6.2: Manias and Crashes

Video - Audio - YouTube (Material for this section starts on slide #8.)

Occasionally, investors get caught up in what are called manias, also known as bubbles. The Internet dot-com bubble of the late 1990’s was one of the most famous stock manias. The NASDAQ hit a high of over 5,000 in March of 2000 only to fall approximately 80% to around 1,100 by October 2002. Before that, there was the “Nifty-Fifty” of the early 1970’s. An investor needn’t worry about valuation. These companies will go up no matter what. Predictably, it ended badly for many of those stocks and their investors. The mania of the late 1920’s resulted in the Crash of 1929. At the peak in September 1929, Radio Corporation of America ‒ you know it as RCA ‒ sold for over $500 per share. In three years, it would sell in the teens, a loss of approximately 98%. The Goldman Sachs Trading Corporation investment trust, a precursor to modern mutual funds, went from over $200 to $1.75. Before then, in the 1840’s, there were 400 railroad firms. Now there are only a handful. In bubbles, a few fortunes are made, many more fortunes are lost.

The greatest bubble of all time will always be remembered as the Dutch tulip bulb craze of the early 1600’s. Although there is controversy over the exact nature of the mania, speculators did drive the price of tulip bulbs to insane levels. One poor fellow who had just arrived in The Netherlands and had no idea of what was happening mistakenly ate one of the bulbs thinking it was an onion and wound up in jail. There are two wonderful books that chronicle the events, Extraordinary Popular Delusions and the Madness of Crowds and The Botany of Desire. The first book discusses the various instances of mob psychology gone mad. It was written in 1841 but is still shocking to today’s readers. The second book discusses our relationships with plants and turns the tables on the human race. Are we controlling the plants or are they controlling us? Great question! Read both books!

During each bubble, the phrases were, “It’s a New Era,” or, “It’s different this time,” or, “The old ways of valuing stock are gone.” And each time, they were wrong! Again, so much for Efficient and Rational Markets!

Why do manias occur over and over again? Why haven’t investors learned their lesson? Leonard Kaplan, president of commodities brokerage firm Prospector Asset Management in Evanston, Illinois, believes that, “[market manias] will happen over and over again because the public is infinitely stupid.”

In his 1972 edition of The Intelligent Investor, Benjamin Graham opined, “The speculative public is incorrigible. It will buy anything, at any price, if there seems to be some ‘action’ in progress. It will fall for any company identified with ‘franchising,’ computers, electronics, science, technology, or what have you, when the particular fashion is raging. … the abuses are so largely the result of the public’s own heedlessness and greed.” Replace “franchising,” computers, etc. with Internet, biotechnology, etc. and Good Ol’ Ben could have been writing in 2000 instead of 1972. Today, the buzz words are cryptocurrencies, meme stocks, and NFTs.

Are we in a mania/bubble now? Many believe we are. Certainly, some stocks are trading at extreme valuations. However, some other stocks are still valued at reasonable levels. What makes the current investment environment seem like a bubble is the pandemonium over cryptocurrencies, meme stocks, and NFTs. “Quick! Hurray! They are giving away free money! Go get yours now! Bitcoin will be $1,000,000 soon!” Our technology changes quickly but our psychology has barely budged since we invented civilization. We want to believe that we can get rich quickly. In any bubble, a few do become fabulously wealthy. Most lose. Some lose everything. When you hear, “Ooo, ooo, ooo! Is it too late to get in?” then the answer is invariably, “Yes, it’s too late to get in.” It shouldn’t be long before we hear, “Ooo, ooo, ooo. Is it too late to get out?” Because …

How do most manias end? Yes, you guessed it! They invariably end with a crash, also known as a panic. “The bigger the party, the bigger the hangover.” They are not fun but the odds are you will live through at least one or two during your investing career. What we hope we have convinced you by now is that you must take a long-term perspective and not panic. It won’t feel good. In fact, it will feel as if someone punched you in the gut. Provided you did not succumb to the siren’s call of quick fortune and chose prudent, long-term oriented companies with their roots deep in the economy ‒ and the world does not end ‒ your portfolio should recover as the global economy recovers.

The following quote is from Jon Lovelace, a mutual fund money manager and the individual who oversaw the exponential growth of The Capital Group, the parent company of The American Funds, in the 1950’s through to the 1990’s. Mr. Lovelace uttered these words in August 1999, a heady time in the stock market when articles and books were touting an imminent “melt up” for stock prices, some predicting a four-fold rise.

“With this many strong years, I have the concern that there are a vast majority of companies that are significantly overvalued on a long-term basis.” ‒ Jon Lovelace

Mr. Lovelace would retire in 2000 with 50 years of experience, just as the bubble was bursting. His words fell on deaf ears. Speculators and traders spent two and a half years from March of 2000 to October of 2002 learning the painful truth about manias and crashes, bubbles and panics.

Oh, by the way, the 2008/2009 market crash was not caused by a stock market bubble. It was a real estate bubble and the mortgage-backed bonds that were tied to the real estate mortgages. We will discuss this later when we get to bonds.

A History of Bear Markets

The table below contains a history of bear markets of the Standard and Poor's 500 since the Great Depression.

A History of Bear Markets of the Standard and Poor's 500

High	Low	S&P 500 at High	S&P 500 at Low	Percent Decline	Months to Recover		S&P 500 P/E at High	S&P 500 P/E at Low	P/E Percent Decline
Sep 1929	Jul 1932	32	4	-88%	267		27	4.3	-84%
Jul 1957	Oct 1957	49	39	-20%	11		15.4	10.6	-31%
Dec 1961	Jun 1962	73	52	-29%	14		16.1	12.3	-24%
Feb 1966	Oct 1966	94	73	-22%	6		19.1	15.7	-18%
Nov 1968	May 1970	108	69	-36%	21		20.2	13.1	-35%
Jan 1973	Oct 1974	120	62	-48%	69		18.6	9.2	-51%
Nov 1980	Aug 1982	141	102	-28%	2		10.3	7.2	-30%
Aug 1987	Dec 1987	337	224	-34%	19		17.3	12.5	-28%
Jul 1990	Oct 1990	369	295	-20%	3		15.3	12.9	-16%
Jul 1998	Oct 1998	1,184	959	-19%	1		34.5	30	-13%
Mar 2000	Oct 2002	1,527	777	-49%	55		37.4	18.8	-50%
Oct 2007	Mar 2009	1,565	667	-57%	66		23.6	9.7	-59%
Feb 2020	Mar 2020	3,386	2,237	-34%	6		25.4	22.2	-13%
Jan 2022	n/a	4,797	n/a	n/a	n/a		23.1	n/a	n/a

Scanning the table, you will find that there is no typical bear market. The percentage declines, the time to recover, and the declines in the Price-to-Earnings ratios do not follow any particular pattern. Some experience deep declines; some do not. Some take years to recover; some recover quickly. Again, the key point to remember is that bear markets will come and ‒ assuming the world does not end ‒ bear markets will go. Prudent, long-term prepare themselves emotionally for these events and do not panic. In fact, history tells us these have been the best times to allocate more resources to your investments. But as we cautioned, it jest ain’t gonna’ be fun to live through them. Oh, well. We did warn you, didn’t we? Do you want to eat well or do you want to sleep well?

Note: As mentioned beforehand, a bear market is generally defined as a 20% decline in prices. Many histories of bear markets do not include the late 1998 market downturn since it did not actually decline 20%. Also, at the time of this writing, we are still wallowing in the bear market that began in 2022. When will the next bull market start? For prudent, long-term investors, a better question is, “Which companies will do well over the next 3 to 5 years and beyond and are any of them on sale during the current bear market?”

October is the Cruelest Month

With all due respect to T. S. Eliot, we beg to differ. April is not the cruelest month. October is. The following table shows a very interesting and puzzling characteristic of severe one-day declines in the stock market.

Date	Net Change	Close	% Decline
19-Oct-1987	-508.00	1,738.74	-22.61%
16-Mar-2020	-2,997.10	20,188.52	-12.93%
28-Oct-1929	-38.33	260.64	-12.82%
29-Oct-1929	-30.57	230.07	-11.73%
12-Mar-2020	-2,352.60	21,200.62	-9.99%
6-Nov-1929	-25.55	232.13	-9.92%
18-Dec-1899	-5.57	58.27	-8.72%
12-Aug-1932	-5.79	63.11	-8.40%
14-Mar-1907	-6.89	76.23	-8.29%
26-Oct-1987	-156.83	1,793.93	-8.04%
21-Jul-1933	-7.55	88.71	-7.84%
15-Oct-2008	-724.00	8,577.91	-7.78%
18-Oct-1937	-10.57	125.73	-7.75%

Notice how out of the thirteen worst days in the market, six of them were in mid- to late-October and one was in early November. Two of the days were in March of 2020 and were caused by the Covid-19 panic. We should really discard those days from this list. Therefore, we are left with the fact that seven of the worst eleven days occurred at the same time of the year. This is the October effect, as it is sometimes called. Why? Why have so many more severe market declines happened in this period?

The reality is that there is no good explanation for this that can be tested and proven. Most likely the best explanation goes back hundreds of thousands of years. The season is not called the fall for nothing. We saw the leaves change and the plants die off. We saw the days growing shorter and the nights growing longer. The temperature dropped. We looked around and knew that some of us weren’t going to make it to the next spring. There is a very good reason that All Soul’s Day, the Day of the Dead, All Hallows' Eve, and Halloween are in this season. As much as we like to believe that we are masters over nature ‒ flip a switch, push a button, shelter in our climate-controlled cocoons ‒ the truth is we are still animals, slaves to the natural world around us. The belief is that these animal instincts spill into the stock market from time to time. This leads us to our next section on Investor Psychology and Common Investor Weaknesses.

FOOTNOTE: You may be wondering why these remembrances and festivals would not occur in December and the winter solstice, instead of the fall. The winter solstice begins the return of the sun’s journey back to us. This is the reason the end of December was chosen to celebrate the birth of the Christ child. Jesus Christ was called the Light of the World. The winter solstice marks the birth of the light. For more about the symbols that permeate our world and how they affect us, please consider reading The Hero with a Thousand Faces by Joseph Campbell. If there is one book you should read in your lifetime, it is this one. Mr. Campbell has created a “how-to” manual for humans. In The Hero with a Thousand Faces, we learn that we are all heroes on an adventure. That adventure is what we call life. We see how the world’s major religions are calling to us from thousands of years ago. They hope we learn how not to waste this precious gift that we have been given. And if that does not pique your interest, it is also the book that George Lucas used to create Star Wars. Mr. Campbell was on the sets of the first three Star Wars movies as a consultant. He was the man behind the Force. Oh, by the way, although they won’t acknowledge it publicly, Disney has stolen from Mr. Campbell many times, the most egregious being The Lion King. Dear Students, The Hero with a Thousand Faces is a life-changing book. Read it!