51:44.800 | once the market starts going down a bit,

00:51:47.680 | or there's not as much frenzy and speculation going on,

00:51:51.360 | that leads to problems for fraudulent companies

00:51:54.200 | because any kind of wrench in the gears

00:51:57.320 | brings everything to a halt.

00:51:58.560 | And so what you tend to see

00:52:00.720 | is that when people start to lose money

00:52:03.000 | in a previously high returning,

00:52:05.760 | but maybe fraudulent company,

00:52:07.640 | they start scrutinizing their investments much more.

00:52:10.920 | And that's usually when the fraud gets uncovered.

00:52:13.640 | - Warren Buffett had a great quote here too.

00:52:15.560 | He said, "When the tide goes out,

00:52:17.720 | "you get to see who's swimming naked."

00:52:20.360 | - Exactly.

00:52:21.680 | - Let's move ahead to today.

00:52:24.240 | Let's look at where we are today.

00:52:26.200 | And I don't wanna make any market timing decisions,

00:52:29.120 | but what do we have going on today

00:52:31.000 | that would be reminiscent of boom and bust?

00:52:36.000 | I mean, we certainly have low interest rates,

00:52:38.080 | lower than the inflation rate.

00:52:39.800 | So that's one factor of the triangle.

00:52:42.240 | I think another factor in the triangle

00:52:45.320 | is the oxygen or the marketability.

00:52:49.040 | When we talked about

00:52:49.880 | these special purpose acquisition companies,

00:52:52.800 | which are nothing more than shell companies

00:52:54.400 | which come public for no stated reason.

00:52:57.880 | A lot of them are celebrity backed.

00:52:59.840 | Like you could name some celebrities.

00:53:02.320 | - I think Shaq has the spec.

00:53:04.120 | - Shaq has the spec.

00:53:05.480 | And then they go out and they acquire a private company

00:53:09.280 | and it's a backdoor way

00:53:11.280 | of getting that company on the market

00:53:13.560 | without having to do with traditional IPO.

00:53:16.880 | Hundreds of these things have come out.

00:53:18.920 | - And in terms of marketability,

00:53:20.600 | you were talking earlier

00:53:21.480 | about the end of fixed commissions.

00:53:24.080 | Today, we have that again to a more extreme level

00:53:26.640 | with introduction of commission free trading

00:53:28.560 | in the fall of 2019.

00:53:31.080 | And that coupled with fractional shares says,

00:53:33.760 | I don't know how you could make buying

00:53:35.920 | and selling stocks any easier at this point.

00:53:38.080 | You can do it on your phone in fractional purchases

00:53:41.200 | and with no commission.

00:53:42.400 | So I don't know how else you can kind of reduce

00:53:45.280 | the friction of buying and selling.

00:53:47.080 | - So we have the oxygen

00:53:49.080 | with the spec seeming to continue to come out.

00:53:51.680 | We've got the fuel, which is very low interest rates.

00:53:55.280 | We've got some speculation going on.

00:53:58.280 | New stocks that have very little revenue

00:54:01.920 | shooting to the moon.

00:54:03.840 | You have to step back and say,

00:54:05.560 | is the market, the US market getting a little bit fraught?

00:54:09.520 | - I also think it's just strange

00:54:10.640 | how you have this kind of bifurcation

00:54:12.880 | and there's like the dichotomy of bubbles

00:54:16.320 | and speculative excess, like you just mentioned.

00:54:18.640 | But at the same time, you now have value

00:54:21.760 | after a decade plus of value underperforming.

00:54:24.600 | And at the same time that there's all these

00:54:26.680 | bizarre speculative manias going on,

00:54:29.120 | it's also at the same period where

00:54:31.360 | value is starting to perform well again.

00:54:33.760 | And I feel like with the SPACs and electric vehicles

00:54:37.600 | and GameStop, et cetera, those feel bubbly

00:54:42.400 | and they're definitely speculative, but it's siloed.

00:54:45.920 | There's a, I think James McIntosh

00:54:47.760 | at the Wall Street Journal,

00:54:48.760 | he recently wrote an article using the bicycle bubble

00:54:52.520 | as an example where he was talking about how

00:54:55.400 | even when the bicycle boom bust,

00:54:58.200 | it didn't have any broader impact on economy.

00:55:02.240 | And his point was that there can be bubbles

00:55:04.840 | that boom and bust, but the overall market isn't affected.

00:55:07.920 | And if some of these electric vehicle companies went South,

00:55:12.880 | that wouldn't necessarily impact the broader market.

00:55:15.960 | It's different than if every sector in the S&P

00:55:19.040 | was feeling speculative,

00:55:21.160 | but it's these small enough industries and sectors

00:55:23.600 | that I feel like they're bubble-ish signs,

00:55:26.400 | but they're mini bubbles.

00:55:27.840 | - So I like the word silo.

00:55:29.160 | You said it great, siloing these things is right.

00:55:31.960 | There are bubbles in some areas of the market,

00:55:34.720 | but will it affect the whole market?

00:55:36.960 | Maybe not.

00:55:38.320 | Jamie, this has been really a great conversation.

00:55:40.120 | Thank you so much for your time.

00:55:41.520 | And the name of the website is Investor Amnesia.

00:55:46.520 | So I have one last question for you.

00:55:48.640 | When is the book coming out?

00:55:51.680 | - Whenever I can have time to write one.

00:55:54.840 | That and hosting a financial history podcast

00:55:58.760 | are things I often get asked about,

00:56:00.440 | and I always respond that I would love to do them.

00:56:02.720 | I just barely have time to do the work I'm already doing,

00:56:05.320 | so I don't know where a book or podcast are gonna fit in.

00:56:08.320 | - Well, thank you again for being on the show, Jamie.

00:56:10.320 | I've really enjoyed the conversation

00:56:11.880 | and look forward to many great things coming from you.

00:56:15.120 | This concludes "Bogle Heads on Investing," episode number 31.

00:56:19.040 | I'm your host, Rick Ferry.

00:56:20.800 | Join us each month as we interview a new guest.

00:56:23.920 | In the meantime, visit bogleheads.org

00:56:26.880 | and the "Bogle Heads" wiki.

00:56:28.400 | Participate in the forum and help others find the forum.

00:56:31.760 | Thanks for listening.

00:56:32.760 | (upbeat music)

00:56:35.480 | (upbeat music)

00:56:38.080 | (upbeat music)

00:56:40.720 | (upbeat music)

00:56:43.320 | [BLANK_AUDIO]

Bogleheads® on Investing Podcast 031 – Jamie Catherwood, host Rick Ferri (audio only)

Chapters