We Study Billionaires - The Investor’s Podcast Network - TIP520: Investing Through Post-bubble Markets w/ Jamie Catherwood

Starting point is 00:00:00 You're listening to TIP. In this episode, I welcome back financial historian Jamie Catherwood. Jamie is a client portfolio specialist at Oshanasi Asset Management and also the author of the popular blog, Investor Amnesia. In my conversation with Jamie nine months ago or so, episode 427, we dove into what drives market bubbles, fraud, and mania. After seeing the largest asset bubble in history begin to burst, I wanted Jamie's historical perspective on a post-bubble world. In this episode, you will learn how markets from

Starting point is 00:00:33 the 1800s can inform how we view our market today, how the frauds of today like FTX draw similarities to frauds of the past, exactly why market regulations developed in the U.S., how the crypto market resembles the early days of the stock market, where the term bankruptcy comes from, and a bunch of fascinating facts and stories from the past. It's always a pleasure to speak with Jamie and hear his encyclopedic knowledge of financial markets. I hope you enjoy it. So with that, here's my conversation with Jamie Catherwood. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to The Investors Podcast. I'm your host,

Starting point is 00:01:27 Trey Lockerbie, and I'm happy to welcome back to the show, Jamie Catherwood. Jamie, welcome back. Thank you so much for having me. Honor to be back. Well, with the last year we just had, and it's been about a year since you and I last spoke, you know, you being a historian, I've been eager to ask you a question that comes up a lot over the last year about what period of history most resembles today. I know that there's been a lot of comparisons to the 1970s thrown around, but I figured you might have some different ideas around maybe other periods in time that look like

Starting point is 00:01:56 what we're seeing today. Yeah, so anyone that's familiar with my work will know that I, like, I like to look at things before the 1970s. I figured the 1970s weren't old enough for you. Yeah, 1870s, we're talking. But in all seriousness, if you do want to read about that, my colleague at Oshanasi Asset Management, Aaron Stanhope, a member of our research team and client portfolio manager, he wrote a great paper called The Great Inflation. So if you go to our website, Osam, osam.com, you can find that. And he kind of walks through the similarities and more importantly, the key differences between the 70s and today and why this is

Starting point is 00:02:39 not like a 1970s great inflation. But to actually answer your question, I would say that the period I'm finding most interesting in terms of a parallel to today would be the 20s, which I'm sure most people know by now, but I found really interesting since honestly COVID started the similarities in progression and timeline between the kind of early 19 or late 19 teens and 20s with today because while we obviously at least knock on wood didn't have a don't have a world war today it looks like that also might be following path when the rush of Ukraine stuff started but thankfully so far that's been avoided but in a hundred years ago you had a pandemic with the Spanish flu after that you had a wave of summer protests around race

Starting point is 00:03:27 called the Red Summer of 1919, which was kind of similar to the George Floyd, Black Lives Matter summer of protests and kind of demonstrations. And then you had a reopening where things were really kind of speculative and surging to kind of make up with for the pent up demand that had existed while we're all locked down, which also occurred coming out of World War I and Spanish fully 100 years ago. But then in 1920, 1921, you had a really sharp and severe recession. which was very short, but again, it was a problem of, in that case, rampant inflation very quickly turning to rampant deflation. It was an interesting period. But then after that is when you got the roaring 20s, but people kind of like to skip over that part when they talk about the roaring

Starting point is 00:04:15 20s of, you know, came out of the pandemic and then we had a recession. And then we had the roaring 20s. And so today, obviously, the parallels are pretty obvious. We had a pandemic. We had the George Floyd summer, and then we had the recession. And now the question is kind of, are we going to keep following roughly in line with the 20s or that we would be experiencing or on the precipice of experiencing a true like roaring 20s? Or is it going to be something different where the economy takes longer to kind of rebuild and truly get back to the pre-COVID levels? And so time will tell. But I think in terms of similarities, there are few periods that have so much in common. And so we'll see.

Starting point is 00:04:59 I know we're going to talk about that later, but it'll also be interesting to see like the 20s, obviously a great deal of speculation in a largely unregulated asset class. In that case, equities, because it was before the 29 crash and a lot of the kind of regulation that came in after that. And today we have crypto. So we'll come back to that. But it'll be interesting to see how that kind of narrative also helps with each other between 100 years ago and to today.

Starting point is 00:05:25 In the article you just mentioned, and we'll be sure to add it to the show note so that our listeners can find it. There's a quote in it that I wanted to describe. I think it summarizes pretty well, but it says, as we dive into the impact on equity markets, there does not appear to be a link between high inflation and lower equity returns, most likely associated with the compression and valuations that occurs, as it did during the great inflation. That said, certain factors like value, most of the cost.

Starting point is 00:05:52 momentum and shareholder yield historically hold up quite well in moderate to high inflation regimes. So I thought that was a really interesting point because I think a lot of people think there is a high correlation between inflation and performance of stock. So I think it's interesting to dig in a little bit more there. Can you highlight anything else on that subject around performing assets, sectors, et cetera, that actually do perform or even factors that actually are best to kind of focus in on during periods like this? Yeah, so factors in general tend to hold up very well during inflationary regimes. In addition to this paper by Aaron, which goes through and shows kind of the returns across

Starting point is 00:06:34 different factors in different inflation regimes since 1926, there is a great paper by J.P. Morgan aptly titled The Best Strategies for Inflationary Times, pretty to the point. And in that paper, which you think came in like two years ago at this point, they are for factors that they looked at essentially eight high inflation regimes starting with, I think coming out of World War II. And then there's been like eight kind of main inflation regimes since then. And so they look at how different assets and kind of investing styles or sectors performed in each of those regimes and then also on average.

Starting point is 00:07:14 And so they found that across those eight regimes that from a factor standpoint, momentum was the best performing factor across all inflation regimes and the size factor was the worst. And then for sectors, energy was the best sector across all eight inflation regimes and consumer durables. And so like consumer staples was the worst performing kind of by some margin. And so it's a really interesting paper and it was interesting to see momentum in their research was the highest performer. I was also very surprised to see that. What do you think is causing that the momentum?

Starting point is 00:07:53 It's just that there's more speculation that comes around periods like this. I guess so. Honestly, I'd have to look back into it. It's been a little while since I read the paper. But yeah, I was pretty surprised, honestly. But I'm sure there's some good reason listed in the paper. When you and I spoke about a year ago, the market was just sort of beginning to crack. I mean, the S&P was down from a tie about 11%.

Starting point is 00:08:13 So there was a lot of speculation at that time around whether this was just a correction. or if we were actually going to enter into a bare market. And so I'm curious just from history, if you've learned anything from sort of post-bubble markets, because obviously our last conversation was built a lot around bubbles, how they occur, and why they might burst. So I'm kind of curious about what you see happening in the aftermath of a big bubble bursting like the one we're seeing now. Yeah, I think you see a couple different things, which I know again, we'll come back to with

Starting point is 00:08:46 the whole FTX kind of unraveling. But what you tend to see in general is a lag between, as a friend Jim Chanos likes to say in his class that he teaches on the history of fraud, that the fraud cycle lags the market cycle. And so what that means is that when there's a bull market and people are more willing to kind to suspend their sense of disbelief and they're a little more willing to kind of not even willing, but they just inadvertently kind of subconsciously do less due diligence because when things are going up, you just feel less of a need to kind of find reasons to find a negative problem with an investment. As long as it's making money, there's a little reason to question it.

Starting point is 00:09:28 And then conversely, when everybody starts losing money in a downturn and financing dries up, but also your asset values are dropping, then that tends to be throughout history where frauds and not even full-blown. and frauds, but just kind of bad business models and bad businesses in general that might have been able to kind of skate by on hype and momentum in a bull market. You see a lot of those companies get unraveled and called out in the bear market because they're just not able to kind of smooth over the cracks with stories and narratives anymore. And, you know, precarious financing. The market definitely prefers facts and statistics over exciting stories when people are losing money. I think, and not to just keep quoting him, but Chaynes has said that a stock price is the best prosecutor and defense that you can have because when stock price is good, you're kind of untouchable.

Starting point is 00:10:29 And when it's bad, people have questions and you need to have answers. And so I think today we've definitely seen, even if not as much in equity markets, certainly in some other asset classes that might be more digital. You've seen some unraveling of many of the players in large exchanges in some cases. And so we'll continue to see, I mean, we saw an equity market is not with necessarily frauds, but just the wave of downsizing and layoffs. And specifically the tech sector and a lot of these kind of VC funded startups. either slashing their valuations or slashing their headcount once the bear market started because a lot of, even in the private sector, the comparisons to publicly traded tech companies move to private markets in a negative direction. And so I think some of that stuff in hindsight,

Starting point is 00:11:20 you could have seen coming, like how many employees do some of these companies really need and how many benefits do they need to offer in a bull market? Well, that matters a little less. But when your company is losing money and the stock price is going down, then you have to make kind of tougher decisions. And so just generally, I'd say whether it's fraud or just kind of questionable business models, I think those all get found out in the bear market. It's reminding me of, you know, the Bernie Madoff. You know, there's a great new docu series on Netflix.

Starting point is 00:11:53 I even watched the whole thing. I'm about halfway through. But when you mentioned when the stock market does, goes, you know, the prices are bad, you have to have some answers. This was interesting because apparently as he was starting his kind of market maker business, which was legit, as I understand it, he also had this kind of shadow advisory firm. And he lost everyone's money early on. And it was about $30,000. And he borrows it from a friend, gives it back to everybody. And instead of tells him, hey, I lost all your money. I'm going to make you whole. He said,

Starting point is 00:12:23 I was, you know, I sold everything before this happened. And luckily, you know, you're going to get your money back, which just made him look like a genius, much more money piled in. It just, it speaks to sort of the, you know, the psychology around markets, right? Instead of hearing, you know, hey, the market's going bad, but he had a good answer for it. That meant it actually did the opposite you might expect and more people wanted to give him money. Yeah, it's like we just describe. It's funny when we have no idea of the context, but we know the outcome. So we ascribe like a narrative to it without actually knowing if it's even remotely true. Oh, he's just a genius investor that avoided the crash, not, oh, he actually lost everything

Starting point is 00:13:00 and had a friend give him a loan. Yeah, so sometimes we believe what we want to believe, right? Exactly. But he's a great example of that kind of unraveling with the 2008 crisis is when his kind of pyramid scheme got highlighted. Enron after the dot-com bubble burst is another example. There's no shortage throughout all of history. basically every big kind of speculative bubble. Once you see that unravel, you tend to see a lot of these

Starting point is 00:13:27 sketchy and questionable actors and businesses get outed. So on that note, the biggest fraud we've seen so far in this downturn is obviously FTCS. And while that's not market or equity related, it's obviously in the crypto space. It still seems to be pretty influential. And I'm curious if we'll see anything like that in equities, given all the regulation we have around it. You know, many people were surprised to see FTX and just to give you some idea. Apparently, the Bernie Madoff's game was around 65 billion. You know, FTX is, I think, around 8 billion.

Starting point is 00:14:03 And but still huge, right? And a lot of people were very surprised to see them file bankruptcy essentially overnight. So it brought up the phrase bankruptcy to me. I was kind of curious about this. So I wanted to learn a little bit about the history of bankruptcy. I would look to you or someone like you to share something about where the term bankruptcy comes from? Essentially, back in the 14th century in Italy, their bankers at that time were conducting their business and transactions off of a bench. A bench is what they called it,

Starting point is 00:14:36 but it really looked kind of more like a big table. But for all intents and purposes, it was this bench that they would sit on, they have the table, and that's where they would basically sit in squares in Italy. So you can picture somewhere like Venice and all these Venetian bankers sitting out in a courtyard and they're doing their banking from this table. If a banker went insolvent, though, and they could not continue lending out money or meeting their payments, then to signal and kind of shame that banker publicly and to let people know that he was insolvent and had gone bust, the kind of authorities or other bankers would break that person's bench in half as just kind of public signal. Like this guy literally blew up, he broke his bench in half. He's insolvent. And the

Starting point is 00:15:20 Italian, sorry to any Italian listeners, brace yourself. The Italian phrase at that time was Banka rupta. That meant broken bench. And so obviously you can see how over time banka rupta broken bench goes from broken bench to bankruptcy. So bank erupta, bankrupta, bankruptcy. That's where we get the term bank drop from because it goes back to broken benches when a banker went insolvent, they smashed his bench. And so broken bench equals bankruptcy. Let's take a quick break and hear from today's sponsors. All right.

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Starting point is 00:20:00 All right. Back to the show. So for those who stayed away from FTX and the like and even crypto in general, a lot of them are probably taking a victory lap now and saying I told you so. I love that you highlighted in your blog that for those that view crypto and digital assets is nothing but a lawless cesspool of frauds and scams, it's worth remembering that equity markets were no different in the 19th century and early 20th century. The 1800s endured a full century of rampant fraud and market manipulation before finally getting its act together. So I wanted to see if you could give us some analogous examples to FTX that we saw in the 1800s. Yeah. So there's no kind of shortage there.

Starting point is 00:20:44 I would say that the 1800s, so essentially the point of my piece was that today we're seeing everything in crypto kind of play out at a much faster speed simply because of the technology available today. but also we're witnessing more of it in real time just because of like social media and news and the internet obviously compared to the 1800s. And so everything is just kind of happening faster. But in the 1800s, I mean, there was everything that's going on in crypto today was happening in the 1800s in the stock market and even early 1900s. It wasn't really until 1929 crash, as we'll get onto, that substantial regulation came in to place, I think it was not until 1909 that like any type of ruling around insider trading

Starting point is 00:21:36 was made. And even that was like a court case ruling and didn't really lead to widespread kind of legislation or regulation. But it was the first time that any kind of ruling was made. And so basically any time before 1909 and really 1929, there were not really any rules around insider trading. One of my first. favorite stories was of a stenographer at a company, I think it was like a mining company. And she knew because of her position that there was $10,000 missing from the company is like Treasury. And she knew that it was going to become public.

Starting point is 00:22:19 And so she shorted the stock. And from shorting the stock, because she made a ton of money once the news came to light that, oh, like there's $10,000 missing, like someone's taking money from the corporate coffers. The stock price plunged and she made a bunch of money from shorting it. But when everyone discovered the missing money and then saw that she's, you know, wearing nicer clothing and really like upgrading her jewelry and everything and she has been spending a lot, people just assumed, oh, she took the money. But it really was no, she just knew that the money was missing because of her access to the documents.

Starting point is 00:22:51 And so at that time, that was perfectly legal. like no one questioned her motives or made her give back the money once it was found out. But today, you just, I mean, can you imagine someone using their position to look at the documents short their own company's stock and then be just totally, like totally allowed to keep all those profits? And so at a higher level, though, a point in that piece was that really the crypto market today to me is in a stage of like democratization, even though that's, the most annoying buzzword today. It's democratization without regulation. And so what you had with the equity markets in the 19th century and 20th century was you had the period in the 1800s, you know, the gilded age where it's the robber barons like Jay Gould, Jim Fisk, etc, all basically just manipulating the market, not obviously everything, but that was the era of robber barons who

Starting point is 00:23:50 got their name from doing sketchy things in the stock market and just kind of business. business generally. And so you had rug poles, you had insider trading, you had pools like moving stock prices for their benefit while leaving kind of retail investors holding the bag. And it wasn't until the kind of, what do you call it, bucket shop explosion and then shutting down in the 19, I think it was 1915 that the last kind of bucket shop or the federal ban on bucket shops was put in place, where the reason bucket shops have been so popular, I mean, those were just kind of degenerative speculating dens. They used to call them gambling dens

Starting point is 00:24:30 because you weren't actually buying or selling the underlying stock. You were just betting on the direction of the price. And so bucket shops were created, one, just because people love to speculate. But two, at that time, the minimum order sizes on the traditional stock exchanges were way too large for the average retail trader to participate in. And so they were kind of barred out generally just people that weren't wealthy were kind of barred out from the stock exchange because of the prohibitively high minimums. So the bucket shops, even though you weren't actually buying or selling the stocks, kind of gave you a way if you weren't rich enough for the stock exchange to participate in financial markets or at least kind of feel like you were. And so when the bucket shops were eventually shut down by the government, suddenly these people had nowhere to really go.

Starting point is 00:25:20 And so because the exchanges still at that point had not realized that, hey, you know, this crowd is actually a new, like, business. They're a whole new group of leads essentially and customer base if we just lower our minimums, which is what they ended up doing. And so suddenly you had this sea of like retail investors and speculators coming into the actual market because they could no longer trade at bucket shops, which had been shut down. And so you had a wave of retail investors and speculators coming into the market at a time when the market is heavily influenced by these speculators and robber barons. And there was no real protection in place to help them. And so one of the reasons the 1929 crash was so bad was it had up to that point, it was like the record level of retail participation in a market bubble.

Starting point is 00:26:18 crash because again, bucket shops being closed down, that was really the first bubble that they could broadly participate in because they were finally allowed to come on to the traditional stock exchanges after they lowered their minimums. And so it was after the 29 crash where the average kind of person that had been participating in the market and had not been discouraged from taking on too much leverage, they got destroyed in the aftermath. And so having such a high retail participation rate in that crash and then being so effective it afterwards led to all these acts and, you know, establishment of the SEC, et cetera.

Starting point is 00:26:54 And it was that kind of regulation that really helped kind of institutionalize the asset class from a regulatory standpoint. Because again, before there was really nothing in place to protect the average investor. And so it went from democratization where the average investor that had been in the bucket shop moves over to the traditional stock exchange. And so theoretically, markets have been kind of democratized because a larger number of people can access them. But before the 1929 crash, there was not a concurrent level of regulation alongside that democratization. So that led to a lot of people being wiped out in 29, not even just wiped out by the crash because market crashes are just a part of investing, but that they were not

Starting point is 00:27:42 kind of steered away from just outright frauds that people were knowingly peddling because they knew that there was the sea of kind of innocent retail investor crowd coming in the 20s. And so today, where I think we are with crypto and this whole FDX thing is that because I don't want to speak in generalities, but for this purpose, it's just simpler. The crypto community by and large is obviously against kind of government intervention regulation because it's kind of antithetical to crypto itself. It's all about, you know, decentralization. But having said that, I think that there is a need for at least some level of regulation just to have some safeguards in place because right now it's kind of at that point

Starting point is 00:28:27 of 100 years ago where there's democratization because that's, I mean, crypto is like ultimate democratization, but not enough regulation. And so you have just, I mean, if you look at the last like year, no shortage of high profile bankruptcies, frauds, etc., where a lot of people are left holding a lot of losses and there's no real regulation in place to protect them. And so while crypto and government regulation kind of go against each other, I think that in order for the long-term success of crypto and digital assets as an asset class, For that to be successful, I think there has to be some sort of regulation so that people not currently in the community will feel more, will feel safer about making a first investment if they feel like the asset class in space as a whole is less kind of sketchy and dangerous like it is today for a completely new investor. It's hard to tell as someone just entering the space, whether you're buying like a shit coin scam or an actual. quality investment. And so we'll see what happens. We'll see, I think FTX could be that kind of

Starting point is 00:29:43 tipping point where regulators really figure out like they need to put some type of framework in place to avoid something like this happening again. It seems like we're getting close to that because you know, SECs are considering all of these coins outside of Bitcoin as securities. So they're kind of falling under that regulation. I think that's going to only increase. You know, and the difference there, right, Bitcoin being actually decentralized versus a lot of these coins like FTT, which is just made out of thin air from my FtX. You know, there's a big difference, right, between something that's truly decentralized and something that's just basically, I don't know, a tech company, more or less, right?

Starting point is 00:30:18 So it's an interesting dichotomy. And I think that there is going to be a lot of regulation on crypto itself in that same kind of way. Something you mentioned there about bucket shops was interesting to me. And I wanted to kind of dig on that because just so I get the history right, the way I understand it, well, first of all, in the early 1900s, I think the ticker machine was created. And that just spawned this whole new era of speculation so much so that I guess the medical times in 1904 called it tickeritis because there's all these guys supposedly being hypnotized, so to speak, by just the tickered noise that you wrote about, which I found so fascinated.

Starting point is 00:30:53 And with the bucket shop example, you were speaking about how there is sort of this, the retailers were only bullish, you know, it would seem, right? They're only buying, which just kept driving things up and up, whereas the bucket shops would be forced to just take the sell side and so much so that it would overwhelm the market and eventually draw down the price because otherwise the bucket shops are owed a lot of money. So I just feel like that part of Wall Street hasn't changed. And I'm curious to know, like even though these retailers went from bucket shops to exchanges, is that dynamic still the same? Whereas it's just that, you know, nowadays retailers can get more short and are doing so. Yeah. So I think like the lesson that I took from

Starting point is 00:31:35 that kind of wash sale idea. So for crypto, I feel like the true Bitcoin kind of like maximalists are very bullish on Bitcoin, but they would agree with a lot of other crypto skeptics, not Bitcoin skeptics, that like a lot of crypto outside of Bitcoin is sketchy. That's what I've been told by Bitcoin maximalists. And so when I wrote this, a lot of what I'm talking about is from an article I wrote for Bitcoin magazine. And the point I was making with this wash sale, kind of anecdote is so for the wash sales, the difference between a bucket shop and a traditional stock exchange was that on the stock exchange, you know, I place a trade through you, trade, you get a commission for making the trade, whatever, but you're still working with me

Starting point is 00:32:22 on the same team, essentially. You're just getting a commission from doing business or placing my business. Whereas in a bucket shop, it was a zero-sum game where because you're not buying the actual underlying stock as a speculator in a business. bucket shop, you're just betting on the direction. If you bet on the stock to go up, you know, say XYZ Railroad is what everybody wants to trade in 1894 one day. And so everybody in a bucket shop is trading XYZ railroad stock and they're all betting on it to go up. If the stock does go up and the bucket shop is wrong, or not even the bucket shop is wrong, but it's that all its customers were right, then the bucket shop loses money because they have to pay out the winnings. And so

Starting point is 00:33:05 there's like this opposing relationship between the bucket shop owner and the speculator in there because basically every dollar that the speculator wins, the bucket shop loses. And so because obviously no bucket shop wanted to lose a ton of money, so when the speculators in a bucket shop were all betting on the price of a stock to go up and they're all doing it at the same time and the bucket shop would know they're on the hook if it got paid out. What they would do is they would go place a massive. sell order at a lower price than the stock was trading at on the actual stock exchange to then bring down the price so that when the ticker tape brought through the pricing information for

Starting point is 00:33:48 XYZ railroad, it would show, oh, the stock price actually fell a lot and is falling. And so the customers did not correctly bet on the price of the stock. And so they lost. And so the bucket shop manipulates the market essentially to get out of paying out all these winnings to its customers by driving down the price. But what was interesting about that is that this basically need for bucket shop owners to try and avoid it paying out money to their customers. That mechanism proved to be the link between the fictitious trades in a bucket shop, because again, you're not ever owning the underlying stock, you're just betting on the price. It took that fictitious trading and actually provided a link to the real stock exchange because customers, how they bet in the bucket shop

Starting point is 00:34:34 Again, if it became too large and everybody all at once is betting on positive price movement for XYZ railroad, then the bucket shop has to go make a huge sell order on XYZ railroad in the real market, which brings down that price. And so the real market is actually being moved by the kind of sketchy, speculative activity in these bucket shops. And so for crypto, I think there's a real analogy there where the Bitcoin kind of maximalists, even though they think just like people, you know, at the top hat people in the stock exchanges in the 1910s, early 1900s who thought, you know, these bucket shops are nothing other than gambling dens where degenerates go to hang out. They had a very morally superior view of themselves.

Starting point is 00:35:21 They thought, you know, this is just this little speculative den, but it doesn't really affect our markets until then it did because of all these wash sales. And so today, I think the Bitcoin people that almost want to ignore the kind of shady stuff, goes on in crypto more broadly because they feel that Bitcoin is not sketchy like that. They think it's kind of separate. But the problem is, is that what goes on in these like more sketchy ecosystems of crypto do affect Bitcoin because Bitcoin is the main asset that companies are using, like when the whole Luna coin blew up and all that, like the price of Bitcoin was affected.

Starting point is 00:35:59 And so just like activities and these more speculative bucket shops ended up influencing negatively the price of the stock on the stock exchange, these kind of side episodes in the crypto world that are not actually directly about Bitcoin are still moving Bitcoin and more mainstream crypto prices because it's just bringing that kind of sketchiness to everyone. It kind of brings down the whole system, not brings it down, but affects the whole system. And so, again, I think to cut that link, more regulation will be needed because what basically happened after the 29 crash is that the real kind of focus was making it a better pool to invest in by discouraging or catching more of the frauds and sketchy companies that would have gone public before government regulation. And so it's just ensuring that the individual investor kind of has the best chance because at least there will be a higher level of company on average in the market because of these greater regulations.

Starting point is 00:37:07 So to kind of highlight how much of an impact this regulation had and the kind of quality of companies trading at the time, one of the stats that really stood out to me was around IPOs on stock exchange. before and after the Securities Act. So before the Security Act of 1933 was put into place, the average five-year return of IPOs on stock exchanges that were not New York Stock Exchange. So basically all normal non-New York stock exchanges, the average five-year return for IPOs was negative 52%. So pretty terrible. And that was the average before the 33 Act.

Starting point is 00:37:57 And then afterwards, the average five-year return for IPOs on non-New York stock exchanges changed to a positive 5.7% after the Securities Act. So average five-year return for IPOs before the Securities Act was negative 52%. And then after the Securities Act, the average five-year return for IPOs on these exchanges was positive 5.7%. Was part of that because during the 1929 boom, there was a lot of IPOs happening, much like the SPAC, TACUTACUTUC-2020, we were seeing? Yeah, so it's a great question because that's obviously the first thing you kind of think

Starting point is 00:38:39 is like, oh, well, I mean, are these terrible returns just because of the 1929 crash? And I'd have to go back and look at the appendix of the paper that I got this from, but they do construct their analysis in a way that accounts for the 1929 crash. And so that number doesn't. Yeah, it's something like that where it's not distorted. They specifically call out the 29 crash and how they account for it. So it's not skewing the numbers. They're still that kind of stark surprisingly.

Starting point is 00:39:10 So to me, what those numbers kind of point to is that the just amount of terrible companies that were IPOing before regulation was put in place, if the average return is negative 50%. And again, it shows because there were no rules around like prospectuses and anything like that before all of the post-29 regulation was put in place. There was really no, there's nothing discouraging you from launching your sketchy, shady company, much like when the ICO boom was going on, there was not much stopping, you know, even celebrities, some of which are getting in trouble now for their involvement in pushing ICOs. But there's just nothing really stopping someone from floating these questionable companies.

Starting point is 00:39:50 Whereas after the regulation was put in place, you know, someone that might have floated a sketchy company before the 29 crash now knows that they will be liable for any misrepresentations or lies put in a prospectus that has to be sent to the SEC. And so you're just obviously not going to go through all that effort if you know from day one, this company is really just like a scam for me to raise money. And so the just average quality of companies available to invest in improves. And I think that's what's kind of missing today from the crypto landscape is that level of regulation where you know that the worst, like bottom 25% of companies, like just straight

Starting point is 00:40:33 scams and frauds, has already been kind of taken out of the market. And so you have a better chance of success by if you just blindly, you know, through a dart at a board, you'd have a better quality company. than if there was no regulation put in place. SBF, obviously still in the news, was once compared to J.P. Morgan for bailing out a lot of crypto companies, which is also kind of interesting leading up to the demise, let's say, of FTCS. Talk to us about the panic of 1907 and why this comparison to J.P. Morgan is being made. So it's really interesting always in hindsight, these comparisons for people that turn out to be not so great,

Starting point is 00:41:14 because I think he was also called like the next Warren Buffett. But yeah, so 1907 panic was a really interesting one. A large reason why it started was actually from a year earlier in April 1906 with the San Francisco earthquake. Quick history. It's kind of a quirk at that period. Over 50% of fire insurance companies in San Francisco were British, which becomes very important because I think it's like April 6th, 1906. the San Francisco earthquake happens. And what a lot of people I think don't know is that it wasn't actually the earthquake that did the most damage.

Starting point is 00:41:51 It was the fires because essentially the earthquake took out the city's water mains. And so earthquake happens. It hits a bunch of pipes and whatever causes fires. But then because the city's water mains have been taken out, there was no water to put out the fire. And so for four straight days, the whole city just burned. and something like 20,000 blocks were like destroyed in between 30 and like 70%, which I know is a huge gap of San Francisco population went into homelessness because of that fire. I mean, even if it's just 30, that's still a lot of people. And at the time, there was no earthquake insurance.

Starting point is 00:42:29 And so people that had had their house destroyed by the earthquake, but it didn't catch on fire, they had no real way to get insurance because it was just from the earthquake. but if they did have fire insurance, what a lot of people started doing was literally just setting their house on fire because there was no earthquake insurance. So they knew like if we're going to get anything out of this, it's by letting our house on fire and then saying like the earthquake caused our house to catch on fire. But this is important because, again, as over 50% of the fire insurance companies in San Francisco were British, when this event happened, suddenly British fire insurance. firms had a lot of money that they were on the hook for to pay out. And so what happened was Britain ended up sending the equivalent of 13% of their nation's gold supply to San Francisco on ships because these firms, like, were just, they needed to pay out so much money. And after Britain sends out 13% of their gold supply, they hike up their rates afterwards and really

Starting point is 00:43:40 contract their kind of market because they're trying to bring gold back over to London after depleting its reserves so much. And so this had knock-on effects for global markets, specifically in New York, because this was happening at a time of year where financial markets were already kind of fragile because of just seasonal funding and capital needs around kind of more agricultural stuff. And so even though it seems like an unrelated event, this earthquake had knock-on effects because it really kind of tightened up markets. And then alongside that, you have the Knickerbocker trust company and all these other sketchy trust companies that were highly levered and taking a lot of risk on speculative stocks. And so markets were already kind of fragile because of the

Starting point is 00:44:26 San Francisco earthquake issue. And then alongside that, you had a failed corner of the copper market and then the collapse of Knickerbocker Trust Company and all these other trust companies. And at the time, we didn't have a Federal Reserve. And so J.P. Morgan, the person, ended up basically acting like the Federal Reserve and as a lender of last resort and providing capital and doing deals with companies and individuals that needed help because there wasn't really another place for them to turn. So basically what ended up happening was the government realized we can't continue to rely on a single person, you know, to bail us out of future crises. that panic also highlighted downsides of relying on gold as the base of kind of your monetary system

Starting point is 00:45:16 because something like a earthquake and a lot of British fire insurance firms leading to a lot of gold needing to be moved, causing financial markets to tighten and become more fragile. It just really highlighted how kind of susceptible the gold standard was to these types of shocks. And so that and the need for a federal reserve or some type of central bank were really two of the lasting kind of impacts from the 1907 panic because it just really highlighted, you know, JPMorgan dies. What are we going to do? So it led to the creation of the Federal Reserve in 1913. So yeah, panic in 1907 is kind of like the last pre-fed real panic. That's what we call key man risk when you are relying on JP Morgan only. And, you know, that stock market around that time felt almost. 50% and it started this huge run on banks, you know, to your point. And so one piece of history related to that, I'll detour for a second is, you know, Warren Buffett lost 244 million on Irish banks in 2008 for this reason. They were, they were over levered. And he said in his

Starting point is 00:46:22 shareholder letter that year that they appeared to be cheap, but they were levered 30 to one. And so when the great financial crisis happened, they were wiped out or nationalized. And Buffett lost about 89% on those bets. They actually, after he wrote him down, they actually went down further. So at least he got out a little bit before zero. But it's not often to recognize that even the greats, you know, miss every now and then. And those over levered banks do cause issues. But getting back to the Fed, I was kind of curious about this because, you know, speaking

Starting point is 00:46:53 about pros and cons of regulation, right? I wouldn't say we've necessarily seen less volatility, although that's fairly debatable. Was our Federal Reserve Bank, the first of its kind in third. theory, right, or in just structure when it was established in 1913. And not so much, you know, as we know it in this modern era today, but just going back centuries even, was there ever anything like a centralized bank of this kind of sort of magnitude that was proven out in concept prior to our own? Yeah, definitely. So first, I realized I didn't fully answer your last question. So the parallel to SBF with FTX is that earlier in the summer of 2022, when there were a

Starting point is 00:47:33 bunch of crypto companies going bust. He was stepping in to provide liquidity and save these companies. I think Celsius was one of them. And so the comparisons were kind of clear where he was supposed to be the revered kind of like banking God and exchange God of finance today. And he was like the good guy. And he was coming in to provide liquidity and safety essentially for struggling companies in a downturn just like J.P. Morgan did. But it worked out a little differently for JP Morgan and SBF. In terms of a central bank in the Fed, the U.S. was actually, I don't know, in the grand scheme of things where the U.S. kind of nets out in founding a federal or like a central bank, but there are definitely earlier examples. So in 1609, this wasn't necessarily a fully

Starting point is 00:48:29 fledged central bank, but most economic historians consider the Amsterdam Viesel Bank, the Bank of Amsterdam to be the kind of first central bank or pre-central bank. It might not have done one or two things like a kind of standard central bank does today. But at the time, it was doing many things that a central bank would do today. Similarly, in 60, which also that makes sense because the first stock exchange opened in Amsterdam in 1609, actually, too, the same year. So, that was a big year for finance. And in 1694, the Bank of England opened, which was actually happening at a time when I think we talked about it last time. That was during the London treasure hunting tech bubble boom that the Bank of England was founded. So there is definitely

Starting point is 00:49:23 precedent for the U.S. to follow. And in fact, early on, the panics in the U.S. were kind of really modeled upon Walter, what's his face, Walter Badgett's kind of rules for acting as lender of last resort based off of the British experience, specifically in panics, like the panic of 1825, and how the Bank of England acted in that episode influenced the way that we structured and thought about our own central banks. So it was definitely I don't know on the later, that'd be interesting to see, you know, of like major countries when they founded theirs. I don't know if we were really late to the game or somewhere in the middle, but there's

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Starting point is 00:53:30 All right. Back to the show. So going back to those earlier days of insider trading and lack of regulation, it was once true that access speed and analysis were. the three main competitive advantages in markets. It's probably still true today, but access and speed have definitely, I think, declined in relevance because they've been democratized. So since we're now in this age of information, I mean. So walk us through how technology has evolved since the curb traders of 1837 to the systems we have today and maybe throw in now the mention of carrier pigeons,

Starting point is 00:54:03 because that one just, you know, tickles me. Yeah, that's always a good one. So, yeah, essentially, So I wrote this article about how kind of throughout history, the sources of competitive advantages have kind of followed this cyclical pattern where there's three stages, access, speed, and analysis. And as you referred to in your question, the first stage is access. So at this point, you can get an edge over the competition, you know, just by getting access to market information that's not widely available. So if you have some unique data set or there's just general market information that's not democratized and not everybody can just find it on their phone, you have access to that information in itself as a competitive kind of edge over the competition.

Starting point is 00:54:52 But then over time, as more and more investors do get access to that same information, obviously you lose your competitive advantage because everybody has the same info. So then the competitive advantage becomes much more about speed. So it's not getting access to the same information as everyone else, but it's developing methods, which we will come back to, whether it be technology or carrier pigeon, just to get you that information faster than anybody else. So you can trade off it before anybody else knows. But carrier pigeons get arbitraged away. And so what Trey is referring to there is in the 1800s, there was a guy,

Starting point is 00:55:33 in Boston, who was offering a news service for investors where essentially he had, he would station himself in Halifax, which was like the northernmost point for ships coming in from, I think Liverpool. And he would use carrier pigeons to go out and meet the boat, basically discover the news and then send the carrier pigeons back home to Boston to his colleagues there who would unravel the pieces of paper. patched the pigeons, find out what the news from Europe had been, and then distribute it to their subscribers so that they would know the news from Europe far, I mean, relatively long before anybody else would know. And so while that seems like, you know, how much could you really

Starting point is 00:56:20 get from that? When it came to things like discovering the outcome of like a big battle or like the death of a leader or something, that small window of time, just like a few hours, can make a huge, huge difference. So that, again, is a perfect example of the kind of speed phase where you're just trying to receive information faster. After technology kind of gets democratized so that everybody's getting the same information at the same speed, the third stage of this kind of competitive edge cycle is the analysis phase, where at that point, everybody's by and large getting the same information and

Starting point is 00:56:56 they're getting it at the same time. And so at that point, outperforming the competition and kind of getting your competitive advantage is sourced through just superior analysis of the widely available information. So today, you're not going to get an edge by, you know, finding out what the, what a company's revenue for Q3 was from their 10K because everybody's going to get that information that's released at the same time. And most people, by and large, I would say 98% of them. investors have access to the internet readily available.

Starting point is 00:57:31 And so that's not going to be your source of advantage. But just being able to kind of use that information for better insights than your competition is where you can get kind of a source of alpha. And so over history, what you see is that once that cycle kind of completes one iteration, usually there's some either new data set that becomes available or new technology that allows access to new information or you can get that information faster. It kind of like resets that cycle. And so in this paper I wrote, I used an example of these curb traders that in this period of history, which was like the mid-1800s and throughout the rest of the century,

Starting point is 00:58:13 there was like a two-tiered system on the New York Stock Exchange where what they call it, I think almost like a dual-class system. Yeah. I'm trying to remember what the two were called. But I think it was the open board was like the very old money, wealthy, elite. They literally traded in tailcoats and top hats. And they would sit in like armchairs that were dead. It was their personal arm chairs. Like they had assigned seats. And you had to pay a lot of money to get a seat on that open board. And they traded, I think like five hours a day and took like a break for lunch. Yeah, it's very, very aristocratic and bougie. Alternatively, for the people, that couldn't buy those seats because, you know, they're tens of thousands of dollars,

Starting point is 00:59:00 they traded on the curb exchange, which was literally just the curb outside the traditional stock exchange where it was in the street, open cry, you know, there's no top hats or armchairs out there. And these curb traders, though, because the snooty, like open board trading inside from the armchairs, they obviously are moving a lot of money and prices based on their trading. because they're the kind of large capitalists. Because the curb traders weren't paying for the seats, they obviously weren't privy to that information and that trading like in real time.

Starting point is 00:59:34 And so a group of curb traders drilled a hole in the side of the building so that they could spy in on the open board trading sessions and like learn information that way. And so going back to that kind of cycle, obviously that access to information in itself was a competitive advantage for them. But soon over time, that kind of dual class structure dissipates it, breaks away, and more investors figure out how to get access to that information from trading sessions inside. And so that's no longer an edge.

Starting point is 01:00:08 So then you move to the speed component where we had the pigeon system type things. And then finally, it gets reset. But what really reset or kind of brought through markets to that analysis phase in 1930, in early 20th century markets was the ticker. Because before that, again, without technology, providing everyone the same information at the same time, you had to drill holes in walls or, you know, use pigeons or something else. Some people were using these optical telegraphs where they're like these chain on hilltops, you know, stretching from like Philadelphia to New York, where if people in Philadelphia learned a price, they would set on a telegraph that looks like a windmill. Like it's a visual

Starting point is 01:00:53 tower basically, and just like a windmill has the rotating arms that spin around, these optical telegraphs had long, like wooden arms that could be put in certain shapes, which would communicate different numbers and letters. And so if someone in Philadelphia in that first tower, like, knows the price of this stock is, you know, $48.50 and 50 cents before anybody else, they can communicate that info using these optical telegraphs from Philadelphia to New York in like 30 minutes. minutes. So again, just another way outside of pigeons to get that speed faster. But after the ticker comes along in 1867, suddenly everybody hooked up to a ticker receives price information

Starting point is 01:01:35 from the New York Stock Exchange at the same time. So before the ticker, just being near the New York Stock Exchange physically provided you with a huge advantage because you would know price information faster than anybody not living in New York because they would have pad shovers, what they called them. There's people who literally just ran to and from the exchange back to the brokerage office, back to the exchange, et cetera, et cetera. And so just being physically near the exchange got you an advantage. But the ticker through telegraph cables just used technology to distribute that information. And so the ticker helped investors spend more time doing actual analysis of prices in the market and looking at trends than simply trying to get access to

Starting point is 01:02:21 that information. Once the ticker comes along, that's when you start to see a lot of more sophisticated kind of investment strategies and approaches because not only did the ticker in real time give everyone access to information, but someone in the 19th century called the ticker a recorded history of the market, which I think is a really cool idea. And that's technically kind of what it is because it's not even just what's this price right now in the exchange, But once you get that price, you now have it. And so just from having the ticker, you suddenly are able to do an analysis of the last five years of railroad stock prices.

Starting point is 01:03:02 And now that you have that recorded history of the market, you can actually study trends because you have the data and you don't have to spend 80% of your time as an investor just trying to get information and get it faster. You can actually just spend more time on doing analysis. And so today, in the age of information, by and large, obviously, you know, high frequency traders and alternative data sets that hedge funds use, et cetera, ignoring that because it's a smaller percentage. By and large, all investors are getting the same information at the same time.

Starting point is 01:03:37 Like, I don't think you're going to find out the S&P 500 price faster than I am, unless your Wi-Fi is a little bit faster, but nothing that's going to give you a competitive advantage. And so today, I think a lot of the tools that are coming to market, the first one that comes to mind is like Dilupa. A lot of the tools, I think today are ones less around, like for investors, I think are less around like getting better information necessarily that other investors can't access. And it's more around how do we automate the data gathering and data kind of synthesizing. processes that you do and take a lot of time, but are nothing really special. They can be automated so that you as the investor and analysts can spend more time actually analyzing these companies and getting an edge that way.

Starting point is 01:04:29 So, to Loop is just the example in my mind. Like, their thing is that they just automatically pull numbers from 10Ks and stuff and 10Ks as they're released and update your models in Excel with like the click of a button. So instead of you as the investor having to go do all that yourself and update your models manually, which is just even though it's small, it's like all that stuff is manually, mentally draining. That just gets automated so you can spend more time on the analysis of that information and hopefully generate more actionable and insightful investment decisions because you're able to spend more time doing what you should be doing as an investor, as an investment analyst,

Starting point is 01:05:10 which is analyzing. So I think that would be interesting. I feel like we're just kind of entering that stage of the cycle now where there's a lot of companies dedicated to helping investors do more analyzing than kind of just gathering data or gathering it faster. Regarding the optical telegraph that you mentioned, there's a funny part in this article everyone should check out it. Because in some ways, it's like the first early examples of cryptography would seem in a way. And almost as you mentioned, I think the first sort of cybercrime that happened as you. which is pretty interesting. But on that note about competitive advantages, obviously Jim O'Shaunas, the founder of Osam, where you work, his edge was built on quant investing. He was the pioneer

Starting point is 01:05:52 of that. He's actually, I think you retired at the top of this year. So before we will talk about some of the tools that you guys have been focused on there, I'm kind of curious about your experience and Jim stepping away doing his new venture and what Osam looks like, right, without the founder. at the helm. Yeah, so Jim, obviously, someone who's had a profound impact on my career and kind of personal and professional development. So he will be sorely missed at the firm. I joke with him that he's been in the industry for decades. And after like three years of me being at his firm, he retired. But yeah, in all seriousness, Jim over his very successful career,

Starting point is 01:06:35 built an incredible team at Osam. And so his retirement and departure is just sad on a personal note, but also exciting. Everyone's very excited for his new venture, literally, O'Shaughnessy ventures. So we have a great team in place. The day to day isn't changing at all. And it's really exciting time at OSAM with our Canvas platform and custom indexing and everything. For me, even though this is more of that recent history, I think it's really a really

Starting point is 01:07:05 cool to see Canvas be so successful today because it's really an iteration of what Jim tried to launch in the 90s, but the technology and timing of the market was just not there. I think, but he had a company called Netfolio, which was all about building personalized funds for the individual investor using technology, but didn't really lead to anything just because of timing, late 90s. But then, you know, now like 20 years later, same idea is now implemented in Canvas. So it's kind of cool to see that full circle happen.

Starting point is 01:07:44 Yeah. Last time Jim was on the show, we kind of touched on that. And he was mentioning the idea of custom indexing and how revolutionary it would be. But I know that the tool is only available for advisors. So I'm curious to know your thoughts on how this technology may ultimately help investor returns, whether through advisors or maybe eventually even to retail. anytime we get like an inbound from someone that's interested in Canvas as an individual investor, we will always try and pair them up with one of our Canvas partner firms.

Starting point is 01:08:18 So if anybody is interested, certainly don't hesitate to reach out if you're willing to work with an advisor. But yeah, in terms of competitive advantage, we think that this one canvas and custom indexing in general is one of the best competitive advantages an advisor can have, because especially right now, because with technology, there's always that kind of flipping point where having a new technology or software, what have you, at the beginning is a competitive advantage because you're offering something to the end client, in this case, you're investor that other companies can't offer. But then as everyone kind of recognizes the power of the new technology, it becomes table stakes to have, it's interesting how it becomes, oh, wow, you have canvas.

Starting point is 01:09:05 like you do custom indexing to, oh, you don't have canvas or you don't do custom indexing. And so while we're obviously not there now, we think that that's where it will, that's where things are trending towards because, you know, in every other facet of life, we want personalization and something tailor made versus an off-the-shelf, you know, cookie cutter product. And so our view is why would financial markets be any different? And the examples people tend to use are just related to stuff like, you know, as P500 without, you know, Exxon or other stocks like that that they don't like. But that really kind of undersells and understates the level of customization and impact you can have at scale when you're personalizing each client's individual account for things even like taxes. So in terms of boosting investor returns, the ability to, because just, I guess, stepping back for

Starting point is 01:10:05 second, custom indexing for anyone that doesn't know is building your portfolio using single stocks instead of an underlying commingled fund. So just like an advisor would create a model using ETFs and mutual funds, they can create using Canvas, our custom indexing platform at Oshanasi Asset Management, to build a model with those same exposures but using individual stocks. And so why that's important is because it allows you to, one, customize basically anything because you owning the individual stocks instead of just an S&P 500 ETF. But by owning the individual stocks, you can also do a lot of tax loss harvesting that you

Starting point is 01:10:47 could not do in a commingled fund because, you know, say the market, the SMP 500 was up 15% in a year. In the ETF, all you can do is sell that share of the ETF, which would be at a gain, so that would trigger a taxable event. But if you own the S&P 500 as a custom index, just part of your exposure in your account, then even in a year where the overall index is up, there's still on average like 36% of companies, at least in the Russell 1,000, on a given year of 36% of companies in the Russell 1,000 are at a loss, regardless of whether the market is up or not. And so if you have a custom index, you can sell those stocks at a loss to offset your bill, your tax bill on the 64% of stocks in the index that went up. And so like in the first half

Starting point is 01:11:38 of 2022, we're still getting our data for the second half of the year. From January 1st to June 30th, 2020, we harvested losses 6,000 times across our canvas accounts and generated $100 million in net losses, which led to, on average, 170 basis points in tax alpha for our canvas accounts. So if the index was 7%, on average, the canvas after tax return was 8.7% for those canvas taxable accounts. So you can have a huge impact on investor returns from a tax side, but there's also a bunch of other interesting stuff that we can do with that kind of power of customization at scale.

Starting point is 01:12:21 Super fascinating stuff. Jamie, this was so fun, man. I always enjoy having you on. I always learned so much. And it's almost like refreshing to go past the 1900s every now and then just to get some more perspective. So I always enjoy, keep doing what you're doing. And let's do it again. I hope we can do it some time again this year. Before I let you go, though, Jamie, please hand off to our audience where they can learn more about you and investor amnesia and the Sunday reads and all the great stuff, including maybe Canvas or anything else you want to share. Yeah. So if anyone listening enjoyed this conversation, hopefully all of you, then you can find my website, which has all things financial history at investor amnesia.com, because we never learn from history. And you can sign up for my newsletter there, which goes out every Sunday morning to 14.5,000 subscribers. And I also have some online financial history courses available on my site where you can, learn financial history from people like Jim Chanos and Neil Ferguson and Mark Andreson. If you want to learn more about Canvas, you can go to canvass.osam.com. All right, Jamie, thanks again. Let's do it again sometime this year. I appreciate you coming on. Awesome. Thank you so much, my man. All right, everybody, that's all we had for you this week.

Starting point is 01:13:38 If you're loving the show, don't forget to follow us on your favorite podcast app. And if you'd be so kind, please leave us a review. It really helps the show. If you want to reach out directly, you can find me on Twitter at Trey Lockerby. and don't forget to check out all of the amazing resources we've built for you at the investors podcast.com. You can also simply Google TIP Finance and it should pop right up. And with that, we'll see you again next time. Thank you for listening to TIP.

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We Study Billionaires - The Investor’s Podcast Network - TIP520: Investing Through Post-bubble Markets w/ Jamie Catherwood

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