A Tale Of Bubbles Old And New -- Plus, How To Avoid Them
Back in July of 2014, I shared an incredible story with StreetAuthority readers. I say "incredible," but the truth is it's all too familiar if you've paid attention to the stock market for longer than five minutes.
In that article, I told the story of how an obscure company called had become all the rage among so-called penny stock investors. Touted as "the next big thing" in the social media startup world inside stock trading chatrooms and message boards, investors began buying up shares of the over-the-counter (OTC) stock -- sending it up a mind-numbing 23,000% in a matter of weeks.
Cynk Technology Corp was once a stock trading at six cents a share. It soon had a $6 billion market cap and was trading near $15 a share.
Financial blogs and major news outlets began to take notice and did some digging...
Turns out, Cynk had a grand total of one employee, no corporate website, no revenue from the past three years and $39 in assets. Naturally, the Securities and Exchange Commission thought this was a little odd. So they stepped in and halted trading of the stock. And just as soon as the foolish speculators (they don't deserve the term "investors") who bought the stock thought they had made a killing, they were swiftly wiped out.
Fast forward to 2017. I came across another crazy story from Bloomberg about a mysterious Chinese company that gained more than 4,500% since 2015.
Here's a clip from Bloomberg:
Shares of Wins Finance Holdings Inc., a company that guarantees loans for small businesses in China and leases equipment to them, have soared as much as 4,555 percent since debuting on Nasdaq in 2015. The firm’s market value surpassed $9 billion in February, about four times as much as LendingClub Corp., an online lender with 50 times the revenue. Even Wins said in a release that it had no idea what drove the surge in its stock, which boasts the best performance in the Nasdaq Composite Index over the past 12 months.
As the story continues, it just gets weirder. We're talking about no evidence of an actual office at the headquarters of its U.S.-listed address, an association with a formerly-bankrupt New York financier, repeated denied requests for interviews with Wins executives, an uncovered backdoor method used to get the company listed on U.S. exchanges, executives with suspect operating history at former companies, the list goes on...
But what's really troubling (and what Bloomberg pointed out) is this... How could shares of this company -- which nobody without a direct affiliation can speak to its actual validity as a going concern -- make it into the portfolios of millions of investors and retirees? After all, due to its listing on the Nasdaq and Russell 2000, index funds must also own the stock itself.
If you're a student of the stock market, then you've seen this movie before. The details may change, but the story pretty much stays the same.
The Original 'Pump and Dump'
Consider a story I've shared before about the South Sea Company. It comes from Charles MacKay's classic book, "Extraordinary Popular Delusions and the Madness of Crowds".
The South Sea Company was a British joint stock company formed in 1711 as a way for government officials to fund Britain's growing debt levels. The scheme essentially went like this... if you were an existing bondholder of Britain's debt, you were issued shares of South Sea Company. In turn, South Sea was granted an exclusive royal charter to conduct trading activity in South America -- which sounded lucrative on the surface.
But the story of South Sea became one of the earliest examples of irrational market exuberance. In fact, we owe credit to the events of this period for coinage of the term "bubble."
Meb Faber of Cambria Investments did an excellent job of recounting this story (and relating it to current markets), in his book, "Global Value." Here's a passage about South Sea from Meb's book:
Trading in the South Sea Company was one of the earliest "pump and dump" schemes in history. South Sea Company's management lacked any relevant shipping and trading experience but were shrewd stock promoters that took office space in the finest area of London's financial district and decorated their offices with opulent furniture and art. The public could not get enough of the shares given the ostensible wealth that had already been created for South Sea's management group. In the end, when the insiders knew that the company's earnings would be abysmal, management began quietly selling at the height of the market. South Sea Company shares began to plummet, and to make matters worse, company officials allowed shareholders to borrow money to buy shares (effectively granting them margin). As share prices fell, investors were forced to sell even more shares.
There's a lot more to the story, but you get the idea. (I highly recommend reading MacKay or Faber's book if you want to learn more.)
The moral of the story is that whether we're talking about the South Sea Company, Tulip Mania, Bitcoin, Cynk or Wynns... There will always be bubbles... bad actors... and irrational behavior in the markets.
The Timeless Advice Most Investors Ignore
Getting caught up in the market's irrational behavior is a sure way to lose money in stocks. And nobody likes to lose money. So when looking to invest alongside the "smart money," I suggest turn to one of our top analysts, Jimmy Butts, head of StreetAuthority's premium advisory, Top Stock Advisor.
Time and time again, Jimmy harps on investing in what we like to call "Forever Stocks." These are companies with dominant positions in their industry that have a demonstrated history of richly rewarding shareholders for years on end. You'll be much better off holding these kinds of investments than you would be chasing the latest market trends or hot penny stock.
There's a reason Warren Buffett says his favorite holding period is "forever." That's because the S&P 500 has NEVER suffered a loss in a 20-year period dating back to 1950, according to an Oppenheimer study.
Of course, I'm not implying that you can simply just buy any stock out there and expect to make money. But if you hold quality stocks for the long haul... but we do know that you'll be far better off than trying to time the market and chase stocks. That will not only likely be a frustrating failure, but also a good way to lose a lot of money.
So if you're tired of losing alongside the "dumb money" and frustrated with the hysteria of the market, then Jimmy's Top Stock Advisor service is a great starting point. To check out his latest research report, go here.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.