Wednesday, September 26, 2007

Lessons from the Dutch tulipmania

TheStar

Retailers suffered huge losses during the Dutch tulipmania from 1634 to 1637. We need to be extra careful in view of the excessive speculation in the China and Hong Kong markets as well as the subprime problems in the US housing market.

Q: What can we learn from the past market speculative manias, like tulipmania?

A: Lately, the Shanghai Index and Hang Seng Index touched new highs again. Besides, the Dow Jones Industrial Average was just about 2% shy of its recent peak of 14,000 points. Some analysts and fund managers have started to wonder when this excessive speculation would end, especially for the China market.

In this article, we will look into one of the past speculative manias, the Dutch tulipmania, which happened in the Netherlands from 1634 to 1637.

The tulip originated in Turkey but diffused into western Europe in the middle of the 16th century. The bulb can propagate either through seeds or buds that form on the mother bulb.

Due to slow propagation and popular demand, the tulip was viewed as an expensive, beautiful and rare flower. Hence, as the tulip was grown from bulb, the main object of this mania was the tulip bulb, not its flowers.

The market for bulbs was originally limited to professional growers. However, as a result of the inflow of large amounts of foreign funds and a rising demand for bulbs in France, the speculative buying interest started by end-1634. Many retailers liquidated their assets just to participate in tulip speculation.

Towards mid-1635, prices rose rapidly and people could buy it on credit. Many big merchants showed little interest while many lower middle and working classes were speculating in tulips.

At the latter stage of speculation just before the market crash, bulb prices surged 26 times within a month in January 1637. However, as the late buyers were unable to resell them at higher prices, they were forced to cut losses.

As a result of panic selling, the price tumbled to just 5% of its peak value in the first week of February 1637. Many middle-class people suffered huge losses.

Even though tulipmania happened more than 300 years ago, the recent speculative mania in the China and Hong Kong markets worry us.

According to Guillermo Calvo in his research titled, “Tulipmania”, he defined tulipmania as: “Situations in which some prices behave in a way that appears not to be fully explainable by economic fundamentals.”

Given that the China market jumped from the low of about 1,000 points to the present 5,400-level within a two-year period, it is hard to believe that its economic fundamentals can sustain such high market valuations.

Even though we are quite bullish on its long-term prospects, we are also concerned about the sudden surge in market value within such a short period of time.

Q: Given that the US Federal Reserve has lowered its Fed rate, can we say that we have seen the worst of the subprime woes?

A: Although the sub-prime issue has been outstanding for more than a year, it appears to be getting bigger rather than smaller. Nobody knows how serious the problem will be.

We like to use the Cockroach theory to explain the current phenomenon. Based on this theory, when you discover one cockroach in your cabinet, most likely there are more cockroaches there. This theory explains that one piece of bad news is an indication that there is more bad news to come.

Our view is as long as the US property prices continue to dip, we need to be extra careful as they can spread to other types of mortgages.

Disclaimer: Reading materials in this site are obtained from its respective website and it is for information purposes only. It is not Malaysia Unit Trusts - administrator view and it is not to be used against Malaysia Unit Trusts - administrator.