Boom and Bust Book Review

Avoiding buying into the peak of booms and selling at the bottom of a bust is one of key skills of any investor. But what causes them? The recently published book entitled “Boom and Bust” by academics William Quinn and John D. Turner attempts to answer that question by a close analysis of historical market manias.

I found it a rather slow read to begin with but it proved to be a very thorough and interesting review of the subject. It covers bubbles through the ages such as the Mississippi and South Sea schemes back in the seventeen hundreds, through the railway and cycle manias plus Australian land boom of Victorian times to those in more living memory. That includes the Wall Street boom and 1929 crash, the Dot.com bubble of the 1990s and the sub-prime mortgage crisis in 2007/8.

The latter resulted in a world-wide financial crisis with particularly damaging effects in the USA and UK. Banks had to be bailed out and bank shareholders lost their lifetime savings. But the dot.com bubble had relatively minor impacts on the general economy.

I managed to sell a business and retire as a result of the dot.com bubble at the age of 50 because it was obvious that IT companies in general had become very highly valued. Software and internet businesses with no profits, even no sales, had valuations put on them that bore no relation to conventional valuations of businesses and forecasts of future profits were generally pie in the sky. One of the things the authors point out is that insiders generally benefit from booms while inexperienced retail investors and unwise speculators with little knowledge of an industry are often the losers.

How are bubbles caused? The authors identify three big factors which they call the “bubble triangle” – speculation, money/credit and marketability. The latter is very important. For example, houses owned by occupiers tend to be part of markets that are sluggish and not prone to volatility as buying and selling houses is a slow process. But when sub-prime mortgages were created a whole new market was brought into being where mortgages could be easily traded. At the same time, the finance for mortgages was made easier to obtain.

The latter was by driven by political decisions to encourage home ownership by easier credit and by the relaxation of regulations. Indeed it is obvious from reading the book that politicians are one of the major sources of booms. Governments can easily create booms, but they then have difficulty in controlling the excesses and managing the subsequent busts.

The Dot.com boom was partly driven by technological innovation that attracted the imagination of the public and investors. It might have contributed positively to the development of new technologies, new services and hence to the economy, but most companies launched in that era subsequently failed or proved to be poor investments in terms of return on capital invested. Amazon is one of the few success stories. As the book points out, market bubbles tend to disprove the theory that markets are efficient. It is clear that sometimes they become irrational.

There are particularly good chapters in the book on the Japanese land bubble in the 1980s and the development of China’s stock markets which may not be familiar to many readers.

The authors tackle the issue of whether bubbles can be predicted and to some extent they can. But a good understanding of all the factors that can contribute is essential for doing so. Media comments can contribute to the formation of bubbles by promoting companies or technologies but can also suppress bubbles if they make informed comments. But this is what the authors say on the Bitcoin bubble and the impact of social media and blogs: “The average investor was much more likely to encounter cranks, uninformed journalists repeating the misinformation of cranks, bitcoin holders trying to attract new investors to increase its price and advertisements for bitcoin trading platforms”. They also say: “Increasingly the nature of the news media is shifting in a direction that makes it very difficult for informed voices to be heard above the noise”.

Incidentally it’s worth reading an article by Phil Oakley in the latest issue of Investors Chronicle entitled “Tech companies still look good”. He tackles the issue of whether we are in another Dot.com era where technology companies are becoming over-valued. His conclusions are mixed. Some big established companies such as the FANGs have growing sales and profits and their share prices are not necessarily excessive. But some recent IPOs such as Airbnb look questionable. Tesla’s share price has rocketed up this year but one surely needs to ask an experienced motor industry professional whether the valuation makes sense or not.

The authors suggest that buying technology shares can be like a casino. Most of the bets will be losing ones but you may hit a jackpot. I would suggest you need to pay close attention to the business and its fundamentals when purchasing shares in such companies.

In conclusion the book “Boom and Bust” is well worth reading by investors, and essential reading for central bankers and politicians!

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Mello Meeting Report, Stopping Market Abuse and FRC Fraud Meeting

So far this week I have attended a couple of webinars. These are now getting totally out of hand now that folks have realised they are so easy to set up. I seem to have at least one lined up every day recently and sometimes as many as three. This can get very tedious if they last more than a few minutes each.

The first one I attended on Monday was the Mello meeting and I dropped out after a couple of hours so can only report on the first two sessions. The first one was Keith Ashworth-Lord and a colleague in Sanford DeLand Asset Management talking about their Buffettology Fund. Keith is always worth listening to as his approach to investment very much the same as mine, although I don’t actually hold the fund as I prefer investment trusts. The Buffettology fund has a great performance record, and is of course based on the investment style of Warren Buffett.  

One interesting comment he made was “one day we will stop investing in retail – probably now”. His key tips for investors were “do your research” and “monitor the delta” (i.e. the changes in financial ratios).

It was disappointing that the company did not manage to launch a new small cap investment trust, but they tried to do so when nobody was buying anything in the market. Shares might have been cheap then and have since recovered so it was a missed opportunity.

Of course like all fund managers Keith talked his own book, i.e. promoted the merits of his holdings, some of which I also hold. Keith was of course very careful in what he said – no direct encouragement to buy the shares. But this is a form of market abuse of course, in the same way as the shorting brigade rubbish the holdings where they are short by publishing derogatory articles. It has occurred to me that one way to stop both the approaches is to introduce a simple rule that nobody (person or company, or their associates) can publish articles or talk about companies in which they have an interest. That would surely stop both the positive and negative promotions.

That would of course imply that only independent journalists and media could comment on stocks or funds. Would that be a bad thing?

Some people argue that those who short stocks and publish derogatory articles on companies at the same time are doing a public service in bringing to the attention of the public the issues, and without them the problems might go unreported. But that is not necessarily so – see the reporting by the FT on Wirecard for example.

The second Mello session was a presentation by Sumo Group (SUMO), a video game development company which was new to me. There is a big demand for their services, revenue has been growing rapidly and financially the profits also now look good. It’s worth looking at their web site for examples of some of their work. They are clearly operating in a growth sector.

But I have my concerns. Do they have any IP or barriers to entry? Not apparently so. It also looks a very labour-intensive business, dependent on recruiting skilled developers. At the same time they seem to be mainly sub-contractors to game publishers, rather than owning their own games. Also they appear to have a “project” based business model which I never like. This is the kind of business that does well when demand is strong, but can come a cropper when it fades away.

Yesterday I attended a presentation by the Financial Reporting Council (FRC) on a revision of Audit Standards to assist the detection/prevention of fraud. This was a joint UKSA/ShareSoc promoted event. The main presenter was James Ferris.

The intention is to remove the ambiguity over auditor responsibility to identify fraud, and not just a director responsibility (because as one person pointed out, sometimes the directors are complicit in a fraud as happened at Patisserie and in other companies).

These changes to the relevant audit standard might be helpful but there is also the question of increasing the obligations of directors to identify and prevent fraud – this is an issue the Government is considering.

Mr Ferris said that auditors need to generally develop more fraud awareness which one cannot dispute.

There is a public consultation on this matter which has recently been published and which you may care to respond to – see https://www.frc.org.uk/news/october-2020/consultation-on-revised-auditing-standard-for-the . The first document mentioned there contains useful appendices on how to identify fraud.

I consider most of the proposals therein to be sensible, but of course prevention is better than cure. Auditors are unlikely to detect fraud until they have been running for some time, and the money extracted may have long disappeared. Tougher penalties for corporate fraud and the publishing of false accounts are also needed.

Finally we seem to be heading into the normal pre-Xmas market boom that happens most years. This has been accentuated by many people not being able to spend on shopping, holidays, restaurant meals, etc, so the savings ratio has gone up (less spending, more saving). With deposit interest rates at record lows, a lot of money has clearly gone into the stock market. The hope of a Brexit free trade deal at the eleventh hour is also boosting optimism while the economic impact and high Government borrowing associated with the epidemic and lock-downs is ignored.

I think I’ll stand aside from this market euphoria as I am already fairly fully invested.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Companies House Changes – 3 Consultations, and Banning Short Selling

The Government has issued three public consultations covering these subjects:

  1. Improving the quality and value of financial information on the UK companies register.
  2. Enhancing the powers of the registrar.
  3. Implementing the ban on corporate directors.

These follow on from a previous consultation entitled “Corporate Transparency and Register Reform” which contained proposals to reduce fraud and improve transparency, and which I reported on here: https://roliscon.blog/2019/05/11/changes-proposed-at-companies-house/ and you can see my response to that consultation here: https://www.roliscon.com/Corporate-Transparency-and-Register-Reform.pdf

The latest consultations can be found here: https://www.gov.uk/government/news/government-launches-consultations-to-crack-down-on-company-fraud-and-improve-corporate-transparency

These proposed changes will certainly improve the quality of information on the Companies House Register and in general should be welcomed, but they will impose more obligations on smaller companies. The consultations may be of particular interest to company directors and those who file information with Companies House such as accountants and company secretaries. But they ask a lot of questions, so perhaps best to review and respond to these consultations over Xmas. There are easy on-line questionnaires to which you can respond.  

Banning Short Selling

There was an interesting article in the Financial Times on short selling yesterday. It reported that South Korea is to attack those who bet against companies by short selling and is threatening jail and hefty fines. They are particularly concerned about “naked” short selling where stock is sold when not owned (e.g. rather than by borrowing it first), but they have also extended a ban on all short selling. Similar bans are in place in Malaysia and Indonesia.

The intention appears to be to halt speculative trading. Is it wise to do so? My view is that short selling as such can assist markets to identify a realistic price on stocks, but the problem is that it can also be associated with abusive practices where those doing so do not just keep their opinions to themselves but broadcast negative comments on a stock. Those comments can be sometimes fair and accurate but at other times they are not. It is very difficult for companies to respond to such comments and get them corrected or removed.

Of course one can argue that this sometimes happens in reverse, i.e. stocks are promoted by puffs or ramping to drive the price higher. Company directors themselves can be the source of such activity. The real issue is about media regulation where in the modern world both positive and negative commentary can be widely promoted on the internet without any regulation whatsoever.

That is the problem that needs tackling in essence, and banning short selling is at best a temporary measure that does not attack the underlying issue and in particular the excessive speculation that can take place in stock markets.  

Naked short selling might reasonably be banned though on the principle that nobody should be trading shares in which they do not have a financial interest. At least if they have a long holding, they may take the interest of the company into account. But if they have a short holding, their interest may be solely in damaging the company.

It is a long-standing principle of insurance that you cannot insure something in which you do not have an interest – for example someone else’s life unless you might suffer financial loss as a result of their death. Why? Because it is widely acknowledged it could lead to abuse, or in the case of life insurance that death might be hastened! You have to have an insurable interest to obtain insurance. That I suggest is a good principle to follow on share trading.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Burford Capital Share Trading and Why No Transparency?

Burford Capital (BUR) was affected by a shorting attack from Muddy Waters (Carson Black) who have published several dossiers attacking their accounts. As I have said before, I have never had any interest, long or short, in the shares of that company but I have publicly questioned the business model, their corporate governance and the prudency of their accounts. But other investors take a different view of the company.

Burford have alleged that there was some manipulation of their share price taking place at the time of the shorting attack, i.e. market abuse by such methods as “spoofing and layering”. They went to court to force the LSE to disclose the share trades so that they could determine whether this was in fact the case and to identify who might have been doing it. The application was supported by a joint letter from ShareSoc and UKSA.

The High Court rejected the application on a number of grounds. For example because the FCA and LSE had already reviewed the matter and could not confirm the allegations.

ShareSoc director Paul de Gruchy has now published a blog article which covers the judgement. See: https://www.sharesoc.org/blog/regulations-and-law/slave-to-the-algorithm-burford-and-the-importance-of-maintaining-confidence-in-a-broken-system/

It is very good analysis of the problem of identifying market manipulation when the market is dominated by high frequency trading. For example it says: “An ordinary investor may wonder what strategies could be revealed by releasing the trading data in relation to a single company on two days. It appears that there is a genuine fear that “algorithmic” trading companies would have their secrets exposed by this information”; and: “This may look like market manipulation, but the LSE, who have a commercial interest in maintaining the income stream provided by high frequency, algorithmic trading, say it is “legitimate”. Indeed, it is a noticeable feature of the judgment that the judge appeared unconcerned by the clear conflict that the LSE has in being a commercial business seeking to maximise revenues with its role in identifying market manipulation. A cynic might say that the difference between “legitimate” and “illegitimate” market manipulation depends on the level of fees you pay to the gatekeeper”.

The share trading all took place some weeks ago. What damage could have been done by disclosure of the trades? The Court could have imposed confidentiality conditions to avoid wider public distribution if they had a mind to do so. The fact that the FCA have given it a whitewash hardly inspires confidence either as they have been notoriously inefficient in pursuing wrong-doing in financial markets.

We do not know whether there was any market manipulation taking place and we will never know as Burford is not going to appeal the judgement. That is a shame because transparency is all important in financial markets.

Investors do want to know when market manipulation is taking place and who is doing it. As Mr de Gruchy says: “It was hard to imagine how confidence in the markets could be further eroded. This judgment has managed to do so”. I completely support ShareSoc’s stance on this issue.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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