Caption: “Museum Attendant (in 1925) These instruments, known as stock-tickers, were in use in Wall Street up to the year 1914. They were abandoned when the public got out of the market, and they are now very rare.”
From the Archives
Speculative Notes (1864)
What Is and What Is Not an Investment?
Investor Amnesia Course
Towards the end of last year I launched a brand new online financial history course covering Bubbles, Manias & Fraud. The course boasts more than six hours of content split into 37 videos across seven riveting topics like Railway Mania, the South Sea Bubble, Brewery Mania, and more. Students are taught this fascinating material by the world’s foremost investors and financial history experts.
Well 2006 is off to a great start! Wait – I mean 2021. One could be forgiven for thinking that we were actually living in 2006 given the types of stocks that have rallied 100% YTD in just 20ish days: GameStop and Blackberry. While it is nuts that either of these companies are rallying to the extent that they are, we are going to focus on GameStop because it is more interesting and has some fascinating historical parallels.
Here is Bloomberg’s summary of the madness transpiring with GameStop’s stock:
“In the battle between short-seller Citron Research and an army of Reddit-charged day traders, GameStop Corp.’s seemingly endless rally to an all-time high has given the stock’s bulls a win, though not without controversy.
GameStop’s 83% gain through Friday comes after it more than doubled the week before and marks the most volatile 10-day period on record, data compiled by Bloomberg show. The stock was halted at least four times in New York trading on its way to a a record close. The stock surged 51% Friday to $65.01.
At one point, the video-game retailer was the most actively traded U.S. company with a market value above $200 million, data compiled by Bloomberg show, as millions of shares exchanged hands every few minutes…
Reddit users continued to pump up their bets with one user saying they relied on it to pay their student loans.
GameStop’s parabolic rise, which has come amid steady and elevated short interest and increasing volume, has showcased the divide between retail bulls and bears betting on a quick return to reality. More than 193 million shares were traded on Friday, marking the most active day for the company since it went public in 2002.
GameStop became a “cult stock because of Ryan Cohen’s success with Chewy” and retail investors “appear confident that he can implement omnichannel initiatives that will materially grow their earnings,” Wedbush analyst Michael Pachter said in an email…
Reddit’s ‘Angry Mob’
A backlash against Citron by some vocal Reddit users over its views on GameStop came to a head on Friday when the short seller said it will stop commenting on the stock following the actions of “an angry mob.”
“We are investors who put safety and family first and when we believe this has been compromised, it is our duty to walk away from a stock,” Citron managing partner Andrew Left wrote in a Friday letter.
The statement came a day after Left said in a YouTube video that he’d “never seen such an exchange of ideas of people so angry about someone joining the other side of a trade,” referring in part to Reddit users who have been particularly vocal on the social media site in seeking to promote their positive opinions on the video-game retailer’s stock.
GameStop is up 245% in January to date, with its average daily rolling 10-day volatility peaking at the highest level in the nearly two decades the stock has been trading, data compiled by Bloomberg show. Friday’s eye-popping surge fueled its market value above $4.5 billion at its peak.”
What I find fascinating about this whole saga is that it provides yet another example of how technology and the democratization of finance is – in certain situations – handing power back to the retail masses often at the expense of legacy groups that drive markets. We have seen countless times over the last year how retail fervor, and specifically the WallStreetBets subreddit can have a meaningful impact on markets.
As the articles linked today point out, in the past there have been concerns over competing with large institutions that may have an informational advantage they can use to manipulate prices, or concerns by short-sellers that amid a craze they should not short due to fears of being cornered if they did short. This week with GameStop and Citron, however, is an fascinating example of a well-known short seller being afraid to comment further in fear of triggering a Reddit community of individual investors that have demonstrated the power to move GameStop’s stock price against Citron.
Before we dive into this week’s post on the first activist campaign, market corners, short-squeezes, and more, I wanted to point out that I’m experimenting with a new format for the linked articles and I hope you enjoy. I think it’ll help you pull out key info faster and decide whether or not to read the linked paper.
Let’s dive in!
Why This is Relevant:
I mean it’s a detailed look at the first stock market corner, what more do you want? Also, the phenomenal charts and historical insights we’ve come to expect from Global Financial Data are always a welcomed treat.
“Jacob Little was the first and one of the greatest speculators on Wall Street. He engineered the first successful stock corner on the New York Stock Exchange in 1835, and was known as ‘Ursa Major,’ or ‘the Great Bear of Wall Street.’ Like any bear, he was loathed by the bulls, but through his stock operations, he became one of the richest men in the United States. Although Little is now mostly forgotten, his speculative expertise laid the foundation for Jay Gould, Daniel Drew, Jesse Livermore and others who followed in his footsteps.
Jacob Little was born in 1794. His father was a man of large wealth and distinction who was ruined financially in the War of 1812. Little’s father helped Jacob get a position with Jacob Barker, one of the leading merchants of New York. In 1822, Little started his own business as an exchange specie broker, dealing in banknotes issued by private bank, where he gained a ‘reputation as an honest, energetic, and successful broker.’ Jacob Little opened his own brokerage house in 1834 in the old Exchange Building in Wall Street, and for the next twenty-five years, Jacob Little & Co. dominated Wall Street. “
“Although Jacob Little was the first stock market tycoon, the first to corner a stock, the first to make millions and lose millions over the course of a lifetime, he is barely known today. What little we do know of him are stories drawn from reminiscences of his fellow traders. Even if you assume that the stories about the Morris Canal, Harlem Railroad, Erie Railroad and others are true, it still makes you wonder what he did the rest of the time he spent 25 years on Wall Street.Little didn’t create the largest brokerage firm on Wall Street in the 1850s by shorting a few stocks. He had to be a consistent market trader who went bullish and bearish, who probably traded bonds more than he did stocks, and dealt with everyone on Wall Street successfully, despite his reputation. Perhaps it is the untold stories of Wall Street that are more interesting than the ones that are told.“
Shareholder Activism at the Dutch East India Company 1622 – 1625
Why This is Relevant:
Part of the reason why GameStop rallied so much this week was because activist investor Ryan Cohen recently wrestled control of three board seats from the company. Investors are optimistic about his ability to push the company in the right direction by expanding their online presence. This letter from the activist investor details what the company’s management team is doing wrong, and the remedies for their business woes.
This paper is fascinating because it takes a look at the Dutch East India Company and the first activist investor in market history: Isacc Le Maire. most modern activist investors, Le Maire penned a letter to management criticizing their control of the company’s finances and their transparency with shareholders. Now, to be fair, Le Maire was also a former East India Company board member that had been fired for embezzling funds from the company, but his activist campaign is interesting nonetheless.
Le Maire’s initial tactic was to set up an investment company dedicated to short-selling the Dutch East India Company’s stock in an effort to force management to comply with his demands:
“After Van Oldenbarnevelt rejected Le Maire’s request a month later, Le Maire, together with a few members, incorporated the Groote Compagnie, which engaged in short speculations on a large scale. Le Maire hoped that, if the share prices would fall below par value, the investors would ask their money back in 1612. This would require the VOC to be liquidated and would give Le Maire himself the opportunity to set up new trading companies. The partners of this Groote Compagnie supposedly spread false rumors and committed fraud.
The Groote Compagnie’s short speculations were initially successful: the price fell from 212% in 1607 to 126% in 1609.51 But they did not have the intended result. At the request of the Lords XVII, the States of Holland prohibited the trade in blanco actiën – shares one does not hold oneself. A counter-petition by several anonymous merchants who asserted that the falls in prices were the result of poor management did not succeed. Nor was the primary aim achieved, namely that, in compliance with the Charter of 1602, an audit would follow and the participants would be able to withdraw their money. According to the directors, an audit would play into the hands of the Spanish and English competitors. Moreover, long-term investments would preclude (partial) liquidation, which would be the consequence if the participants reclaimed their money. The directors argued further that investors had sufficient exit-opportunities at the stock-exchange…
Le Maire’s short speculations nevertheless resulted in dividends being distributed for the first time in 1610. Given the lack of liquid assets, it was decided that dividends would be distributed in mace at a value of 75% of the nominal capital. A second distribution followed soon afterwards, largely in kind and a small part in cash. That distribution in cash was made only on condition that the payments in kind were accepted. Several participants objected to the distributions in kind as these led to falls in prices on the market. Many of them did not object to the fact that it concerned a distribution in kind, but rather to the fact that distributions were calculated on the basis of too high a market price, owing to which they actually amounted to less than they seemed to. These participants later received a payment in cash at the same level in 1612, 1613 and 1618. In 1620 another dividend distribution of 37.5% took place. In total, during the first Charter, 200% of the nominal capital was distributed, which, based on a correct valuation of goods distributed in kind, comes down to about 7.5% a year.”
This article is a fascinating look at the earliest examples of activist investing.
“This paper explores the reason for the absence of control rights of shareholders in the Dutch East India Company (VOC) and the background of the conflict between shareholders and directors that arose in 1622/1623 when the VOC Charter of 1602 was extended.
The VOC was the result of a merger between several companies that had been trading in the East Indies between 1594 and 1602. The legal structure of most of these “pre-companies” which were incorporated for a single voyage to the East Indies, prevented shareholders from having actual influence. In most of these companies, the shareholders invested their money, not in the company itself, but via one of the individual directors. The relationship between a shareholder and most of the pre-companies was therefore indirect, which impeded the exercise of control rights. Furthermore, shareholders may not really have been interested in their control rights given the high returns and the expectations of the newly opened trade route.
When these pre-companies were merged into the VOC in 1602, nothing changed with respect to the absence of shareholder control rights. The VOC, however, was established for a longer period and had to meet other more long-term challenges than those faced by the pre-companies. The failure to adapt the control structure to suit the different circumstances may have been a source of the conflicts that arose between the directors and shareholders between 1602 and 1623.
In 1622, upon extension of the 1602 Charter, a significant conflict erupted between the shareholders and directors. The so called dissenting participants complained about the numerous conflicts of interests that had been arising between the various directors and the VOC. They accused the directors of abuse of power, short-selling and self-enrichment. They argued that shareholder approval was required for the VOC to turn to the capital market to borrow funds. They also demanded that large investors be entitled to vote on the appointment of new directors. As the dissenting participants supported their arguments by referring to the English East India Company, the corporate governance of the EIC is briefly described.
Publishing their complaints in pamphlets, the shareholders mobilized public opinion and attempted to convince merchants not to invest in the Dutch West India Company, which was being incorporated at the same time. They exerted pressure on the government to ensure that more rights were granted to the shareholders when the VOC Charter was extended.
Theoretically, the activism of the “dissenting participants” was successful. The 1623 Charter granted certain rights to large investors, including the right to nominate new candidates for appointment as director. The 1623 Charter further regulated insider trading by the directors and encouraged the directors to pay a yearly dividend to the shareholders. In addition, a committee of nine shareholders was entrusted with the supervision of the VOC directors. This corporate body was known as the “Lords IX” (Heren IX). In practice, however, the directors were able to frustrate many of the corporate governance improvements.”
From Le Maire’s letter to management:
“The dissenting participants [shareholders] are not slaves, but free people in free countries. They only ask to be allowed to appoint administrators of their goods themselves, to whom they entrust such administration.
That this request is not unfair is evident from the fact that even the King of Spain gives merchants who sail to the East Indies and Spanish merchants who trade with the West Indies the opportunity to appoint the agents or bookkeepers of their goods to whom they themselves entrust such management. In England as well, one sees that the participants in the EIC have the most to say: they remain masters of their own goods and each year appoint and dismiss from their midst as they see fit a Governor, his deputy and the Court of 24 Committees, as well as an auditor. And each shareholder is entitled to inspect the books and merchandise and see how the goods are converted to cash. This is evident from a certificate from the English East Indies Board, of which the dissenting participants have obtained an authentic copy.
Does this not turn you pale, oh shameless directors! Or does no red blood flow through your veins? But neither law nor reason can make you change your minds. Other countries set the standard and you remain stuck in your old ways. You do not follow any good examples. It appears that although greed has not blinded you, it has indeed made you insensitive and leprous.”
Large Investors, Price Manipulation, and Limits to Arbitrage: An Anatomy of Market Corners
Why This is Relevant:
What was so crazy about the events that transpired this week regarding GameStop was that it was largely fueled by a herd of retail speculators originating from a Reddit community. This paper dives into the history of market corners and the influence of large single investors / institutions. The GameStop / WallStreetBets example is an interesting microcosm of the modern market in that it is the opposite of what the authors’ of this paper outline. Due to social media, the internet, etc. large masses of smaller investors can move a company’s stock price in coordinated efforts like those of this week.
In the words of Michael Scott: “How the turn tables have…”
“This paper investigates price and trading volume patterns around some well known stock market corners in US history. The analyses are based on a hand-collected new dataset of price and trading volume reported in the New York Times and Wall Street Journal from 1864-1928. We present strong evidence that large investors and corporate insiders possess market power that allows them to manipulate market price. Our results show that market corners as a result of manipulation tend to increase market volatility and could have an adverse price impact on other assets.
We demonstrate that the presence of large investors makes it extremely risky for short sellers to arbitrage mispricing in the stock market. This creates severe limits to arbitrage in the stock market that tends to impede market efficiency. It can create a situation when there can be overpricing but arbitrageurs are unwilling to establish a short position because of manipulation risk (in addition to fundamental and noise trader risk). Therefore, regulators and exchanges need to be very concerned about ensuring that corners do not take place since they are accompanied by severe price distortions and significant erosion of liquidity.
“In 1868, the whole floating supply of gold was about $20 million and the government held about $75 million in reserve. Jay Gould thought that this whole supply could be cornered and thus selling it at an inflated price. He conspired with Abel Corbin, the brother-in-law of President Grant, to influence government policy on gold. On numerous occasions, he lobbied Grant and government officials on the benefits of high gold prices. For a moment, it appeared that Grant was quite convinced. Gould proceeded to accumulate a $50 million position in gold and the price had risen from 130 to 137.
To increase his chance of success, Gould then launched an aggressive lobbying of government officials who began to suspect his speculative motives. Sensing the government might intervene to break his corner, he secretly sold his position while urging his friends to buy at any price. On October 4, the feverish purchase by Gould’s friends had pushed the gold price from 140 to 160, but government selling later during the day quickly broke the squeeze and brought the price back to $140. This day had gone down in history as another Black Friday, since hundreds of firms on Wall Street were ruined by the huge price swing.”
Squeezing the Bears: Cornering Risk and Limits on Arbitrage during the ‘British Bicycle Mania’, 1896-1898
Why This is Relevant:
This paper discusses how a fear of being cornered acted in itself as a short-sale constraint during the Bicycle Mania of the 1890s. In other words, people were hesitant to short these outrageously overpriced bicycle companies for a fear of being cornered.
While there are obviously major differences between the two situations, it is interesting that after the Reddit Army took on Citron Research in the GameStop war and drove prices up some 51% on Friday alone, Andrew Left of Citron came out and said that the firm would stop commenting on GameStop because of the actions of the “angry mob” (Reddit investors). There are some similarities between this fear of how other investors could force a short-squeeze and the situation covered in this paper on bicycle mania.
“This paper argues that the risk of being cornered constituted a short-sale constraint that exacerbated an asset-price bubble in bicycle shares in 1896-1898. Although only three corners occurred, the losses experienced were so substantial that this still represented a significant source of additional risk. High-profile cornering incidents, in which short-sellers usually made extremely heavy losses, were typically followed by periods of relative buoyancy in the cycle share market, and the most severe cornering losses are associated with a structural break in the prices of other cycle shares. Furthermore, shares which were particularly vulnerable to a corner appear to have been more overpriced than the rest of the market.
Cornering risk is unlikely to have been the primary driving force behind the reversal in bicycle share prices; it appears to have merely exacerbated overpricing, and slowed the subsequent downward adjustment of share prices. Nevertheless, the results of this paper suggest the need to reconsider the role played by short-sale constraints in historical asset-price reversals. The lack of regulation in early regional stock markets allowed investors to make unlimited naked short-sales, but also did nothing to ease the risks involved in doing so. Short selling therefore came to be seen as inherently dangerous, best left to specialist ‘bears’, who were subject to social disapproval. The limits this placed on arbitrage could form part of the explanation for the multiple asset-price reversals that occurred in early stock exchanges.”
“This is relevant for two reasons. Firstly, stories of members of the public making extravagant gains are likely to encourage other non-professionals to invest in cycle shares. The role of simple, colorful stories in spurring further investment in a bubble has been emphasized by Karl E. Case and Robert J. Shiller (2003). Secondly, holders of shares in other companies are likely to have become more inclined to join pooling operations. This may have been a factor in the development of the two further corners that took place in 1897, both of which required some small shareholders to commit to a similar arrangement. This, in turn, increases the cornering risk for short sellers to account for. The incident therefore would have made traders wary of short selling, while encouraging investment from uninformed investors. In combination, these factors could have contributed to the high price of cycle shares.”
What Moved Share Prices in the Nineteenth-Century London Stock Market?
Why This is Relevant:
Especially last year, and this year so far, markets have been driven by a lot more than just plain old fundamentals. This paper looks at the period between 1823 and 1870 to determine what drove market returns, and their findings posit that only 15% of the variation in stock prices are explainable by economic fundamentals. 15%!! This paper is a fascinating look at what really drives markets.
“Using a newly-constructed weekly stock-market index for the nineteenth-century, this paper has sought to understand what moved stocks in the period from 1823 to 1870. We find that changes in economic fundamentals explain around 15 per cent of the variation in stock prices for the entire period and up to 35 per cent in the post-1845 market. Short-term interest rates and proxies for long-term interest rates were important explanatory variables, with exchange rates and aggregate dividends being somewhat less important.
In terms of what caused substantial movements in the market in the nineteenth century, geopolitical events were the most common reason given by the press. Specifically, wars and revolutions involving European powers are especially important, but imperial wars and wars involving the U.S. are not. Other common causes of large movements include monetary policy, financial crises, and railway sector news.
The findings of this paper shed light on the development of the early equity market. In the era when equities became more widely held, it was economic and geopolitical news which affected stock prices most. This implies that they were regarded as being important risk factors and determinants of future performance, possibly helping to explain patterns of investment at this time.
The findings also imply that were some important differences between the equity markets of this era and modern markets. Changes in economic variables explain more of the movements in the historical period than in modern markets. In addition, the number and scale of substantial movements were smaller than we find in modern markets, suggesting that modern markets are much more volatile, and the press was able to provide explanations for the vast majority of substantial movements in the Victorian equity market. This differs from modern markets where the press and commentators are oftentimes unable to adequately explain substantial market movements. Another difference is that large movements in the Victorian era are much less likely to be attributed to monetary policy changes than in the modern era. Future work should explore why the equity market evolved to become more volatile and why large market movements became more difficult to rationalise.
“We find that changes in economic fundamentals explain around 15 per cent of the variation in stock prices for the entire period and up to 35 per cent in the post-1845 market. Short-term interest rates and proxies for long-term interest rates were important explanatory variables, with exchange rates and aggregate dividends being somewhat less important.”
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