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Quote of the Day

 

“First we find it in a state of quiescence, -next improvement, -growing confidence, -prosperity, -excitement, -over trading, -convulsions, -pressure, -stagnation, -distress, -ending again in quiescence.”

-The banker and bullionist S.J. Loyd describing the credit cycle after the Crisis of 1825, in which on the day in 1825, reached the climax of its panic as 40 banks fail.

 

December 14th – This Day in Stock Market History

 

December 14th, 1825 – As the world’s largest speculative commodity bubble pops, banks in England that had recklessly extended credit for speculation in commodities, bonds, and stocks are beginning to fail. On December 14th, 1825 a London bank Pole & Co. would fail, causing bank runs and immediately bringing down 40 other commercial banks. In the Panic of 1825; stocks would fall 80%, troops would be called to control riots, and the Bank of England would nearly fail.

 

Source: Devil Take the Hindmost

The Panic of 1825 was started by massive speculation into South American mining companies and commodities in particular. Even The Bank of England had extended credit recklessly to speculators betting on share prices of mining companies rising. Anglo-Mexican mining shares rose from £10 to £150 in a month. Shares of Real del Monte (a Mexican silver miner) rose from £70 to £1350!

stock_chart_panic_of_1825

However by fall 1825, the bank of England was rapidly running out of gold deposits, and was forced to contract the credit it had extended in order to try and restrict the flight of gold from its vaults. But that contraction smothered out the credit required by the speculators, many of which were buying on margin. As the crisis worsened in early December, banks began to fail. This day in 1825 in particular was responsible for over 40 banks being brought down as a result of the London bank of Poole & Company not paying their debts.

In the end, stock prices would fall 80% and troops would be called to protect the Bank of England from a gathering mob. At its low point, the Bank of England would have gold reserves of less than a million pounds, less than a 2 day supply!

But the Bank of England had a savior in 1825 – By Christmas Eve 1825 the risk of failure at the Bank of England would be over due to a gold deposit of more than 300,000 coins from Nathan Rothschild. Although the bank was saved, the economic crisis would continue on for another year.

 

For those looking for a little more information on the Panic of 1825, here’s an article from the St. Louis branch of the Federal Reserve that goes into a little more detail (and is the source of the chart above).



 

Best December 14th in Dow Jones Industrial Average History

1914 – Up 3.92%, 2.14 points.

 

Worst December 14th in Dow Jones Industrial Average History

1916 – Down 4.27%, 4.38 points.

 

 

Read of the Day

Of course there have been many examples of reckless speculation since 1825. Most recently, the tech bubble in 2000 saw similar euphoria quickly followed by despair. In early 2000 Jack Bogle, the founder of Vanguard gave a speech which should have served as a reality check for investors. Bogle starts by describing the market over the last couple decades:

During the final two decades of the 20th century, the U.S. stock market has provided the highest returns ever recorded in its 200-year history—17.7% per year, a rate at which stock prices double every four years. What have been the sources of this unparalleled growth? Well, complex and mysterious as the stock market may seem, its returns are determined by the simple interaction of just two elements: investment returns, represented by dividend yields and earnings growth; and speculative returns, represented by changes in the price that investors are willing pay for each dollar of earnings.

Bogle goes on to explain what must happen for the market to justify their prices, and give projections for future returns:

bogle_speechThe speech is titled “Investing in the New Millenium” and is available here.

 

By the way, how did Bogle’s projections turn out?

For the S&P 500 from January 1999 to January 2010:

Total Return: 11.91% (just over a 1% annual compounded return – Ouch!)

sp500tr1999-2009

 

 

Final PE Ratio: 20.70

Final S&P 500 Earnings: 57.05 (Though still recovering from the 2008/2009 crisis. S&P 500 earnings for 2010 would be $85.31. but still far from Bogle’s projected $101.50.