The Cycles of Stock Speculation4
All speculators, and most investors, possess a general idea of the range and trend of prices for a considerable period. This knowledge is more frequently based upon impressions gained during their own years of activity in the speculative world than upon research. The knowledge gained by active participation is certainly the most forcible and lasting, but is frequently productive of erroneous ideas, as will be set forth hereafter.
For the purpose of giving a clear idea of the movements in stocks during recent years, the accompanying chart has been arranged. The use of circles in lieu of the customary straight lines was hit upon as presenting more clearly to the eye the comparative extent of each year’s movement, and more plainly distinguishing one year from another. These advantages are gained without obscuring from view the general trend of prices for the period considered.
For the purpose of establishing a single hypothetical stock whose movements should be representative of the course of all other active securities, the fluctuations of twenty stocks were welded together. That is to say, the high points of these stocks for the year 1896 were added and divided by 20. The same course was followed with the low points, and each year considered was treated in like manner. By drawing a circle upon a numbered chart with the upper rim resting upon the figures representing the high point, and the lower rim upon those representing the low point, an average price for the year is necessarily established at the axis.
The size of the circles shows the actual and comparative extent of the movements, and the position of consecutive years on the diagram shows the general trend of prices.
In selecting the twenty stocks to be used in forming a composite security, care was taken to eliminate the shares of such corporations as have undergone radical changes during the period considered, 1896 to 1905, inclusive. The Rock Island Company, for example, is in itself an important system, but owing to the conversion of $75,000,000 Common stock into $200,000,000 of mixed securities in 1902, the tracing of its subsequent movements would involve unnecessary computations and explanations. It may be added that experimental tests show that the hypothetical stock, call it “Composite Common” for the sake of convenient reference, was faithfully representative of almost all movements from 1896 to 1906, and that the selection of other stocks would have made only insignificant variations in the general result. The original intention was to extend the investigation for a longer period than ten years, but so many readjustments, assessments, and other changes occurred in listed securities prior to 1896 as to make a clear showing difficult.
Common stocks of railroads only were considered. Few Industrials have reached their tenth birthday, and aside from this, their introduction would make a false showing by increasing the dividend rate with no corresponding increase in the selling price of the stock.
The twenty stocks chosen for amalgamation were as follows:
Atchison, Topeka & Santa Fe, Baltimore and Ohio, Canadian Pacific, Canada Southern, Chesapeake & Ohio, Chicago & Great Western, Chicago, Milwaukee & St. Paul, Chicago & Northwestern, Chicago, St. Paul, Minneapolis & Omaha, Erie, Illinois Central, Louisville & Nashville, Missouri Pacific, New York Central & Hudson River RR., Pennsylvania, Reading, Southern Pacific, Southern Railway, Union Pacific, and Wabash RR.
PRICES OF COMPOSITE BY YEARS
FROM 1896 TO 1906, INCLUSIVE.
| Year | High | Average | Low | Fluctuation |
|---|---|---|---|---|
| 1896 | 44 | 37½ | 31 | 13 |
| 1897 | 53¼ | 43⅞ | 34½ | 18¾ |
| 1898 | 62½ | 53¼ | 44 | 18½ |
| 1899 | 72½ | 64¼ | 56 | 16½ |
| 1900 | 80½ | 70½ | 60⅜ | 20⅛ |
| 1901 | 106½ | 89⅞ | 73¼ | 33¼ |
| 1902 | 119¼ | 105½ | 91⅝ | 27⅝ |
| 1903 | 106½ | 89⅞ | 73¼ | 33¼ |
| 1904 | 105½ | 91 | 76½ | 29 |
| 1905 | 122¾ | 109⅝ | 96½ | 26¼ |
| 1906 | 125¾ | 111⅞ | 98⅛ | 27⅝ |
Fractions were necessarily omitted from the totals employed in charting the movements. They are, however, unimportant. Dividends on Composite Common were as follows:
| 1896 | 1⅖ | % |
| 1897 | 1½ | % |
| 1898 | 1⅝ | % |
| 1899 | 1⁹/₁₀ | % |
| 1900 | 2½ | % |
| 1901 | 3 | % |
| 1902 | 3½ | % |
| 1903 | 3⅜ | % |
| 1904 | 3⁷/₁₀ | % |
| 1905 | 3⅞ | % |
| 1906 | 4¾ | % |
FLUCTUATIONS OF STOCKS FOR TEN YEARS.
(The rims of the circles touch the average high and low points of 20 railroad stocks, each year for 10 years.)
Reproduced, by permission, from Moody’s Magazine of August, 1906.
It has been the frequent contention of the writer that a chart as a basis for speculative ventures is ridiculous, but a diagram framed for the purpose of pointing out certain facts, or inciting the student of speculative affairs to investigation of causes is a different matter. No interested person can look at the accompanying chart without being struck at once with the decline of 1903 following the steady advance of the preceding years. If this observation incites intelligent investigations as to the reasons for the reversal, much good may result. On the other hand, the fallacy of operating on mere mechanical records of the past is shown by the same diagram. If the chart had been handed to one of the mechanical traders in 1902 he would have argued that the average price of each year marked the approximate low point of each succeeding year. It certainly does look convincing, but what follows? The infallible system not only fails to work, but reverses itself, and the average price of 1902 becomes the approximate high price of 1903 and 1904. At about the time the system player has gathered enough figures to go on, a change occurs. No intrinsic merit attaches to any kind of diagram, they being merely convenient forms for tabulating history.
Some interesting coincidences occur in the chart; most remarkable is the exactly similar size and position of the circles representing the years 1901 and 1903. In no instance did the high or low points of any integral stock correspond in these years, but the total footings were identical in each case.
The speculator may extract some value from the diagram by observing that opportunities for profits of forty or fifty points did not occur during the entire period. The extreme possibilities in any one year were 33 points, and much less on the average. If the trader had purchased or sold Composite at an average price, his possibilities of profit would have been limited to about 15 points in any one year. This does not accord with accepted theories. The ordinary speculator who pursues his operations for ten or fifteen points successfully is almost certain to believe that much more profit lies before him, that he is only getting started. There is a reason for this; the public trader takes for his barometer some security which has been conspicuous for its extended fluctuations; he naturally notices and remembers it to the exclusion of the rank and file of stocks. For example, every active participant in speculative affairs knows that Copper had a range of 75 points in a single year, 1901. He bases possibilities too much on this sort of knowledge without reflecting that Copper was a cardinal exception, and that in order to participate in such movements he must throw caution to the winds, and deal in stocks which offer no degree of safety.
Another point established is the lapse of time required in a readjustment of values. It took Composite Common seven years to advance from an average price of 37 to an average price of 105, 68 points. This again falls short of the speculator’s ideas. He expects to buy a stock at 50 today, and sell it at par six months hence, an operation which is shown by the movements of a representative stock to require a period of six years. Again his expectations are founded on exceptions. The same line of reasoning applies to one case as to the other. The speculator unconsciously magnifies everything connected with speculation.
In reviewing the movements of prices from 1896 to 1905, the most important question is, what caused the reversal of form in 1903? A complete answer to this question would be highly educational. There was no panic, nothing faintly resembling one; business suffered some stagnation, it is true; there was a falling off in the iron and steel business, but crops were good, and wheat, corn, oats, and cotton brought good prices in both 1903 and 1904. Serious business depression was more in anticipation than in realization, but 1904 witnessed no material recovery in prices. These causes do not fully explain so radical a change. If conditions had been such as to cause a reduction of dividends, or a scarcity of money in 1903, the decline would be explained, but money was plentiful enough, and dividends were unchanged. The ratio of dividends as compared with prices was also fairly maintained from 1896 to 1902, and it would appear that prices should merely stop advancing when dividends became stationary; but prices did not merely stand still, they went materially backward.
Without pretending to enter into a full discussion of the causes for the change, one or two points may assist in forming a conclusion. The steady advance in prices from 1896 to 1902 represented two things—a recovery from the great depression of 1893, and the natural advances of property values in a prosperous and growing country. The latter point is the more important, and as there has been no cessation of the growth of population or prosperity, other causes for the reversion must be sought. It is not sufficient to merely say that the recovery over-leaped itself, for such an event would have plainly mirrored itself in a reduction in the rate of dividend returns.
Capitalization of railroads in 1903 increased about 14% as compared with an average increase of 6% in the preceding seven years. Add to this the tremendous increase in the capitalization of industrial corporations, and an over-supply of stocks appears as one of the contributary causes—undigested securities.
Dividend rates were maintained, but were not increased. This particularly affects the simon pure speculator. Nothing will drive him into a panic quicker than a decreased dividend, and nothing makes him so sanguine of higher prices as an increase in the rate of payment. He is always basing his operations on rumors of higher dividends, and when one of these rumors fails of verification, it is almost as bad as a decrease.
And dividends did decrease in one important quarter; United States Steel, the speculative favorite, capitalized more heavily than a dozen ordinary corporations, cut its rate from 4 to 3½%, with every promise of a further reduction. This had a far reaching effect, both on speculators and small investors.
It is certain that fundamental conditions have more to do in shaping prices than has speculation, but the speculator helps, and in 1903 he was particularly potent because of the excesses engendered by the unusual speculative advances of 1901 and 1902. He helped to make the prices and he helped to break them, so he may be considered a factor in the reversal.
The small investor helped. He, too, is a dividend man; he seldom looks at earnings, improvements, or extensions—he wants dividends. United States Steel was a body blow to him; it not only affected his purse, but it frightened him.
And it is probable that an army of small investors sold their holdings for another reason—they discovered that they could make a higher rate of income in other channels. So long as both dividends and prices advanced they were satisfied. They were speculating, not investing, but you cannot convince the ordinary man that buying a stock outright, in the hope of an advance in price, is speculation pure and simple.
Much of the money diverted from the stock market in 1903 by the class last mentioned, has never returned to Wall Street. This bears out the theory that higher rates of interest are being found elsewhere. Never before has the public refused to enter the stock market during a period of great prosperity. They are absent now, and furthermore, they show no intention of returning. Possibly they are wrong. The same influences which are operating to give them better returns may be operating to greatly enhance the value of the shares they ignore,—but the small investors want dividends. Their failure to enter the stock market would seem to be strong evidence that they are finding other investment-speculations more attractive than listed shares. If this is the case, the influences leading to higher interest rates are already at work, although not clearly discernible. Diversification of investments would tend to obscure the truth for a time.
But whatever the causes for the stock market relapse of 1903 may have been, the recovery has been complete. The average prices of 1906 were the highest on record.