This installment of The Matt Allen Letter is free for everyone. If you would like to read about stock analysis, stock market analysis, and much more. You can subscribe here.
The news has talked about market “bubbles” recently, and I wanted to share some insights on what they are, and one of the most famous market bubbles in history.
1. A hot new investment/product hits the market
2. The market reacts with euphoria
3. There is a BOOM in speculation
4. The Bubble bursts and panic ensues
Why do we repeatedly fall into the same trap?
According to economists David Tuckett and Richard Taffler, we often view a hot new financial opportunity as a “phantastic object,” or an unconscious representation of something that fulfills our wildest desires.
These objects are “exciting and transformational.” They appear to “break the usual rules of life and turn aspects of ‘normal’ reality on its head.” They promise something far departed from the market’s typical behavior.
During a bubble, we formulate a “collective hallucination” of prosperity, and fall victim to groupthink, a phenomenon where “a significant chunk of society feverishly buys into a shared dream” and ignores reality.
In Matt Allen terms: We saw tons of people jump into the stock market in 2020 when “stocks only went up.” This was a mania, and we have since seen some of the most promising growth stocks down 90% since the top.
The average person put money in the markets thinking that they could “hit” the jackpot without spending the time to study.
I personally know people who got upset with “only” 40% returns. However, the stock market averages 10-12% a year over a ten year time frame.
In 2017, we saw people jump into crypto because they thought they could hit the jackpot without having any real knowledge of what they were doing.
Today, the tulipmania serves as a parable for the pitfalls that excessive greed and speculation can lead to.
*Warren Buffett keeps this picture of Tulip Mania in his office.*
In 1637, Tulip Mania is still one of the most famous market bubbles ever. It occurred in Holland during the early to mid-1600s when speculation drove the value of tulip bulbs to extremes.
At the height of the market, the rarest tulip bulbs traded for as much as six times the average person's annual salary.
The tulip is a spring-blooming flower native to the valleys of the Tien Shan Mountains in Central Asia.
It is believed to have been introduced to Europe in 1554, when an ambassador of the Holy Roman Emperor sent tulip bulbs and seeds to Vienna from the Ottoman Empire.
Tulips gained in popularity as people were attracted to their rich color and ability to grow in sub-optimal conditions. They soon became a coveted status symbol for the wealthy.
By the early 1600s, the Dutch Republic was entering a golden age. Their economy was booming!
Many financial innovations popped up during this time - the first stock exchange, for example. But it was another financial innovation that would propel tulips into historical lore: the futures contract.
As tulips grow slowly and may take several years to bloom, paper contracts were written that entitled the buyer to the future tulips. These contracts were freely-traded.
So in addition to the physical market for tulip bulbs, a thriving paper market was established. By 1634, the prices of tulip bulbs were rising sharply. Traders would meet in special taverns to trade tulips.
In these taverns, no bulbs ever changed hands, just the paper contracts. Speculative buying (buying on the expectation of further price increases) took hold. The frenzy was on.
As with all financial bubbles, tulip mania became a self-fulfilling prophecy. Rising prices beckoned new speculative traders into the market, which further drove up prices. Prices continued to skyrocket through early 1637.
At the peak, one tulip bulb sold for ~5,000 guilders, roughly the price of a nice house in the Dutch Republic at the time.
Can you believe that? One Tulip= 1 nice house in the Dutch Republic
But as is common in speculative bubbles, the burst came suddenly. When no buyers arrived at one trading session, the price of tulips fell like crazy!
This led to the Tulip mania being over, and the economy of the Dutch Republic was left in shambles!
The working class people were left bankrupt, and the poor were left homeless.
The tulips had no intrinsic value besides the price that the next person would pay for it.
It is important to remember that when you invest, you have to stay away from the hype. The people who make all of the money in the markets are greedy when 99% of the population is fearful.
Tulip mania is one of my favorite stories, and I hope you enjoyed it!
If you have any questions, feedback, or just wanna say hey, email me at email@example.com
Stay Hungry, Stay Long