Crypto, NFTs and Tulip Bulbs: 2021 from a Historical Perspective
Four tips for navigating the current environment
Tulip Mania 1634
In 1634 in the Netherlands, tulips bulbs (yes, the flower) gained favor as prices increased due to export demand, primarily from the French. Tulips became a symbol of luxury, coveted for the status they implied. As prices continued to increase, many made fortunes trading the bulbs. At the peak of the mania, some farmers traded their homes for a single tulip bulb. The prices remained volatile but continued to increase for several years. In February 1637, buyer demand dried up, prices collapsed, and fortunes and lives were destroyed.
I remember reading this story in my high school economics class and literally thinking it was fiction. My teacher swore it was real, but I couldn’t understand what would compel anyone to trade a house for a tulip bulb.
I never dreamed I would live through a similar psychological mania.
Twice.
Quick Recap of 2021
In 2021, the rate on the 10-year treasury was only 1.5%, near an all-time low. Inflation, on the other hand, hit 6.8%, the highest level in 40 years. That means if you invested your savings in treasuries, you would have lost 5.3% of your purchasing power every year (1.5% minus 6.8%). A combination of historically low interest rates (leading to cheap leverage) and a record $6 trillion of government stimulus left the country awash in capital. Whether you were an individual, a pension fund, or an endowment, you needed to invest that capital in riskier assets just to keep pace with inflation. Which is exactly what the world did in 2021.
The S&P index set 68 records and closed the year up 27%. The valuation of the S&P divided by the average of the past 10 year earnings (called the Shiller PE ratio) ended 2021 at 40x. Only twice in history has the Shiller PE been above 30x. It was 30x in 1929 and 44x in 2000. For those of you who are not stock market historians, neither ended well. A total of 340 venture-backed companies became unicorns (private, venture-backed companies with $1 billion or more in valuation) in 2021. Two years earlier, there were only 394 unicorns in total.
In addition to high valuations of traditional assets, there were several new technologies which excited investors. These included cryptocurrencies, NFTs, social media-driven speculation, and option trading for individual investors via platforms like Robinhood.
This market is frenzied, but not unprecedented. History doesn’t repeat, but sometimes it rhymes. We’ve seen mania in tulips in the 1600s, automobiles in the early 1900s, and the Internet in the late 1990s. Below are four investing tenets helpful in any market, but particularly as you navigate 2022.
Exciting new technologies don’t always make good investments.
At the beginning of the 1900s, it was clear that automobiles were going to be a transformative technology. According to Wikipedia, in the early 1900s, there were nearly 3,000 automotive companies in the U.S. By the mid-1900s, the big three (GM, Chrysler and Ford) had more than 80% market share. If you were an automotive investor at the time, you would have been correct about the impact of the technology, but you would have had a 3 in 3,000 chance of picking the ultimate automotive winner.
The same was true in the late 1990s. It was clear that the Internet was going to be transformative, and, if anything, most investors even underestimated its impact. Thousands of internet companies emerged, and over 1,000 companies went public between 1998 and 2000, including Pets.com, eToys.com, Webvan, Buy.com, Excite.com, and of course, Amazon.com. Had you invested across the entire sector by buying the NASDAQ index in 2000, you would have lost 78% of your money in the six months that followed the peak, and it would be another 15 years before the NASDAQ would recover.
Blockchain, as well as NFTs—a special type of blockchain in which each token is unique—are exciting new technologies. Like automobiles and the Internet, investors are excited by these new technologies. Like with automobiles and the Internet, in the early days, prices soared. As of November 2021, the total value of all major cryptocurrencies was nearly $2.5 trillion. Cryptocurrency now has a valuation roughly equal to 6% of all the currency in the world. NFTs traded $2.6 billion in December 2021, an increase from $65 million in the full year of 2020. A new phenomenon of trading en masse on social media drove up the price of AMC, Gamestop, and several other stocks. AMC stock catapulted from $2 to $72 in a year in which revenues were down nearly 80% from pre-COVID-19 levels, and AMC had lost more than $5.7 billion in the prior two years alone.
In the early days of a new trend or technology, investor enthusiasm drives prices of nearly everything up. But these manias can end badly. The reason new trends or new technologies often don’t lead to good investment opportunities is that the landscape remains in flux and often the ultimate winners are unpredictable, if not unknowable. Even betting on Amazon wasn’t a sure thing. If the company had not raised $672 mm in convertible debt in February 2000, a month before the market crash, you may never have heard of Amazon.
Cryptocurrencies and NFTs are both exciting technologies to be sure. But the ground is still unstable. Do you really know which of the millions of NFTs will have value in the future? Is Dogecoin the Google of crypto or is it the modern day equivalent of defunct search engine Askjeeves.com?
Your psychology can be your worst enemy.
My Instagram feed sends me countless ads from influencers who claim they are becoming millionaires, “I finally got the courage to quit my job and go all-in on NFTs,” says one. Social media influencer Gary Vanderchuck recorded a 46-second clip where he describes making $91 million dollars in 90 days selling NFTs. In another clip he claims, “NFTs are going to be bigger than the blockchain.” Matt Damon (as a spokesman for Coinbase.com), encourages trading in NFTs and cryptocurrencies. He quotes Virgil, “Fortune favors the bold,” he says. Reddit users post their stock gains and photos of houses, cars, and yachts.
It’s easy to get swept up in the frenzy. The fear of missing out is real.
In his 2000 book, “Irrational Exuberance,” Economist Robert Shiller offers the following insight on investor behavior: “...news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increases and bringing in a larger and larger class of investors, who, despite doubts about the real value of an investment, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement.”
If you buy Apple stock, you receive dividends for your entire life while you own the stock. If you buy a home, you can live in the home or make money renting the home. If you are buying an asset like AMC stock, crypto, or NFTs in which the only value is your hope that someone will pay you more for it in the future, that is a dangerous game. Be careful. Hope is not a reliable investment strategy. And what people value can be very fickle.
As Shiller says, envy is an incredibly powerful force. There’s a reason it is one of the seven deadly sins. And as an investor, envy is particularly dangerous. When your friends, neighbors, and the kids on your Instagram feed are all striking it rich flipping NFTs, recognize that this hype will ignite an animal instinct in you, the very instinct which drives speculative bubbles. Be aware of envy and beware of your animal instincts. Both will drive you in the wrong direction.
Beware of the mania of crowds.
Describing the tulip bulb mania, in his 1841 book, “Extraordinary Delusions and the Madness of Crowds,” historian Charles Mackay wrote, "Many individuals grew suddenly rich…Everyone imagined that the passion for tulips would last forever…nobles, citizens, farmers, mechanics, seamen, footmen, maidservants, even chimney sweeps and old clotheswomen, dabbled in tulips."
In 1929, preceding the stock market crash, Joseph Kennedy famously said, “When the shoeshine boys are giving stock tips, it’s time to sell.” In Michael Lewis’s “The Big Short,” the tipping point for Mark Baum shorting the housing market was when he learned an exotic dancer in Miami owned multiple rental properties.
My Uber driver, my workout buddy, and dozens of 20-somethings on my social media feeds are “dabbling” in NFTs and crypto and giving me stock tips. The point at which everyone jumps on the bandwagon just might be my signal to jump off.
Invest in what you know and understand.
Many people spend a lifetime making their money and literally minutes investing it. They read an article or get a hot tip from a friend or online source and pull the trigger, not wanting to miss out.
I imagine Gary Vanderchuck will do well in NFTs. He has a massive multi-million person online following to which he can hype and sell his art/NFTs/tweets. My teenage son, on the other hand, has dabbled in collectible sneakers and has lost money with every purchase. While I don’t own crypto, I keep a mental tab and try to predict where the price is going to go. I’ve been wrong nearly every time.
There is an old expression, “If you look around the poker table and can’t figure out who the patsy is, it’s you.”
I worked for several name-brand investment firms, learned from outstanding investors, attended business school, and still lost money on five of my first eight investments. Over 27 years I have come to learn how to reliably evaluate and add value to private companies. I am below-average at pretty much every other type of investing. So I don’t invest in individual public stocks, real estate, crypto, NFTs, bonds, comic books, or sneakers.
Warren Buffett says one of his core investment principles is to stay within his circle of competence, i.e. the things he understands. The magic is not in the size of your circle, but in having the humility to recognize when you’re outside your circle.
“The magic is not in the size of your circle, but in having the humility to recognize when you’re outside your circle.”
Before investing, ask yourself if you really understand the intrinsic value of what you’re going to buy or if you’re getting caught up in the hype.
Conclusion
This is a wild time, but it’s not unprecedented. We’ve seen versions of this movie before; history rhymes. Keep your head. Beware of the mania of the crowd. Recognize when you’re acting with animal instincts or investing out of envy, both will steer you wrong. Invest in what you know and understand. Be careful out there. And you’ll likely come out fine.
Good luck!