You might have noticed that in the last few weeks more and more of my posts have been about historical context. Quite frankly for the past couple of months (as the market has been increasing) I have been doing my historical fact checks. I am a discipline of statistics and when you have once in a lifetime opportunities you need to need to look way back, and I mean way back in history.

I started my search in the 1700’s and moved forwards. For my research I read books and papers, but I have found Wikipedia has some very nice links about panics, recessions and depressions. I was surprised at how many of the references were in Wikipedia.

So you want to know how many panics and depressions we have had up to the Great Depression, which could be considered equivalent to the Great Depression?

  • Tulip Crisis 1630’s
  • Stock Jobbing 1690’s
  • South Sea 1720’s
  • Government Bonds 1750’s
  • Panic of 1792
  • Panic of 1819, 1825, 1837, 1847, 1857, 1873, 1884, 1890, 1893
  • Panic of 1907

Don’t believe me? Do your research and you will see that it is utterly amazing that the central banks and the governments of this world managed to hold this world together as they have since the Great Depression. We have been spoiled!

Between them all here is what I think are the common aspects:

  1. Its all the fault of the speculators! Does not matter what time period, but the culprit of the panic is always the speculator, not the average Joe on the street.
  2. There is always a new paradigm. Until the day of the collapse there are always people who said, “We have entered a new paradigm”
  3. There is always a scapegoat, like our current scape goat called Goldman Sachs! It is amazing that those who prosper in these times are the evil scapegoats who had insider knowledge and wanted to plunder the innocent person.
  4. There are always those that get wiped out financially.
  5. There is always a debate on those who say, “let the house burn”, and those that say, “we need to save them for the sake of the economy.”
  6. There is always a discussion on how to solve this so that it does not ever happen AGAIN.
  7. And finally there are comedians and smart a***s who knew better and gave out “wise comments”.

From looking at the various scenarios and weighing their causes one conclusion that I have come to is that actions like Bernanke and the central banks were the right actions. Capitalism is good, but when you let things burn down you are prescribing an overall hardship that affects all. As George Soros has iterated the problem is not capitalism, but that people like Friedman assume people stay rational, which is not the case. When people act irrationally then things happen that should not happen. I have always believed this, and it is the basis of my entire investing system. I expect people to behave irrationally.

Many of you readers will say, “hey that is socialism and not capitalism”. This is not an argument about socialism vs capitalism it is about populism and societal well being. If the people suffer then those on top will suffer as well. There is no amount of talking and rationalization that anybody can do if the person has no food on their table.

Thus by arguing political leanings, you are arguing against the statistics of what has happened in the past.

The real culprit of these panics are the bubbles themselves. The bubble basis does not matter and it could be tulips, railroads, canals, stocks or Internet companies. It is the bubble and the diversion of capital to the bubble that is the problem. I have come to the conclusion that a bubble forms when capital flows to a particular sector constrict capital flows to other sectors. When this commences you are witnessing a bubble.

This capital flows diversion is an interesting concept because in each and every depression, recession, panic there was always a capital flow problem. What happens is that when the capital flows to the bubble other parts of the economy have trouble functioning. Thus those people who lives should be ok, are in fact beginning to fail. But because the bubble overrides the failings (there are more benefiting from the bubble than loosing) you don’t notice the beginning of the end of the bubble.

Since I tend to invest over the long term, and do not short I have come to an approach on how I would short using fundamental analysis. I would look at the capital flows for a company, sector, industry what have you. And if there are capital flows issues then I would say it is a warning sign and should be kept as a reminder.

Then when you feel the bubble is getting big enough start shorting step by step. The advantage with this approach is that you pay little in service charges in keeping the short. Most people would think you are crazy shorting the company, since there is a bubble.

So what would I short now? Nothing actually since we are not in a bubble. I think right now we are in a functioning efficient market…

BTW does this sound too easy? Actually it is that easy, but there is a catch, do you have the stomach to not be affected by the market? It is the classical Behavioural Economics problem. I am a contrarian investor and let me tell you it was easy for me to buy buy buy in February… Could you have bought in February?