It's 1623, Tulip mania. A single tulip bulb sells for a thousand Dutch florins, seven times the average annual wage. The average tulip trader makes 60,000 florins a month - 400 times the annual wage.
Forty bulbs sell for 100,000 florins. You could have bought 3333 pigs for the same price. People were selling possessions to speculate in the tulip market.
Some tulip traders started selling tulips that had just been planted. Others sold bulbs they intended to plant. Gotta love those futures traders. They called it "wind trade" at the time because that's all the tangible assets you had: thin air.
There has been a lot written about bubbles, and how to spot them. Here are the lessons from 400 years ago. How to spot a bubble:
Everybody is making gains.
People believe the passion for stocks will last forever.
Your ordinary industry is neglected.
Tangible assets are converted to cash to speculate in shares. (Equity mate).
Other asset classes are deserted.
Luxuries of every sort rise in price.
Assets are bought to sell, not bought for their return.
Now let's turn this on its head and see whether we aren't in the opposite of a bubble, a period in the sharemarket when everyone is undervaluing everything, a sharemarket "bust" maybe. Let's see whether we're being too bearish. If so, the following should be happening:
Nobody is making money. Tick.
People believe long-term investment is over forever. Tick.
Everybody is concentrating on keeping their jobs. Tick.
Everyone is trying to pay down debts. Tick.
Other asset classes are swamped (term deposits). Tick.
Luxury items of every sort fall in price (discretionary retailing in a hole). Tick.
Assets are bought for their return, not to sell (income stocks favoured). Tick.
All a bit simple, but there are other factors that suggest we are closer to a bottom than a top. For instance:
There is a lot of cash ready to invest.
The yield gap favours equities over bonds. Yields are historically high. Gross equity yields average 7 per cent against the 10-year bond yield at 4.16 per cent.
Equities are historically cheap at a price-earnings ratio of 10.5 times earnings. The long-term average is 37 per cent higher at 14.4 times earnings with peaks of 20 times.
Balance sheets are historically strong.
So what is holding us back? The answer isn't "price" the price is right. The answer is "risk".
We have spent the past 4? years getting a salutary lesson in risk and its consequences. We are fed up with losing money, basically.
But even with the 82 per cent fall in the Japanese sharemarket in the past 22 years, there have been seven bull markets averaging 58 per cent, each lasting an average of one year and four months. Periods when the risk aversion eased enough for the herd to go back in. It can happen and when it comes to price, the stage is set.
For equities to rally, we just need a catalyst, anything that turns the focus away from fear and risk to greed, or, more likely, the need for a return. It could be a bit of blue sky on Europe after the Greek deal. It could be the pitiful returns and overpricing of fixed-interest instruments and other safe havens, such as gold (zero return) and the mattress (zero return).
But more likely it is going to be the cash simply busting out of its seams.
Consumer, investor and corporate balance sheets are all being rebuilt.
The process may not be complete, but there is a lot of money ready to go. JPMorgan has just announced a $15 billion share buyback and an increased dividend. It has had enough of sitting around and has decided to put its money to work.
A waterfall starts with one drop. Was that it?
Marcus Padley is a stockbroker with Patersons Securities and the author of stockmarket newsletter Marcus Today. His views do not necessarily reflect the views of Patersons.