“There are few fields of human endeavour in which history counts for so little as finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.”
This excellent quote from economist John Kenneth Galbraith got me thinking about how important it is for investors to study financial history. In every other aspect of infrasturcture, whether it be psychology, sociology, city planning, engineering or whatever else, we rely on past experience to guide us in the here and now.
But for some reason, when it comes to finance, every time the market is bullish we are encouraged to disregard the lessons of history. Similarly, when investors are panicking and selling their holdings, few people remember what has happened in the past.
Three reasons why people don’t learn
The truth of the matter is that markets tend to go through cycles. Mark Twain had a lot of great lines, but one of my favourites is: “History doesn’t repeat itself, but it does rhyme.”
Why do so few people seem to recognise this? One simple reason is that knowledge of financial history is not actively encouraged. As far as I know, it is not taught as part of normal coursework in high school, and it is rarely taught even at degree level.
Another reason is that markets are inherently psychologically driven. Even someone who knows intellectually that valuations are getting out of hand may bow to the pressure of the speculative mania surrounding them.
Most financial excesses have their genesis in a new technology or development. The dotcom bubble of the 1990s is one example, and subprime mortgages in the 2000s are another. In both cases, investors were convinced that something new had so fundamentally changed the landscape that the old rules no longer applied. This is the third problem - even well-informed investors who think they can keep their emotions under control end up being deceived by new developments in the market.
How to avoid making the same mistakes
One of the first stock market bubbles in the recent few centuries was the Mississippi bubble in 1720 (the Dutch tulip bulb bubble of 1637 was not technically a stock market bubble, although it was the first speculative bubble). The exact mechanisms behind the Mississippi bubble are a little too complex to describe in a single article; suffice to say that it was carnage. Speculation in shares of the French Mississippi Company got so extreme that when it finally burst, it caused a currency devaluation and a run on the national bank.
The reason I bring this historical case up is to point out that speculative mania has been around for as long as stock markets have existed. The next time that you are told that this time is different, ask yourself why this time should be different to the countless other times that statement has been said.
Disclosure: The author owns no stocks mentioned
Read more here:
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- ”‹What Negative Interest Rates Might Mean for Investors
- The Value Investor’s Handbook: Improving Your Process
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