Motley Fool Hidden Gems Investing - Easy Money, Government Stimulus, Speculative Boom: Lessons from The Great Depression

Episode Date: June 14, 2022

Most eyes are on the Federal Reserve in advance of (we assume) another interest rate hike. (0:25) Bill Mann discusses: - What he's watching in the market - Where he's been putting his money to work and which stocks he's been buying - His relative disinterest in IPOs as an event (13:23) Morgan Housel joins Alison Southwick and Robert Brokamp to talk about the speculative boom that caused the Great Depression, and how those lessons apply for investors today. Stocks discussed: BRK.A, BRK.B, MA, GOOG, GOOGL, DPZ Host: Chris Hill Guests: Bill Mann, Alison Southwick, Robert Brokamp, Morgan Housel Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl   Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. Chris Hill. Today, we've got Morgan Housel doing what he does best, looking at financial history and drawing lessons for today. Motley Fool Money starts now. I'm Chris Hill and I'm joined by Motley Fool Senior Analyst, Bill Mann. Thanks for being here. Bill Mann. Hey, Chris, how are you? I'd be doing better if the market was going higher, but in that sense, I have a lot of company, don't I? We would all be doing a little bit better if the market was going higher. Yes, exactly. I mean, I guess the good

news is that you're not necessarily wondering what you have done wrong. No, that is true. That is some solace. I wanted to get your thoughts on just sort of stepping back. I mean, sure, we could talk about Oracle's earnings if you really want to, but I'm sort of more interested in Bill Mann's big picture view of where things are right now. Because something Jason and I had talked about yesterday was just the level of pessimism in the market right now. I don't want to say it's unfounded, because when you have smart people like Jamie Dimon coming out and saying, I think there's an economic hurricane coming, and the only question is how bad it's going to be. By the way, we're

going to be doing X, Y, and Z with our balance sheet. We're going to be more conservative. If there's a lot of pessimism out there, at least it's grounded in something. Let's stick with pessimism for just one second. Do you look at the commentary? Do you look at the reaction and some of the comments from maybe not Jamie Dimon, but noted investors? Do you think it's in line with your thinking? Because there are some people out there saying, hey, look, this is bad, and I think it's going to get a lot worse. It's amazing to me that you bring up Jamie Dimon in his comments right out of the gate, because Jamie Dimon joined a CEO roundtable. He's told the story a number of times in the early

teens. And one of the first things that he did, the CEO roundtable, they all get together and they talk about, what's this next year going to look like? And Jamie Dimon went through the process. And you would think that CEOs know more than anybody else. He just had some researchers go back and say, okay, they have done this for every single year. Let's go back and see how accurate they were in their prognostications. And Chris, you would not be surprised to hear that they were not very accurate. They were not very good at prognosticating. The people who you would think, and they're in a semi-private room, right? They're not talking to the public. They're talking to each other. They're not very good about prognosticating. Now, I look at what's

happening now. Yes, Jamie Dimon came out and he said, I see a hurricane coming. He is at a structurally important bank, a financial institution. Yes, he sees the sheet music that's being handed to him. But if we were better at prognosticating, do you think that the S&P 500 would have only been allocated 2% to energy companies in 2021. If we were good at seeing what was coming, we're not. We are not good at seeing what's coming. Are you doing, sorry to get personal, but are you doing anything with your cash right now? Something Jason and I talked about yesterday was putting money to work slowly. I'll just say from in my own financial life. Earlier this year, when the market dropped what I thought was a

decent amount, I looked at some of the really stable, sustainably profitable businesses, that their shares looked like they were on sale to me. In some cases, they were. Companies like Microsoft and Johnson & Johnson and Apple and that sort of thing. I thought, okay, I'm going to buy some more shares of those to a company that basically fallen further. I'm one of those people that's like, I think I'm holding onto my cash flow right now. What are you doing with your money? I actually have been investing. One thing that's really important to recognize is that the price you pay is a form of risk. The higher the price of any company, if you can buy it at $10 a share versus $20 a share, it is essentially the same company. If you buy something at a higher

price, you are essentially, even if it doesn't feel like it at the moment, taking on more risk. The inverse of that is now. You have companies that are down 60%, 70%, 80%. Some of them are dramatically the same companies. Some of these companies should have never been priced as high as they were, and will probably never come back. But what's happening right now, now, somebody who lives in an emerging market would be very comfortable with what's happening right now because everything's getting sold. Every asset class, bonds are being sold, sovereigns are being sold, commodities are being sold, stocks are being sold. That is something that people in developing markets are very, they're not happy about, but they're comfortable with.

That type of indiscriminate selling suggests to me that we should, in fact, be looking at the other side of the risk equation and buying. I think it's really easy for people to say, well, this stock's down 90%, so therefore it must be cheap. Some of these companies are never coming back. But I have a hard time believing that Berkshire Hathaway, which I had bought some a few weeks ago, is really that deeply impacted, or MasterCard, or Google, or Domino's Pizza. these are companies that are incredible at making money. And over the cycle, and newsflash, we have not cured the economic cycle. Over the cycle, these companies will continue to make a lot of money. And the last I checked, that's the point of investing. It's Tuesday morning,

as you and I are having this conversation. And I think it's reasonable to say that if not all eyes are on the Federal Reserve. Most eyes are on the Federal Reserve and the meeting and the likelihood of a rate hike coming later this week. Are you watching that? And if not, what are you watching to give you a better sense of where the economy is going in the near term? I mean, I think it's really, it's interesting what's happening. And what we are going through right now is fairly unprecedented. In some ways, right now goes over the last decade, but also what's happening right now is the last four days or the last six months. Our economy is obviously struggling, but we are also seeing inflation. Usually,

when you have an economy that's struggling in the way that ours is now, both the United States and globally, the Federal Reserve or central banks are going to step in and add liquidity. But because we've got an inflationary environment, and it is dangerous, they are having to continue to raise rates, which does not bode well for asset pricing. But asset pricing, ultimately, at the end of the day, that is not the horse that leads the economic cart. I mean, it is actually the opposite. For me, what we're seeing right now is the backside, not just of two years of an incredible amount of liquidity being put into the market, but almost 15 years going back to 2008. We've gone through a decade in which sovereign debt around the world, in 2020, $17 trillion of it

traded at a negative rate, which meant that if you held the debt, you paid for the privilege. This is prior to 2015. That was a unicorn sighting. We are coming out of what has been one of the strangest economic periods in world history, not just our lifetimes. I'm talking 1,000 years of actual centralized financial systems. It just bears remembering that when you come out of something that's weird, that weird things are going to happen on the backside. I've been buying stocks. I'm not particularly convicted about it. If you were to tell me that the market was going to go down another 40%, I'd say, yeah, maybe. People are out there still spending six figures on a weird picture of a monkey that's got some code behind it.

So, who really knows? But I do know right now that the Fed is fighting something that was a natural outcome of some real financial stress. And at the end of it, we will hit an equilibrium. Last thing, and then I'll let you go. You had mentioned that some of these companies are not coming back. You and I have talked before on this show about the SPACs that just littered the market last year and the year before. Certainly now we look at some of them as public companies and think, okay, yeah, you probably shouldn't have. You were a money grab. This was a money grab, and you probably have no business being in the public markets.

Do you look at, I forget who said it, but I heard someone say recently that, you know, asked the question, the rhetorical question, who in God's name would go public in this environment right now? You know, are IPOs something that you look at as a positive sign somewhere, whether it's later this year or into 2023? Because it really does seem like, whereas we went through a long stretch of time where we didn't really collectively ask the question about any company going public, why are they going public? We just thought, oh, okay, here's a company going public.

It seems like, Bill, we're in an environment right now where if a company were going public, that would be the first thing we would ask. Like, really, you're going public now in this? The crazy thing is, I don't really care that much about IPOs, just because I like so much understanding how a management team is going to interact and behave as a publicly traded entity. I don't care what people say, it is an entirely different experience to have the public facing you on a quarter-by-quarter basis from when you were a private company. The thing is, Chris, there are hundreds of SPACs that have been stood up as buckets of money that have an egg timer, they have to continue to bring companies public. You are going to see

additional companies come public. I actually think that it is a little bit more of a target-rich environment. Now, you may see companies that are coming public through SPACs because there is a mutually agreed but not expressed desperation between the two. Like, we need the money, have the money, let's do a thing and we'll deal with the consequences later. You're going to see more companies come public. I tend to think of times like the SPAC bubble, so many companies coming public, you have to remember that they're not doing that for the benefit of investors. They are doing it at a point in time in which it is good for them. The fact that it is a much more difficult time to go public, may actually mean that it is a better time to be on our side of

the ledger and be buyers of stocks. I'm sorry, but your SPAC analogy just immediately brought to mind. A bartender says, last call, and two people just look at each other and thought, all right, why don't we go home together like this? That's right. We haven't been stupid enough yet, but there's just enough time. Bill Mann, always great talking to you. Thanks for being here. Thanks, Chris. In the wake of stocks falling this year, we decided to look back at other market crashes from history. A few years back, Morgan Housel joined Alison Southwick and Robert Brokamp

to talk about the speculative boom that caused the Great Depression and how those lessons apply for investors today. So, let me set the stage for you. It's the Roaring Twenties. In the wake of World War I, the nation's wealth more than doubles. This means that a lot of people had enough money to become full-blown consumers. They could buy newfangled things like electric refrigerators and radios, unless we forget the Model T. In this prosperous America, you could have anything, except alcohol, of course.

But the party did stop, and suddenly. So today, Morgan joins us for our series this month looking at market crashes in the U.S. And why not start with the big one, the Great Crash, Black Tuesday. But before we get into the actual crash, what was life like leading up to the Great Depression? I think whenever people talk about what caused the Great Depression, what caused the crash of 1929, it's always easy to point to one thing. But then, what caused that one thing? You can always keep going back in time and say, what really caused all this to happen?

And if we're talking about the Great Depression, I like to start in World War I. Something really important happened in World War I. Frederick Lewis Allen, who was a great historian who wrote a history of the 1920s and 1930s, he made this point that during World War I, to finance a war, they sold Liberty Bonds to average everyday Americans. Not just wealthy people, but everyday Americans were buying Liberty Bonds to finance the war. And it was the first time that most Americans had any experience with a stockbroker. Stockbrokers up until that point only dealt with wealthy people and aristocrats, and now it was everyday train conductors and farmers going in and talking to a stockbroker to buy

these Liberty Bonds because there's such a push of patriotism to buy these bonds. And because of that, not only did people get their first taste of what it was like to work with a stockbroker, but stockbrokers had to learn all kinds of new skills to sell to these average everyday people, and high-pressure sales tactics, how to needle their insecurities and get them to buy something that they really didn't need. But the salesman's job was to convince them that they needed this. It set up, in the late 19-teens, this early dynamic of Main Street's affiliation with Wall Street that had no relationship before that. That's where I think the seeds of the Great Depression were ultimately planted,

of getting everyday people who didn't have a lot of money, had no sophistication, no training or education, getting them involved with Wall Street. But then they had no place to get educated, either. You're just going to have to trust this stockbroker guy. That's the first seeds that were planted. And then, after World War I, all the troops came home, devastating period for the war, and the economy instantly falls into a really deep recession, really bad. high deflation, really high unemployment in the early 1920s.

Frederick Lewis Allen makes this really interesting point, I think, that between the war and then the recession when people came home, the people just got tired of being tired. After seven years of everything going wrong, there was a period in the early and mid-1920s where people just said, I'm ready to have fun again. We've been dealing with a decade of everything going wrong between war and the recession. I'm ready to let loose and have fun again. It was almost like the spark that he wrote about, that in the early 1920s, people were just ready to have fun, and they just let loose.

A few other things happened at the same time that's really important to the lead-up of the Great Depression. To continue on with the stories of really awful things happening, in 1921, there was a really awful famine in Russia, and the United States wanted to do something about it. The U.S. government set an artificially high price for the price of wheat and told farmers, as much wheat as you can grow, we will buy it from you at this inflated price. The price of wheat at the time was, I think, $0.40 a bushel. The government said, we will buy as much as you can grow at $1 a bushel, so that they

could send it to Russia to help break the famine. So, you had all these farmers that overnight were minting money and planting as much wheat and corn as they could and making a fortune doing it, selling it to the government. It was so lucrative to be a farmer back then during this time because of these inflated prices. they had what were called suitcase farmers, which were people from Chicago and Minneapolis who were lawyers or insurance salesmen that would take the train into Iowa and buy a small farm and grow wheat. They'd come in with their suitcase and they'd be farmers on the weekend and go home because you can make so much money doing it. Farming was such a big part of the

economy back then that in the early 1920s when this started, it was just a huge stimulus to the overall economy, this big farming surplus that was going on, at the same time that you had people that were ready to get back into having fun and helping grow the economy again. So, almost overnight in the early 1920s, the U.S. economy took off like a rocket ship. Part of that was coming out of this recession in the early 1920s, and then you combine that with this big farming stimulus, and it was just, boom, off to the races. And because of the psychology at the time, Frederick Lewis Allen writes a lot about this at the time. People were so ready to have fun again that you mix that excitement with

that much extra money that was flowing around, and it was just a boom time in the 1920s. And you mix optimism with a lot of money, and people start making really bad decisions. And then, if you also add in debt, because a lot of people didn't necessarily have all the money to buy these new consumer goods or these investments, but there were people who are willing to lend them money to do that. Back then, the marginal requirement to borrow money to buy investments was only 10%. If you wanted to buy $1,000 worth of stock, you only need to put down $100. All that thing had to do was drop 10%, and then you've lost all the equity in that investment. Also, during this period in the 1920s,

two of the most important inventions of the 20th century, the car and the radio, were coming online for average, everyday people. That just added to the sense of optimism of what we could do as a country, what our potential was. It completely changed American life in the span of a few years, the car and the radio. Then you add all that together, you have people who, for the first time ever, have connections to stockbrokers, you have this big economic boom from farming, and you have all this optimism coming from the car and the airplane. In the 1920s, I think a lot of people know, the booming 20s, the roaring 20s, it was a great time for a lot of people. That just led to a lot of excitement and over-optimism.

So, it led to, in the late 1920s, probably the biggest stock bubble that we've ever seen. That really took place in just a year or two. It was really in 1928 and early 1929 that the market just went straight up, just went parabolic. Then, day after day after day, Stock prices for all companies were just going straight up and increased by several multiples just in the late 1920s. It created a bubble. It's hard to measure it because earnings and whatnot weren't measured back then, but probably much bigger than the 1999 stock bubble. Just completely detached from reality by 1929. Let's get to the actual bursting of the bubble. What's interesting, too, is that it didn't happen in one day. We talk about the

crash of 1929, but that played out over a week. It was basically three days in October of 1929 where the market fell about 12% each day consecutively. I think putting that together, rather than all happening at once, having it spread out a little bit, gave investors at the time... I don't think it was as traumatic as we would expect it to be today, because it happened slower than, say, the crash of 1987. It just played out slowly. People were so accustomed to prosperity and rising stock prices that the 30% decline that happened in October, was it a big deal? Of course. Did stockbrokers jump out the window? Literally, yes. There are accounts of that happening. But I think people were so shocked.

And a 30% decline in the grand scheme of things isn't that huge. In three days, it's big, but it's not that big a deal. Stock prices fell 20% in the U.S. in 2011. there was still a pretty big sense of optimism at the time. Herbert Hoover, who was president, and Andrew Mellon, who was Secretary of Treasury at the time, made a big push in the media and newspapers to say, business is sound, the fundamentals are strong, this is a temporary break as they called it back then, but we're going to pull through this, everything is OK. I think people bought it at the time. As the month kept playing out into November and December of 1929, things stabilized and recovered a little bit. The big idea was,

That was it. That was tough. But things are going to move on and things are going to keep going. So there was a little bit of a rally after that, but people really had no idea what was still to come. Yeah, so what was still to come? How long are we going to suffer here? Even by mid-1930, most economists thought, by looking around at what was happening, that we were in a pretty bad recession, but nothing more than that. A pretty severe recession, but nothing of historic terms. It was the summer of 1930, and as we moved into 1931, the banking system started cracking, which was caused a lot by two things.

One, all these investors with margin debt were buying from banks who were now defaulting on their debt that they were borrowing against. But also, wheat prices and corn prices started plunging. So then, farmers, who had been a big driver of the economic boom in the 1920s and had leveraged up with all kinds of debt to buy farm equipment and whatnot, were defaulting at record rates, too. Back then, the Federal Reserve worked in a different way. They didn't bail out banks like they do today. And more importantly, the big thing was, there was no FDIC insurance. So, if your local bank was going down, your life savings was going with it.

So, that began the bank runs of the early 1930s, which is where things really started getting out of hand. It peaked in 1932. There was a starting wave of bank failures in 1932. The big one, actually, was a bank in Austria called Credit Ansalt in Vienna. It was a huge bank in Austria, and it failed overnight, and no one really saw it coming. There have been some economists who've mapped this, how it happened. After Credit Ansalt failed in Vienna, then it spread to Paris, and then spread to London, and then eventually spread to New York. Then it was a bank called the Knickerbocker Trust in the United States that failed in New York.

After that, the curtain just came down. Knickerbocker. That's the most perfect name for a failing bank in the 1920s. You couldn't write that. After the banks started failing, that's where things started getting really ugly in the United States. Now we're into 1932. We're three years after the crash of 1929. To me, that's probably the biggest misconception of the Great Depression. There was a crash in 1929, and then boom, welcome to the Great Depression. And it wasn't. The first couple of years played out slowly over a period of many, many years. And if you think about the 2008 financial crisis, the worst of that was really contained

in a 90-day period. It was late 2008, September, October, November, and then it was pretty much over. The Great Depression played out over three years. That, I think, did the opposite of what the 1920s did. People just got accustomed to pessimism. Their hope vanished after you'd has been beaten up consistently for three years, people just lose all their optimism and all their faith. That feeds on itself. If businesses and employees and investors don't have any optimism, don't have any confidence, then it's really hard to get the economy going. Nothing goes up. The stock market bottomed in mid-1932. Unemployment in the economy bottomed in 1933, four years after the crash.

How did we recover? How did we get out of this? This is where things could get political. A lot of people still disagree with this 90 years later, but Franklin Roosevelt is elected in 1932 and starts the New Deal. There's that element of it, of economic stimulus from the New Deal, changing tactics and whatnot. There's also a thing with all recessions, that prices get low enough, stock prices, housing prices, labor prices, if things get low enough, then it's attractive to get back in business. Every investment, every business opportunity is attractive at some price. Prices got ridiculously low in the 1930s everywhere. The price of labor, the price of food.

By 1932, stock prices were down 89% from their 1929 peak. Completely obliterated. But there are still a lot of good companies out there. You talked about the FDIC. Did that come out of this? What other legislation or regulation came out following the Depression to keep this from happening again? It's obviously never going to happen again! Knock on wood, right? No, it's only going to happen for the next three episodes of this podcast. Not this bad, of course. The few big ones besides FDIC insurance, one was the SEC. A lot of the reason that the market grew so high in the 1920s is because

fraud and bad behavior in the stock market was rampant. One of the big actors during the 1920s who made a fortune ripping people off in the stock market was Joseph Kennedy, JFK's father. He made a fortune in the 1920s bringing together groups of investors, and then they would corner a stock and put out false information. Since they had a corner, they could drive up the price. Then once rising prices got other people excited, they would dump their shares back on them. There was all this misbehavior in the stock market that was perfectly legal back then, even though they were really taking advantage of vulnerable people. With that came the SEC. The punchline of the story is, you know who the first

chairman of the SEC was? Joseph Kennedy. Same guy! What was FDR's quote about that? I forget. Something along the lines of, if you want to catch a bank robbery, you have to put a criminal in charge. Something along those lines. That was the other big thing besides the FDIC, was the SEC. As we're winding down here, what is your takeaway for investors? What's one good lesson from the Great Depression that our listeners should take away? There's a lawyer during the Great Depression in Benjamin Roth who kept a really incredible diary. He was a lawyer, but he was an amateur

investor, too, and an amateur economist. Really smart guy. His son published the biography I think five years ago. It's called A Great Depression, A Diary. It's really fascinating just to see a layman's perception of what happened during the Depression. He constantly writes about in 1932, 1933, he uses the same phrasing over and over again. He says, everyone knows stocks are cheap, but nobody has any cash to buy them. He talks about it all over the place. He says, not just stocks, he's talking about buildings and real estate in his neighborhood. There's a warehouse down the street. It's selling for nothing, but nobody has any cash to buy it. He writes about it in the sense of all this opportunity

that's lost. If anyone had any cash during that period, they could mint a fortune. There was just opportunity laying right in front of them, but no one had any cash saved up. To me, I used to write about this quite a bit when I was here at The Motley Fool. People really discount cash as an asset when things are going well. Cash doesn't earn a return. Why would you want to earn cash, put your money to work, it's not doing anything for you. The value of cash is what it can do for you when things turn down, and things eventually will. That's when you earn your return on cash. I've always held more cash than I think any financial advisor would say is necessary, but that's why I do it. I think I'm earning a good return

on my cash. I'm just not going to realize that return until things get hairy again. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill, thanks for listening, we'll see you tomorrow.