Sunday, October 15, 2017

Frank Newman: October crashes


“October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.” (Mark Twain.)

It's thirty years since the 1987 sharemarket crash - Monday the 19th of October 1987 (US time) to be precise. Wall Street had its biggest one-day fall in the history of the stock exchange, down 22 percent.

We knew what was in store when the New Zealand market opened on Tuesday morning, the 20th. It was going to be bad, and there was nothing we could do about it. What we didn’t know was how bad it would be. On the Tuesday our market was down 15 percent.

It's moments like those that reveal one’s score on the pessimism/optimism scale. The extreme pessimists took the view that the financial system was about to collapse and the world would never be the same again. The extreme optimists saw it as a mere bump on the road and a fantastic buying opportunity. Most did not know what to make of it so sat on the fence, and watched. Sadly the optimists were wrong. The Dow Jones bounced back, but our market didn't - because so many of the companies listed on our exchange were highly leveraged asset shufflers. Within two months our market had lost half of its value from the peak, and by February 1988 it was down 60 percent.

It was a crazy time - some say it was irrational. And in one respect it is irrational to make investment decisions without having any regard to the underlying value of the investment.  Questions like what are the earnings per share, or what's the asset backing per share did not feature in the minds of buyers. They were simply speculating that the price would be higher tomorrow.

On the other hand it is very rational for people to gamble on something that could make them very rich, very quickly. We can see that in play ever week with Lotto. Buying a Lotto ticket is an irrational investment, but it is rational behaviour.

It's that speculative/gambling aspect that defines a manic market. Speculators are always in markets, but it’s where they dominate a market where the very extreme risks and rewards appear.

The 1980s boom was propelled by the economic reforms introduced by the 1984 Labour government, with Roger Douglas as the finance minister. Within one parliamentary term he removed the regulatory barriers imposed by National's Rob Muldoon and opened up the economy and the foreign exchange market. For the first time companies could borrow from overseas, which opened the door to a wave of highly leveraged asset shufflers like Equiticorp, Omnicorp, Judge Corp, to launch raids on what were sleepy and undervalued companies. In the four years to October 1987, over 200 new companies listed on the stock exchange. Today, a new listing is a rarity.

Some say times are different now, and some things have changed. The highly leveraged speculators listed on the stock exchange have disappeared - and back in 1987 cell phones cost $6,000 and had to be lugged around in a carry case. Things are always different, but human nature has not changed and the speculative opportunism that was evident prior to the 1987 sharemarket collapse is just as evident today, albeit it less pronounced.

We have seen evidence of this recently in the Auckland property market. In the four years to December 2016 house prices in Auckland city rose 70 percent from $715,000 to $1.218 million, or $125,000 a year. In my view much of that gain was due to speculators flicking property for quick gains. Typically they would use other assets as collateral to leverage a property purchase, and flick it on for a massive return without tying up much or any of their own money. Questions like the rental potential of the property are simply irrelevant to the property speculator. Their thinking is: buy it, flick it, profit, buy another one, flick it, more profit, buy another one or two or three, flick them, make heaps of money. Retire rich.

Where property and shares differ is in the speed and extent of their movements. Shares can be traded in an instant and the transaction costs are miniscule so the movements are lightening fast. Less so with property - the movements lumber through the cycles.  Shares are a hare, while property is a tortoise. And the moral of that story is: you nap and you lose.

Frank Newman writes a weekly article for Property Plus.

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