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19Aug 2016

Aberdeen Asset Management

Financial folklore

Financial folklore

History is important in investing. Investors like managers with strong track records. Managers like companies with established executives. Executives like to work in industries with a background of success.

But historical facts can be easy to forget. That’s where folktales can come in. A good folktale can prevent such memories from fading. Originally told as entertaining stories to spread culture, folktales are history lessons that can help you recall history.

In today’s lesson on investing, we recount important moments throughout the years of American finance, starting with the most recent.

Little house

Having a little house on the prairie has come a long way since the days of the fictional Ingalls family in 1870s Minnesota. The process of buying a modern house is intricate. The terms and conditions can confuse even the most seasoned expert.

This was evidenced in the housing market crisis that contributed to the financial crisis in 2007-08. Arguably, the U.S. (and the world) may still be feeling the aftermath of the financial crisis. The housing market tumble led to slowdowns in other industries and the overall economy.

But gradually, the U.S. economy and housing market has been rebounding, as illustrated in the animation below of housing price changes.

Source: Davis, Morris A. and Jonathan Heathcote, 2007, "The Price and Quantity of Residential Land in the United States," Journal of Monetary Economics, vol. 54 (8), p. 2595-2620; data located at Land and Property Values in the U.S., Lincoln Institute of Land Policy. For illustrative purposes only.

Tech glitch

Technology stocks seem to be all the rage among investors these days, but they’ve actually been popular for a while. So is the start-up trend. In the years leading up to the new millennium, internet-based companies were being born across the country.

Investors speculated that the internet was somewhat of an avenue to the future of business, with the ability to reach international markets, and thereby, the ability to tap into new sources of potential income.

As investors funneled capital into technology companies in support of riding the internet train, the valuations of many dot-com related businesses soared. Sometimes, the valuations were based only on the possibility of innovation, rather than the innovation itself.

So in 2000, the dot-com bubble burst. Stocks plunged, and companies shut down, which led the U.S. economy into a recession.

But the technology industry seems to be back on a high note today. In fact, some of the top performing companies today are technology ones.

Cash-strapped

Some people expect to hear college students complain about unpaid bills. What if a country, or several countries, said that? This was the case in 1982 when Latin America faced its sovereign debt crisis.

Latin American countries such as Brazil, Argentina and Mexico borrowed a lot of foreign debt at what they perceived to be low costs for years. Latin American economies were booming at the time, and banks didn’t seem to be afraid of lending.

But as Latin American debt multiplied, the countries eventually realized they couldn’t pay off all the debt. To make matters worse, their currency values fell, and interest rates on bonds rose, a hit on all sides for those countries. The International Monetary Fund (IMF) and the U.S. central bank had to intervene.

Latin American countries have grown since then. Many of them have now managed to start rebuilding themselves, with years of lessons learned now in tow.

Robin Hood’s bridge

Stealing is a crime, except in the case of Robin Hood, who was cast a hero for stealing from the rich to give to the poor. In other words, he’s the fictional architect who bridges the wealth gap.

Some experts say stocks are among the top contributors to wealth inequality. The view is that wealthier people tend to own stocks. So the more that own stocks, the better the bridge of the wealth gap.

In 1952, the New York Stock Exchange revealed its first shareholder census, unveiling that 6.5 million Americas (or about 4.1% of the roughly 158 million population in that year) owned common stocks.

In 2001, stock ownership was at 67%, according to the most recent available data from the U.S. Federal Reserve (Fed). While it has now fallen to 49%, it remains an improvement since the 1950s.

Dressed in black

It’s not the color of Wall Street suits we’re referring to that shook stock market history. It’s the event known as Black Tuesday. On October 29, 1929, panicked investors traded about 16 million shares, a significant sign of lost confidence in the markets. The Great Depression of 1929-39 followed.

Some say the crash that contributed to the Great Depression was sparked by the excessive Gatsby-style spending during the Roaring Twenties in the era of “buy now, pay later” indulgence. Some say it was a lack of adequate government oversight, and economic affairs should’ve been less laissez-faire. Others say farmers played their part, producing too many crops and selling them for prices that were too low.

People have speculated for years. Whatever the reasons, the crash was the signal of a broken economy. Investors have now learned to be more conservative and cautious since then, in hopes of preventing this kind of historical repeat.

Where do we go from here?

As history shows, we’ve been through some tough times. The economy is in a constant state of flux, and no matter how we advance over the years, we can’t seem to avoid the bumps. But wounds do seem to heal with time, and we can learn to be smarter with our decisions.

Important Information

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in the market value of an investment), credit (changes in the financial condition of the issuer, borrower, counterparty, or underlying collateral), prepayment (debt issuers may repay or refinance their loans or obligations earlier than anticipated), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase).

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