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The Dorr Report: Booms & Busts

Video transcript is provided below:

If you’ve been an investor in the past decade you’ve probably made a lot of money. Nearly every asset class – from stocks to real estate to art – continue to move higher than Snoop Dogg on a Jamaican holiday. But there’s a big difference between economic growth and financial bubbles, and I’m not blowing smoke when I say it’s hard to see the difference.

So, before you throw caution to the warm Caribbean wind, I thought we might take an unintentionally alliterative look at how the biggest booms become the biggest busts.

I am Jhordan Dorrington, and this is the Dorr Report.

As we know, the economic cycle is a series of four repeating stages: Expansion, Peak, Contraction, Trough. But there is more to it than that. In fact, investing is a lot like poker – having a good hand goes a long way, but so does understanding human behavior.

That same economic cycle can be viewed with an overlay of equally predictable emotions ranging from depression at the bottom to euphoria at the top. It’s there, at the peak and what comes afterwards, that will be the focus of our discussion. That peak is simultaneously when investors feel the most confident and the point of maximum financial risk. A dangerous combination.

Ordinarily prices would climb and roll over the top and fall back down with little more than a flashing red ticker and catchy line in the local paper. But every once in a while, the Euphoria at the top persists, driving prices higher and higher which consequently makes the drop off steeper and steeper. So, recognizing a scenario like this might just save you from the worst part of a good high. The crash.

One of the best examples of this euphoric persistence and subsequent chaos is Tulip-mania. This might sound like your dad launching into a story of walking uphill in snow, but stay with me.

In the 16th century Tulips were a new and interesting arrival in the Netherlands. A market emerged for the flowers and soon investors began trading in tulips; buying them not because the flower itself was worth anything, but because they believed they could flip it for more later. FOMO was rampant and one tulip would be bought and sold multiple times a day.

By 1636 it’s said that you could buy two steeds, a carriage, and a harness for the price of one tulip. That translates to one flower being worth nearly $50k today. Money doesn’t grow on trees but it sure grew in Nana’s garden.

Eventually, just enough people came to their senses and began to divest themselves of the bulbiferous geophytes causing a mass selloff, panic and despair. As it always is in the aftermath it becomes obvious how irrational the euphoria was and the blame game begins.

That was a long time ago right? Now we have rockets that land themselves and whatever acai berries are. But that’s a big part of what fuels euphoria – the belief that this time is different. That now we know more.

Well I have a Dorr Report news flash for you: it doesn’t matter how much investors know because under stress they’re more likely to act on how they feel.

Since then we’ve had numerous financial crises. In fact, they are more common than I think most people realize. There’s obviously The Great Crash in 1929, and more recently Black Monday in the 80s, the Asian Financial Crisis in the 90s, Dot Com bubble in early 2000s, and the 2008 Financial Crisis.

Surely tulips can’t compare to our vast modern economy but could there be something that links them? Yes. Three things actually.

1. There is always some new innovation: Tulips, Trust Companies, Mortgage backed Securities, or CLOs. Something novel to get excited about.

2. Investors begin to place blind trust in financial institutions and outspoken advocates who use phrases like “everything is financially sound”. Believing they must know something you don’t helps justify the divergence between an asset’s actual worth and its skyrocketing prices.

3. Most importantly, the asset is being continually purchased for the sole purpose of reselling it and not based on its intrinsic value.

No one is immune to regular economic cycles and over the long term the ups are generally greater than the downs which results in growth. However, every decade or two that regular cycle becomes quite irregular for a particular asset and those daily ups and downs stop going down completely and reach an irrational and unsustainable level that precipitates a crash. A crash that in hindsight will have seemed obvious, but with a little foresight you may actually see or feel coming.

Pulling back when things are going really well is not an easy thing to do and with risk can come great reward – but it should never come at the expense of your long-term goals and your investment objectives.

Even Snoop will tell you, you can’t have your brownie and eat it too.

I am Jhordan Dorrington and this has been the Dorr Report.

Click here to watch episode one of The Dorr Report, where Jhordan goes into detail on what negative interest rates are and what they mean for us and our economy.