1600-1700s: The early bubbles: Tulip Mania, South Sea bubble, Mississippi Scheme
The earliest documented bubble in the financial markets was the Tulip mania. It was during the Dutch Golden Age where the Dutch had the highest income per capita in the world. Probably with so much excess, they had the capacity to speculate in tulip bulbs using financial contracts and sent the price of a tulip to 10 times the pay of a skilled craftsman.
The Mississippi Scheme was a brainchild of a swindler, John Law. He convinced the French monarchy to give him the trade monopoly in the West Indies and North America and in return, generate revenue to pay off the government’s debts. Law exaggerated the prospects of the Mississippi Company and led to a speculative bubble which burst in 1720.
The South Sea Bubble was another famous event. The stock was floated publicly with the aim to reduce the British national debt. In return, the company was granted the monopolistic right to trade with South America and in the South Pacific. There was rampant insider trading and eventually the inflated stock prices came to a total collapse.
Even the genius Sir Isaac Newton was not spared. He had about £22,000 in South Sea stock in 1722 and famously quoted for saying, “I can calculate the movement of the stars, but not the madness of men”.
Although it was few hundred years ago, you will still see similar irrational behaviour of the crowd that still cause market boom and bust cycles. So we can be sure that human behaviour stays the same regardless of the progress of our society. Understanding it would be the first step to capitalise on human folly. Simple but not easy.
Extraordinary Popular Delusions and the Madness of Crowds covered more topics and beyond the financial markets in 3 volumes. Only 3 chapters in Volume 1 were about financial bubbles. Hence if you are interested only in finance, you can go for a shorter version of the book.
1938: The Birth of Intrinsic Value
This is an out-of-print book and not as well known as the rest of the books in this post. But it doesn’t make it less important.
John Burr Williams was credited as the person who introduced the commonly used Discounted Cash Flow (DCF) and the Dividend Discounted Method (DDM). The number that get spitted out by the calculations is called intrinsic value. The premise is that the value of a business is the summation of its future cash flow discounted to the present value. This is something you would hear Warren Buffett recite from time to time. The Theory of Investment Value documents the genesis of the DCF and DDM models.
1949: The Rise of Value Investing
This book needs little introduction. Benjamin Graham is a well-known name among the investing circles. All thanks to his disciple, Warren Buffett, who constantly praised his teacher in many occasions. Graham has been given many titles such as the Dean of Wall Street and the Father of Value Investing because his work has a profound impact to the investing community.
He was known for the voluminous Security Analysis which he used it as a textbook for the undergraduate program by the same name. The Intelligent Investor is a condensed and less technical version of the Security Analysis and meant for the man on the street who may not have the academic rigour to understand it.
The examples in the book may be dated but the principles of value investing are evergreen and still relevant today.
1957: Switching Over to Growth Stocks
This is the second book that Warren Buffett would recommend you to read after The Intelligent Investor. It also symbolised the change in Buffett’s investing style from Graham to more Fisher. Instead of buying dirt cheap stocks, he turned to buying growth stocks for the long run. In Common Stocks, Uncommon Profits, Fisher laid out 15 points that make a great investment and most of them are qualitative in nature, as compared to the more quantitative nature of Graham’s approach.
1950s: The Start of the Warren Buffett Cult
Warren Buffett started investment partnerships prior to the days of Berkshire Hathaway. He had already developed the penchant to write insightful and candid letters to his investors. Jeremy Miller pored through the partnership letters and compiled the wisdom in Warren Buffett’s Ground Rules. This is a rare insight into Buffett’s early days as an investor.
You can download Berkshire Hathaway shareholder letters for free. But if you prefer a book, you can get The Essays of Warren Buffett, a compilation of the letters by Lawrence Cunningham. Buffett’s letters are probably the most read publication in the investment field.
1960s: Early Days of Quants – Convertible and Statistical Arbitrage
There was a less well-known group of mathematicians who found anomalies in the stock market and an opportunity to exploit it. Ed Thorp was famous for beating the casino odds in the game of blackjack. He moved on to the stock market and found that the convertible securities such as warrants were mis-priced as compared to the underlying securities. So he started a hedge fund and exploited the mis-pricing until it was forced to closed down due to the embroilment with junk bond schemes (which we will discuss this important point in financial history in subsequent paragraphs). Beat the Market details his convertible and statistical arbitrage methods.
While you are at it, check out Ed Thorp’s well-written autobiography, A Man For All Markets, and you will be amazed with his achievements and admire his talents in diverse fields. The book will also give you his views about the financial markets in that era.
1970s: The Market is Efficient! Screw Fundamental and Technical Analyses
The academia has hit back at Wall Street with the Efficient Market Hypothesis (EMH), claiming that their research had proven that no one could beat the market because all information has been priced into the securities. If anyone has beaten the market, it was pure luck.
EMH formed the foundation for index investing. In A Random Walk Down Wall Street, Burton Malkiel presented all the arguments against stock picking, chart reading and other major strategies used in Wall Street. Even though you might disagree with some of these arguments, it is still enlightening to see from the academia’s point of view.
1980s: Turtle Trading Program Created Trend Following Legends
Meanwhile, traders using the trend following strategy were making a killing in the commodities markets. One day, Richard Dennis and William Eckhardt made a bet with each other – Dennis said traders can be trained while Eckhardt believed traders are born.
They recruited people from all walks of life that included a Czechoslovakian-born blackjack master, a Dungeons and Dragons game designer, an evangelical accountant, a Harvard MBA, a U.S. Air Force pilot and a former pianist. This became the turtles trading program (because Richard Dennis visited a turtle farm in Singapore) and the turtles made over $150 million in four years. The Complete TurtleTrader captures this story.
1980s: Junk Bonds Era
Michael Milken is a notorious name in the 80s. He made junk bonds (or a better name would be high-yield bonds) popular and created an age of excess with easy credit for any company. He had amassed a great number of investors craving for yields and enabled him to raise large amounts of money very quickly. He was eventually charged for several crimes such as racketeering and securities fraud, and served 22 months of imprisonment, including a $600m fine.
Without Michael Milken, leveraged buyouts and corporate raiding wouldn’t exist in the 1980s. For better or worse, he played a crucial role in shaping the financial landscape till today. Liar’s Poker is about Michael Lewis’s experience as a bond salesman in that era.
1980s: Inventing the Game of Leveraged Buyout and the Rise of Private Equity Firms
It was said that KKR invented the Leveraged Buyout (LBO) game when it took over RJR Nabisco. Barbarians at the Gate documented this episode and the book was adapted to a movie too. LBO simply means taking up a lot of loans to buy and gain control over a target company. Usually the investors will install a new management, sell off assets and close divisions to try to improve the operating efficiency of the company. Hopefully the company makes enough money to help pay off the loans they took to acquire it in the first place.
Blackstone is another big private equity firm that did a lot of LBO deals and became the largest alternative asset company today. King of Capital documents Blackstone’s roller-coaster journey to become the success today.
Stephen Schwarzman is the co-founder of Blackstone and recently gave his own account of Blackstone history in What It Takes.
1980s: Corporate Raiding
Seems like a lot of things happened in the 80s besides retro music. Corporate raiding took to the stage and Carl Icahn was a key actor. He would mount hostile takeovers of companies he believed to be undervalued and find ways to unlock value after the attack and sell his stake for a profit.
He is still doing that today and a few years ago he took on Apple and pressured Tim Cook to distribute dividends and carry out share buybacks. Today, they have a less tainted name and investors started to see them as heroes. Instead of corporate raiders, they are known as shareholder activists.
King Icahn was written by Icahn’s neighbour, Mark Stevens. Icahn was a private person and refused to have his biography written but Mark persisted. This book probably contained the most information about Icahn than any other publication you can find out there.
Shareholder activism wasn’t new as Graham and Buffett had done their fair share decades ago. It just became rife in the 80s onwards. Dear Chairman is an interesting book that recorded several shareholder activism cases. Many good learning points if you are into value investing and corporate governance.
1980-1990s: Rise of the Quants – The legendary Medallion Fund
The best quant fund mankind has ever known was starting to make their mark – The Medallion Fund. This is the flagship fund of Renaissance Technologies, a company co-founded by math professor, James Simons. The Fund average about 66% annually over a 30-year period! But unfortunately the fund has been long closed to outside money. The staff trade their own wealth and the Assets Under Management (AUM) seems to be kept at US$10 billion.
The Man Who Solved The Market is a biography of James Simons.
1990s: Index Funds Gaining Traction
Index funds were getting more attention and investment dollars in the 90s. John Bogle started Vanguard, one of the largest mutual fund and ETF managers in the world today. He was ridiculed when he created the first index fund on 31 Dec 1975. Today, he made his critics eat their words.
In Common Sense on Mutual Funds, Bogle showed his distaste against actively managed funds and augment his arguments with a lot of data and research. He has since left the world but we are still feeling his impact and contribution to the financial markets.
1993: The Birth of Factor Investing
In 1993, academics Eugene Fama (Nobel prize winner) and Kenneth French discovered the Value, Size and Market factors can drive higher returns in stocks. In the same year, Sheridan Titman and Narasimhan Jegadeesh proved the outperforming Momentum factor.
Your Complete Guide to Factor-Based Investing is a simple-to-read book meant to introduce a layman to Factor Investing. The financial industry are using factors extensively, including one of the largest hedge funds, AQR and the world’s largest ETF provider, Blackrock.
Yours truly is a believer of Factor Investing and use the Value, Size and Profitability factors as my initial filtering to find stocks to invest in. You can refer to our comprehensive Factor Investing guide.
1995: Bringing Down a 233 year-old British Bank Right Here In Singapore
Coming back to Singapore. There was a a guy called Nick Leeson who used to trade for Barings Bank in the trading floors of Singapore International Monetary Exchange (SIMEX). No, it is no longer around – no more open outcry in the pits. Barings Bank was the oldest merchant bank in UK and he single-handedly brought down the bank by doing unauthorised trades for years, hiding losses in an error account. The total damage was 827 million pounds and the bank went bankrupt after a failed bailout.
Rogue Trader is written by Nick Leeson himself. It was adapted to a movie by the same name.
1998: Quants got a bad rep
Your fund should do well given that you have two Nobel prize winners as your principals. But apparently academic theories couldn’t work that well in the real world. The models they built enabled the fund to make good profits until a bad event happened and they lost everything and more due to huge leverage. When Genius Failed is an account of the rise and fall of Long-Term Capital Management (LTCM).
2001: The Fall of Enron and Arthur Andersen
Enron was an energy company that shook the world when its audaciously fraudulent accounting practice was disclosed to the public. The havoc brought down one of the big five accounting firms, Arthur Andersen, who was involved in covering the fraudulent financial reporting as a main auditor.
The Smartest Guys In The Room unveils the forensics of this fraud.
2001: Too Much Luck (and Unluckiness) In Investing
Nassim Taleb broke into the scene writing about the role of luck in the financial markets. He reasoned that it was hard to tell apart luck and skill when it comes to investment successes. There were a lot of survivorship biases and false cause-and-effect associations in finance, leading to a lot of pseudo overconfident expertise and eventually lead big catastrophic failures. He was equally critical to almost everyone in finance, from academics to fund managers and option sellers. His brashness polarises people – either you like him or you don’t.
Part philosophy and part probability, Fooled by Randomness is an important read so you know how not to be unlucky in the markets.
2005: The Envied Yale Model
Many universities need to invest their endowment funds to generate investment gains and pay for their operating expenses. David Swensen is the star in this field as the Yale Endowment Fund achieved 11.8% annually between 1999 and 2009. In Unconventional Success, David Swensen shared how an individual can model after the Yale Endowment Fund.
2007: The Black Swan Gets Its Name
Nowadays everyone seems to be using the word ‘black swan’ loosely and often wrongly. Black swan events are unforeseeable, they are unknown unknowns. But I observed people say something along this line, ‘this debt problem may become a black swan event’. This is a known unknown, not a black swan event. We have to give credit to Nassim Taleb as he popularised this term and its concept widely to the public.
A sequel to Fooled by Randomness, Black Swan talks about unforeseeable events with massive impact. These events are usually more probable than what our models predict and hence we become less prepared for their occurrence. For example, Covid-19 was a black swan event.
2008: Betting On the Great Financial Crisis
The Great Financial Crisis (GFC) in 2008 almost destroyed the banking system if not for the U.S. government bailing big institutions. The Big Short was about unrelated groups of individuals making the same conclusion about the unsustainable sub-prime lending activities in the U.S. They made bets against it and were eventually rewarded financially for the right call. The movie of the same name was enjoyable too but avoid the show if you are offended by profuse profanity.
2014: The Invasion by the High Frequency Traders
The financial markets are getting more and more sophisticated. There’s a new breed of market participants known as the high frequency traders. They put up so much effort to find the shortest path to the servers of the stock exchange in order to shave micro-seconds in trade execution. The speed is now several times faster than the blink of your eye. Many trades are done in the dark pools instead of the stock exchanges themselves. Discount or zero-commission brokerages often sell your order flow to the HFT to get paid.
The Flash Boys give you an inside account about HFT’s unfair advantage, how it was discovered by Brad Katsuyama and leading him to the create Investors Exchange.
Now it is time to read them…
These 27 books will give you a very good understanding about the financial markets and the participants as they documented the defining moments in financial history.
The financial landscape today has been shaped by the confluence of these events. Be sure to read them! If would you prefer to watch a movie instead of reading, then do check out this article too.