The ChoosaBroker Trading Academy

1.2. Financial Markets a Historical Perspective

Course Description

A brief knowledge of the history of financial markets will provide us with some context for everything that we see around us today. It will also show that people, both individually and as a group, are prone to repeatedly committing the same mistakes. The more things change, the more they stay the same. In this lesson, we will learn about –

Short History of Global Financial Markets

Financial markets primarily consist of two sectors of the economy: namely the capital market and the money market. The capital market is a broad term that includes the stock market and other financial trading venues. The Amsterdam Stock Exchange (Bourse), founded by the Dutch East India Company in 1602, was the first to formally begin securities trading. The growth in stock markets gained momentum with the start of Industrial Revolution in Europe. Private enterprises began flourishing, leading to the setting up of partnership firms and joint stock companies. As their numbers increased, more shares were floated to the public, necessitating the creation of an organized marketplace for the exchange of these shares. The London Stock Exchange was established in 1773 to cater to these demands.
In the United States, 24 brokers met beneath the boughs of a buttonwood tree on May 17, 1792 to sign an agreement that gave birth to the New York Stock Exchange. During the Revolutionary War, New York had already become a major financial hub for trading in government bonds. After the war ended, trading volumes increased as new instruments entered the market. Rather than watch more and more brokers pour in to the market and drive down commissions, the states’ most prominent brokers agreed to work together by bringing their entire trading under a standardized exchange framework at a floor commission rate.

Financial Market Bubbles and Crashes

The word “bubble” is typically used to describe an economy that is on the verge of overheating. The recent dot-com and the real estate “bubbles” in the United States left the economy in tatters and made the term globally infamous. But long before it became a common lexicon in the financial vernacular, there were several moments in history when economies in different pockets of the world strained as bubbles burst.
  • Tulip Bubble – Perhaps the first and the most devastating bubble was the “Tulip mania” in the Netherlands in the early 17th century. Newly brought in from Turkey, tulips were a big novelty in the Dutch society of that time. Investor greed drove the price of tulip bulbs to previously unheard of levels, so much so that people began putting up their houses as collateral. But a wave of sales triggered a domino effect, sending prices collapsing.
South Sea Bubble – Share prices of British trading firm South Sea Company skyrocketed close to 900% during the early part of 1720 amid inflated expectations that it would soon yield bumper profits by trading with South America. However, the big money never realized on paper as Britain went to war with Spain, which controlled most of South America. Shares plunged soon afterwards, leaving a chain of bankruptcies in its wake.

The Great Depression – In the five years preceding October 1929’s huge Wall Street crash, shares listed on the Dow Jones Industrial Average zoomed 500%, buoyed by unreasonably bullish forecasts about the US economy. Eventually cracks began to appear, hammering the Dow 90% below its 1929 peak, and plunging the country in to the “Great Depression” that lasted for the next 10 years.

History of Financial Market Regulation

The Dutch were the pioneers in financial market regulation when they imposed a ban on short selling in 1610 after Isaac Le Maire, a prominent merchant, was accused of manipulating shares prices that led to a crash in the Amsterdam Bourse. In 1733, the Great Britain disallowed naked short selling as fallout of the South Sea Bubble. French monarch Napoleon Bonaparte also didn’t like the activity as it directly came in the way of financing his wars. He not only banned short selling, but also signed an edict in 1802 by which short-sellers were imprisoned on grounds of treason.
Following the Great Wall Street Crash of 1929, the Glass-Steagall Act was enacted in the United States with the goal of controlling speculation by prohibiting commercial banks from engaging in investment banking activities. The Act was in force for over six decades until the US Congress replaced it with the Gramm-Leach-Bliley Act of 1999, which removed barriers in the market and allowed commercial banks, investment banks and securities firms to consolidate their services.

Legendary Market Participants

In every human endeavour, an elite few shine brighter than the rest. Most disciplines don’t lend themselves well to making objective comparisons. But in investing, the returns earned are an excellent yardstick to measure long-term success. Let us look at the 5 most famous market participants in modern history.
    • Charles Dow Charles Dow began his life on a Connecticut farm and never received any formal education in finance. But by the time of his death in 1902, he had founded The Wall Street Journal and gave birth to the famous benchmark index that still bears his name. He was also instrumental in laying the foundation for what came to be known as the “Dow Theory,” the governing postulates upon which modern technical analysis is based.
    • Benjamin Graham Benjamin Graham is widely believed to be the “father of value investing.” His second book, “The Intelligent Investor,” is still considered the seminal text on modern financial investing. Graham’s market outlook was based on the principle that any worthwhile investment should be worth substantially more than what investors were currently paying for it. In partnership with Jerome Newman, Graham founded an investment firm in 1926. From that time until the firm was dissolved in 1956, the Graham-Newman Corporation flourished, clocking an average annualized return of 17.00%.
  • Warren Buffet With a total net worth of just under $87 billion, Warren Buffett is the world’s third richest man. Since taking charge of Berkshire Hathaway in 1965, Buffet has managed to churn out average annual return of 20.80% for his shareholders, compared to the broad-based S&P 500 Index, which grew at less than half of that – 9.70% per annum. The duration, consistency and magnitude of these returns are unmatched, helping him earn the tag of the “greatest investor of all-time.”

John Templeton

John Templeton pioneered the growth of diversified mutual funds and invariably sported market-beating returns in a career spanning more than 60 years. His investing acumen can be gauged from the fact that $10,000 invested in the Templeton Growth Fund in 1954 would have turned to a whopping $2 million by 1992.

Peter Lynch

Peter Lynch’s 13-year tenure at the helm of Fidelity’s growth-focussed Magellan Fund saw him return 29.20% annually, crushing the 15.80% appreciation in the S&P 500. Besides his eye-popping returns, Lynch also penned the best-selling investing classic, “One Up on Wall Street.”

Final Few Thoughts

The past is the key to the future. By understanding how the financial markets took shape, and learning about some of the biggest mishaps in its history, we as investors can fast-track our progress and avoid repeating the mistakes that the previous generations of market participants had made.

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