On Wednesday, my son Guy came into my home office after a day of homeschooling. On my screen, I had a meme open about US retail company, GameStop, who’ve dominated the financial news and social media this week.
It’s a fascinating story with multiple players, layers and a plot that will likely fill a soon to be best-selling book. But if you haven’t followed the news, I don’t blame you. It’s a pretty niche situation with, air quote, “traders” speculating on the fortunes of one company.
Bear with me though. The lessons from seeing the GameStop stock rise over 1500% in a matter of days is invaluable.
So, on entering my office my son saw the name ‘GameStop’ on my screen and proudly stated:
“I KNOW GAMESTOP! THEY HAVE GREAT STOCKS!”
And I burst out laughing for all sorts of reasons but mainly in surprised shock that:
- He knew about this breaking financial news story
- He thought a stratospherically high share price was a sign of ‘GREAT STOCKS!’ and
- He got his information from a gaming YouTube-er
After I stopped laughing and asked a few questions, Guy also went on to tell me that:
“THE STOCK IS GOING UP BECAUSE OF REDDIT” (another social media platform).
And that’s when it dawned on me. If my 12-year old son is tuned in to this, there must be millions of people with actual money to invest, who believe they can get rich by betting on companies based on internet chatter.
There are a tiny few who may do well, and the GameStop story does include some early activist investors on a specific mission. But the reality is that when other investors jump on late to the party, purely in anticipation of the stock being able to sell at a higher price, someone ends up holding the bag when prices inevitably tumble.
And it is a fact of finance that even if you are smart, a high IQ does not translate into mastery of investment, because there is more to it than brains. A case in point is the renowned mathematical genius Sir Isaac Newton, who lost $1.25M in today’s money, succumbing to the euphoria and greed of the ‘South Sea Bubble’ in 1720.
The South Sea Bubble
The South Sea financial mania was born on the South Sea Company’s potential access to lucrative trading routes from commodity-rich South America. Speculation in London over the potential profit from this untapped foreign market saw stock in the South Sea Company rise from £128 in January 1720 to £1,000 by the summer.
People fell over themselves to invest as the ‘fear of missing out’ (FOMO) and dreams of unimaginable wealth took hold. I don’t know who coined this phrase but “There is nothing more painful than the sight of watching your neighbour get rich”, hits the nail on the head.
But whilst London speculated, Spain stepped in and quickly imposed some reality into who really ruled those South American waves. It wasn’t London. The South Sea Company was eventually granted only one voyage per year, with Spain sharing the profits. And by the end of 1720, the stock was back to £124, with summer investors pretty much wiped out.
The South Sea bubble is just one of many stories from history. Believe it or not, financial speculation goes back centuries. You have the Tulip mania of the Dutch 1630s, the US railroad boom and bust of the 1870s, The Florida real estate boom of the 1920s that gave us Charles Ponzi and a name forever associated with deceptive schemes. And those are just some of the highlights. Even in recent years, we’ve had the technology bubble of 2000 and subprime real estate bubble of 2008.
No time period, asset class or country is immune to speculation. The common denominator is man. We’re built this way.
Lessons from History
Guy gets a pass from me for thinking ‘GREAT STOCKS!’ because he’s 12 and has much to learn, but the GameStop story evidence’s lessons from history, which people are doomed to repeat for eternity.
In the 1993 book ‘A Short History of Financial Euphoria’, historian John Kenneth Galbraith walks through a number of these historical cases including the South Sea bubble and summarises with the following.
- Lapses into financial short memory have been evident for centuries. People quickly forget previous financial disasters. And when similar circumstances appear, there is a new and youthful generation to make the same mistakes.
- Most people cannot help but be captured by the satisfaction of accruing wealth. That never changes.
- There is an impression that intelligence, of self and others, is associated with the possession of money. The more money with which an individual is associated, the more astute his mental processing is assumed to be. It is an illusion. Financial genius is before the fall.
- Hubris bids up prices until mass disillusion and the eventual crash of whatever is the speculative asset.
- Those involved never attribute stupidity to themselves. There will always be a reason why it was not their fault.
And what about GameStop. Well as I write this on Wednesday evening, the stock hovers around $350 having been at $20 only a few days ago. The story has other angles in play than pure greed, but I have no doubt where this all ends. The company is not worth $350 a share and this will at some point end badly for most.
However, I’d be lying if I didn’t say I enjoyed the entertainment of it all. But entertainment it is, and there is no chance of me acting on it because of FOMO. I do feel sorry for those who will get burned, but the lesson here is to exercise caution when a ‘unique’ investment opportunity presents itself. Whether that is shares, property, art, wine or any other form of investment, history guides us.
And as much as it is boring for me to say this, stick to a well-diversified asset allocation plan, inclusive of stocks and bonds using low-cost funds. I invest in the same funds and asset allocation models I recommend to our clients and I’ll let time do the rest. It’s not about the market action, it’s about investing to meet your financial goals, and for want of a better word, getting ‘rich’ slowly.
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