Dec 15, 2022
Among the broad spectrum of value opportunities that appear on our radar, we often come across companies and industries where the past is a good guide to the future, whether in terms of assessing where we are in an economic or industry cycle, determining what a company’s normalised profitability looks like, or judging management’s long-term track record on capital allocation.
In terms of the length of ‘rear view’ we may consider when making some of these assessments, we can (and often do) look back decades. For some industries and businesses, particularly cyclical leaders, very little will have changed in the products and services they provide, and the make-up of their customer bases, meaning that what happened in past cycles can be a useful indicator of what will happen in the future.
What about events that happened hundreds of years ago? This might seem more of a stretch, as the market for leech bleeders and ice dealers probably isn’t what it was back in the 1800s. But there are still lessons to be learned about human behaviour, and people’s tendency to overreact to both good and bad news – an emotional arbitrage we still strive to take advantage of today in our investment process.
This is what sprang to mind after recently reading ‘Extraordinary Popular Delusions and the Madness of Crowds’ by Scottish journalist Charles Mackay, first published in 1841, which chronicles three of the most famous financial bubbles in history: the Mississippi Scheme of the early 1700s, the South Sea Bubble of around the same period, and the Tulip Mania in the 1630s. In the case of the latter, at one point the price of a single bulb of a rare species of tulip equated to the combined value of “two lasts of wheat, four lasts or rye, four fat oxen, eight fat swine, 12 fat sheep, two hogsheads of wine, four tuns of beer, two tuns of butter, 1,000 lbs of cheese, a complete bed, a suit of clothes and a silver drinking cup”.
While each of these manias was fascinating (and damaging) in its own right, with many parallels with modern day bubbles and their consequences, it is the South Sea Bubble that feels most relevant to some recent developments in financial markets. Initially designed as a way of consolidating, controlling and reducing Britain’s national debt, as well as increasing its trade and profits abroad, the South Sea Company made increasingly fanciful claims, backed by politicians and royalty alike, which the public bought into with frenzied interest, often via leverage, with ruinous consequences when the bubble eventually burst in 1720. The origin of the term ‘financial bubble’ in fact relates to the South Sea Company, as the hundred or so joint stock companies that sprang up to capitalise on the South Sea mania were known as ‘bubble companies’. Such practises were soon outlawed by the Bubble Act of 1720, with 86 bubble companies declared illegal and abolished accordingly.
Some of these bubble companies’ stated intended uses of capital raised do seem rather unlikely to deliver an attractive return (“for repairing and rebuilding parsonage and vicarage houses”, “for improving of gardens”, “for assuring of seamen’s wages”, “for a wheel for perpetual motion”, to give a selection). Charles Mackay suggests that “the most absurd and preposterous of all, and which shewed, more completely than any other, the utter madness of the people, was one started by an unknown adventurer, entitled, “A company for carrying on an undertaking of great advantage, but nobody to know what it is”. Were not the fact stated by scores of credible witnesses, it would be impossible to believe that any person could have been duped by such a project”.
We surely can’t be the first to observe that a capital raise for ‘great advantage’ but whose ultimate target is unknown sounds rather like the modern-day special purpose acquisition company or SPAC (sometimes called a ‘blank-cheque company’), whose popularity has soared in recent years, with 59 created in 2019, rising to 247 in 2020 and a record 613 last year. This year, however, has been a different story, with only 69 successful SPAC initial public offerings (IPOs) in the first half of the year, the highest number of withdrawn SPAC deals on record (including 143 SPAC IPOs withdrawn), and a ‘De-SPAC’ Index of 25 companies that went public via SPAC down more than 80% as of the end of September. Even the self-styled ‘king of SPACs’, Chamath Palihapitiya, recently announced he was closing two SPACs, with stocks that went public through his SPACs falling by an average 60% over the past year.
As for the mastermind of the scheme of ‘great advantage’ of the South Sea Bubble era, on the day of his capital raise he found queues of eager investors waiting at his door, was sufficiently well capitalised to close subscriptions after just five hours, and set off that same evening for the European continent. As Mackay soberly concludes, “he was never heard of again”.