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Quote of the Day

“If you aren’t in debt, you can’t go broke and can’t be made to sell, in which case “liquidity” is irrelevant. But a leveraged firm may be forced to sell lest fast accumulating losses put it out of business. Leverage always gives rise to the same brutal dynamic, and its dangers cannot be stressed too often.”

-Roger Lowenstein, in his book When Genius Failed

August 13th – This Day in Stock Market History

August 13th, 1987 – The New York Times celebrates the “5th birthday of the new bull market”.

On this day, the Dow Jones Industrial Average reaches above 2,700 for the first time (though closes at 2,691.42) on heavy trading.

The markets are on a tear, the Dow is up 42% Year to Date.

Source: Bull: A History of the Boom and Bust, 1982-2004

New York Times coverage of the "Bulls market's 5th birthday"
New York Times coverage of the “Bulls market’s 5th birthday”

Even considering Black Monday 1987 when the Dow fell 24% in a single day, U.S. stock markets would still end the year of 1987 positive, and the bull run would continue largely unstopped for another 13 years!

August 13th, 1998 – As Russia struggles economically, it puts capital controls on the ruble, attempting to limit the currency’s decline.

Russia’s stock market falls 6% on the news, and is now down 75% year to date. Short term interest rates in Russia are at 200% at the time.

The panic caused was hurting one hedge fund in particular – Long Term Capital Management, who had $3.6 billion in assets leveraged at 25 to 1, much of which was used to bet heavily on Russian bonds.

Russia would default on its bonds 4 days later. All equity in Long Term Capital Management would evaporate in the next 5 weeks.

Source: When Genius Failed – The Rise and Fall of Long Term Capital Management

NYT_front_page_-_russia
Front page of the New York Times, August 14th 1998

Best August 13th in Dow Jones Industrial Average History

1934 – Up 2.24%, 2.01 points.

Worst August 13th in Dow Jones Industrial Average History

1940 – Down 3.36%, 4.28 points.

Read of the Day

In 2007 Warren Buffett gave a talk to MBA students at the University of Florida and touched on the topic of Long Term Capital Management:

“It’s…an interesting story…The whole story is really fascinating because if you take John Merriwether, and Eric Rosenfeld, Larry Hilibrand, Greg Hawkins, Victor Haghani, the two Nobel Prize winners, Merton and Scholes, if you take the 16 of them, they probably have as high an average IQ as any 16 people working together in one business in the country…an incredible amount of intellect in that room. Now you combine that with the fact that those 16 had had extensive experience in the field they were operating in…In aggregate, the 16 had probably had 350 or 400 years of experience doing exactly what they were doing. And then you throw in the third factor that most of them had virtually all of their very substantial net worths in the business. So they had their own money up. Hundreds and hundreds of millions of dollars of their own money up. Super high intellect, working in a field they knew. And essentially they went broke. And that to me is fascinating….

But to make money they didn’t have and didn’t need, they risked what they did have and did need, and that’s foolish. That is just plain foolish. Doesn’t make any difference what your IQ is. If you risk something that is important to you for something that is unimportant to you, it just does not make any sense. I don’t care whether the odds are 100 to one that you succeed or 1,000 to one that you succeed. If you hand me a gun with a thousand chambers – a million chambers in it – and there’s a bullet in one chamber, and you said, “put it up to your temple, how much do you want to be paid to pull it once?” I’m not going to pull it. You can name any sum you want but it doesn’t do anything for me on the upside and I think the downside is fairly clear. [Laughter] So I’m not interested in that kind of a game. And yet people do it financially without thinking about it very much.

There was a great book…the title was, “You Only Have to Get Rich Once.” Now that seems pretty fundamental, doesn’t it? …If you’ve got $100 million at the start of the year, and…you’re going to make 10% if you’re unleveraged, and 20% if you’re leveraged, 99 times out of 100. What difference does it make at the end of the year whether you’ve got $110 million or $120 million? It makes no difference at all…It makes absolutely no difference. It makes no difference to your family. It makes no difference to anything. And yet the downside, particularly in managing other people’s money, is not only losing all your money, but it’s disgrace and humiliation, and facing friends whose money you’ve lost and everything. I just can’t imagine an equation that that makes sense for. And yet 16 guys with very high IQs who are very decent people, entered into that game…I think it’s madness.

Parts of the Transcript from Alpha architect article here

You can watch/listen to the whole answer from Buffett here. There are a ton of amazing nuggets in this talk, its worth 10 minutes of your time.

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