On this day after the Kentucky Derby, it’s a good time to drink some water and take a closer look at how there’s something about us humans and speculation that seems to be woven into our DNA as a species.
Just consider the popularity of legal online gambling on everything from dog races, horse races, to the super bowl and to the weather (yes, you can bet on the weather).
Gambling and speculating on anything just seems to push a button in our brains that seems to be too enticing to pass up. Couple that with people getting dressed up and having some mint juleps and you have an activity like horse racing that continues to surprise many with its durability as an economic engine for both Churchill Downs and the Louisville area each year.
In terms of helping clients invest their funds, speculation is a natural, if not quite welcome, guest in the process since all investing carries with it some level of uncertainty that naturally comes from doing something with an unknown outcome.
One of the most respected books about financial speculation’s delicate dance with investing is “Devil Take The Hindmost: A History of Financial Speculation” by Edward Chancellor.
The title for this book comes from a phrase dating back to the early 1600s that means that everyone should (or does) put their interests first without regard for the fate of others, with the devil collecting the stragglers in this implied race or competition. (So it’s definitely not the most warm and cuddly phrase ever uttered.)
The book, however, is a lively recap of how financial speculation was “invented” in a systematic structure back in Western Europe thanks to the tulip bubble in the Netherlands and expanded like a virus from there.
Americans seem especially driven toward speculation. The way that our country encourages and celebrates the lone striver going from rags to riches certainly plays a role.
From “Devil Take the Hindmost”: “According to the financial journalist Alexander Dana Noyes, the American stock market boom at the beginning of the twentieth century was ‘as much a social and psychological phenomenon as a financial episode.’ The same words could be applied to any other period speculative euphoria. We can supplement the economic model of speculation with two conditions, one social and the other political. The first being that self-interest should be the principal economic motivation since manias are less likely when a society has other priorities.”
What I take this to mean is that in a society where financial speculation can result in a massive jump up the economic ladder, people are going to risk more. On the other hand, if a society or country has a strong social safety net and strong regulations to protect innocent people from getting scammed then speculation doesn’t seem so appealing.
Let’s compare France to the United States: workers in France have a cushy retirement plan they can rely on to live in the later years. The U.S. has social security, which is a good thing for retirement, but not enough to replace a person’s salary while working -- and so people naturally enroll in their companies 401(k) or other type of retirement plan to make up the difference. Which is better? That’s a question for another time.
Does this mean that Europeans don’t like to speculate? Hardly. Horse racing is as popular around Western Europe as it is here in the states. And lotteries are well marketed and participated in, and Europeans were heavily involved in the Transcontinental Railroad mania that occurred in the late 1880s.
But the Wall Street crash of 1929 was a red, white and blue event all the way.
There were statements in the financial press leading up to the crash that went along the lines of “this time is different” (a very dangerous phrase when it comes to financial speculation) and that the market was so strong that it was possible to “buy AOT – Any Old Thing”. Groucho Marx wrote in his memoirs that investing during this time was so easy! “You could close your eyes,” Marx wrote, “stick your finger any place on the big board and the stock you bought would start rising.”
Of course it all came crashing down thanks to some badly timed interest rate decisions, the use of buying shares on margin, a sharp run up in stock prices (since 1924, share prices had risen three times faster than corporate earnings) and the prevailing belief that we humans had mastered the economy and figured out how to keep everything going up all the time, forever.
Pride cometh before the fall…
And that phrase, I think, is our best weapon against falling into the oh-so-tempting-pit of thinking that we’ve figured out how to pick stocks, or how to pick a Derby winner, or how to make riches quick without risking too much.
So if you didn’t pick the winner in this year’s Run for the Roses, don’t despair. Even Churchill Downs as a stock has hit a cold streak and is negative 7.79% for the past year and negative 12.58% over the past five years, as of late April.
Are they a takeover target like Brown-Forman, another major company for Kentucky? Churchill has market cap of $6 billion. Brown Forman's market cap is just under $14 billion. The Dallas Cowboys have an estimate value of $13 billion. So I can see where someone from Middle East, maybe the Saudi Public Investment Fund, which plowed $5.3 billion in LIV Golf, might think that a speculative investment in Churchill might make sense. Although getting approval for that takeover would almost certainly face resistance from US regulators.
Only time will tell.
Per usual, Warren Buffett sums up the risks that happen when things seem too easy. And this analogy from Warren B seems especially appropriate on the day following an event as raucous as the Derby…
“The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities — that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future — will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.”
Pictured is Kentucky Derby contender Devil Diver from 1942. He didn't win the big race but he did go on to have a successful retirement as the father of several outstanding offspring.