What Investors Can Learn From Sir Isaac Newton
Tim Price is one of the top investment strategists in the world.
He’s co-manager of the VT Price Value Portfolio and author of Investing through the Looking Glass: A Rational Guide to Irrational Financial Markets.
In one of his letters last year, he talked about Sir Isaac Newton and the South Sea Bubble. The lesson we can learn from Newton is just as valuable now as it was in the early 1700’s.
One that we’ll focus on today.
First, a little background on the South Sea Bubble.
In short, it was one of the biggest stock market mania’s in history. It revolved around a company in England called The South Sea Company.
At the time, the British were building up a massive debt load to pay for the French War.
In 1711, the South Sea Company proposed a scheme for the government to pay off a portion of its debt. (Of course, the company managers had dreams of endless wealth with this scheme.)
The law gave the company a monopoly over trade with the Caribbean, Spanish America, and the Pacific Islands. Hence, the name The South Sea Company.
With the help of rumors, publicity, and bribes, the company portrayed an image of great prospects and financial growth. It didn’t hurt to have a monopoly on trade of faraway lands full of grand stories of massive wealth and resources.
In 1719, the company proposed to offer its stock to the public in exchange for the remaining government debt. (More dreams of endless wealth.)
The House of Commons accepted the proposal in 1720. This is when the real action began.
The company’s managers knew this law and stock offering would fuel speculative interest.
It did. The mania set in soon after.
The stock went from 129 to 1000 over the next few months. The rapid rise in its stock price stoked the power of greed even more.
During this time, hundreds of crazy investment and business schemes popped up to sell shares of stock to the public to meet the feverish demand.
It was so insane that one stock promoter announced the formation of “a company for carrying on an undertaking of great advantage, but nobody to know what it is.”
What rational person would buy stock in that company?
Then like in all stock manias and bubbles, greed turned to fear.
In less than a year, The South Sea Company collapsed along with the exchange.
If you want to read more about it, I recommend reading Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds. You could also get a short book by John Train, Famous Financial Fiascos.
Back to Sir Isaac Newton and The South Sea Bubble.
The example of Sir Isaac Newton may be the finest example in history of an investor being too intelligent for his own good. Britain’s most celebrated scientist was not immune to the profit-making potential of the South Sea Company.
In early 1720 he profited handsomely from his stake in the company. Having cashed out, he then watched with some dismay as stock in the company continued to rise.
As Lord Overstone put it, “No warning on earth can save people determined to grow suddenly rich.”
Losing money is painful. Seeing one’s friends making money when one is not may be even more painful.
So, Newton went back in. He went on to purchase South Sea Company shares at more than three times the price of his original stake. The market then collapsed, and he lost virtually all his life savings.
The experience is said to have given rise to his bemused response: I can calculate the movement of stars, but not the madness of men.
Investors face a similar situation today.
Today’s headline on the front page of the Wall St. Journal reads, Many Investors Bailed Out Early.
From the WSJ,
One of the biggest surprises of the U.S. stock market’s relentless rally is how many individual investors have run away from it.
The Dow Jones Industrial Average closed above 25000 for the first time on Thursday, punctuating a record-setting period nearly unmatched in U.S. history.
Yet throughout the nearly nine-year surge in share prices, small investors have continued to yank money out of funds that own U.S. stocks.
Like Newton, they invested a bit and exited happy.
Now, they see headlines of record stock market highs and the Dow soaring past 25,000.
They ask themselves… Do I buy now? The Dow could go to 50,000! Maybe I should go all in!
Then there’s the crypto mania that has swept the world off its feet. Investors see news of high school dropouts making millions in Bitcoin and want to join the party.
But like Lord Overstone said back then, “No warning on earth can save people determined to grow suddenly rich.”
Don’t be one of those investors who think they can get rich by joining the party late. The stock train left the station years ago.
You’ll be buying shares from investors who already made a ton of money. They bought low and will be selling their shares to you at record high prices.
In other words, you’ll be buying high and more than likely selling low once greed turns to fear.
Look, there is opportunity for investors in certain markets and commodities right now. But the point is not to get in a frenzy because the headlines are hyping record highs and crypto mania.
Be patient and be selective about what you buy. Remember what Warren Buffett said, “Price is what you pay. Value is what you get.”