Bubbles, Ponzi Schemes, and Investments
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Prepared for CCEE Seminar, October 2013.
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Bubbles, Ponzi Schemes, and Investments
- 1. Bubbles, Ponzi Schemes, and Investments Dale DeBoer, Ph.D. 2013
- 2. How would you know? • The (ab)normal market • There is no such thing • Historical performance
- 3. S&P 500
- 4. S&P 500 5.7%
- 5. S&P 500 8.7%
- 7. Thinking about P/E ratios • Suppose P/E = 10 • Price = 10 • Earnings = 1 • Rate of return?
- 8. Thinking about P/E ratios • P/E = 15.6 • Rate of return?
- 9. Thinking about P/E ratios • P/E = 15.6 • Rate of return? • 1÷15.6 = 6.4%
- 10. Thinking about P/E ratios • Issues • Backward looking • Dividends
- 12. Importance of P/E ratios • 1 point increase above long run average correlates with 25% reduction in subsequent return • Statistically significant at 1% • Only captures 30% of variability
- 13. S&P 500 1.8%
- 15. DOW 2.3%
- 16. Can this be beaten? • Without fraud! • Risk-reward tradeoff
- 18. Can this be beaten? • Without fraud! • Risk-reward tradeoff • Leverage • Hedge funds
- 19. • $100 invested • 10% return • $10 earned
- 20. • $100 invested • Same investment, but only 10% down • Interest rate 5% • 10% return on investment • $10 earned - $4.50 paid in interest • Rate of return?
- 21. • $100 invested • Same investment, but only 10% down • Interest rate 5% • 10% return on investment • $10 earned - $4.50 paid in interest • Rate of return? 55%
- 22. Can this be beaten? • Without fraud! • No fraud, but broken fundamentals • Bubbles and the greatest idiot theory
- 23. Text https://en.wikipedia.org/wiki/File:Tulip_price_index1.svg 2,400% over 3 months 30,417,400% over 1 year
- 26. Series average: 3.7% “Bubble” average: 12.3%
- 27. Can this be beaten? • Without fraud! • No fraud, but broken fundamentals • Fraud
- 29. Can this be beaten? • Without fraud! • No fraud, but broken fundamentals • Fraud • Insider information
- 31. Can this be beaten? • Without fraud! • No fraud, but broken fundamentals • Fraud • Insider information • Ponzi schemes, pyramids, and Herbalife(?)
- 32. Charles Ponzi • International exchange coupons and arbitrage
- 33. Charles Ponzi • International exchange coupons and arbitrage • Investors needed • Initial promise: 50% every 90 days • Subsequent promise: 50% every 45 days
- 34. Charles Ponzi • International exchange coupons and arbitrage • Investors needed • Making the payments • Withdraw or reinvest?
- 35. Charles Ponzi • International exchange coupons and arbitrage • Investors needed • Making the payments • The importance of the individual at the center
- 36. A pyramid • The “Prosperity Club” letter • Denver, 1935
- 38. A pyramid • The “Prosperity Club” letter • The power of exponentiation • 8 rounds: 390,625 • 15 rounds: 6,103,515,625
- 39. The Herbalife question • Bill Ackman • Pershing Square Capital Management • “Pyramid schemes like Herbalife [are] particularly vulnerable to product-quality concerns”
- 40. The Herbalife question • Bill Ackman • Multi-level marketing • Is it different from a pyramid? • The question of product
- 41. An economists simple look at investing
- 42. Paul Samuelson • “Investing should be dull. It shouldn’t be exciting. Investing should be more like watching paint dry or grass grow.” • The parable of 64 monkeys
- 43. The Efficient Market Hypothesis • Markets (and market prices) reflect all information • What information is this? • The question of $20 on the sidewalk • Evidence?
- 46. Even if not true... • Can you beat 31,000?
- 47. Even if not true... • Can you beat 31,000? • 7 milliseconds!
- 48. Even if not true... • Can you beat 31,000? • 7 milliseconds! • You are not the bank
- 49. Avoiding mistakes • Seven Deadly Sins of Investing • http://online.wsj.com/article/SB10001424127887324906304579037163080446646.html • Lust: Chasing Recent Performance
- 50. Avoiding mistakes • Seven Deadly Sins of Investing • http://online.wsj.com/article/SB10001424127887324906304579037163080446646.html • Lust: Chasing Recent Performance • Pride: Being Overconfident
- 51. Avoiding mistakes • Seven Deadly Sins of Investing • http://online.wsj.com/article/SB10001424127887324906304579037163080446646.html • Lust: Chasing Recent Performance • Pride: Being Overconfident • Sloth: Overlooking Costs
- 52. Avoiding mistakes • Seven Deadly Sins of Investing • http://online.wsj.com/article/SB10001424127887324906304579037163080446646.html • Lust: Chasing Recent Performance • Pride: Being Overconfident • Sloth: Overlooking Costs • Envy: Wanting to Join the Club
- 53. Avoiding mistakes • Seven Deadly Sins of Investing • http://online.wsj.com/article/SB10001424127887324906304579037163080446646.html • Wrath: Failing to Admit Failure
- 54. Avoiding mistakes • Seven Deadly Sins of Investing • http://online.wsj.com/article/SB10001424127887324906304579037163080446646.html • Wrath: Failing to Admit Failure • Gluttony: Living for Today
- 55. Avoiding mistakes • Seven Deadly Sins of Investing • http://online.wsj.com/article/SB10001424127887324906304579037163080446646.html • Wrath: Failing to Admit Failure • Gluttony: Living for Today • Greed: Following the Herd
- 56. Four “Rules” • Save enough
- 57. Four “Rules” • Save enough • Control expenses • Management fees • Trading costs • Taxes
- 58. Four “Rules” • Save enough • Control expenses • Diversify • Does this conflict with “control expenses?” • The virtue of ETFs and Mutual Funds
- 59. Four “Rules” • Save enough • Control expenses • Diversify • Reallocate