TIP792: Vital Lessons From History’s Strangest Financial Stories w/ Kyle Grieve

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25:24Preston Pysh:All right, back to the show. Now, the problem with Madoff is that when you earn good money for people, word obviously gets out. And when word gets out that others are making money, then that piles more and more people into a fund or position. And what you ultimately get is fear of missing out or FOMO. And FOMO doesn't only affect the unintelligent, it affects absolutely everyone. If I asked you to think about Sir Isaac Newton here for a second, what comes to mind? Probably something to do with his laws on thermodynamics. Here you have one of, if not the most intelligent people in the history of mankind making some of the most boneheaded investing decisions ever.

26:01Preston Pysh:You'd think his intelligence would have helped him overcome the emotional problems that most investors face. Yet intelligence is not powerful enough to save us from our own emotions. Which raises the question, if intelligence can't overcome emotions such as FOMO, what does? So let's rewind to 1711 when the South Sea Company was formed as a joint stock company in Britain's parliament. It planned to reduce the cost of national debt in return for providing monopolistic trade with Spanish colonies in South America, Central America, the Caribbean, and a few years later, exclusive right to sell slaves in that region.

26:36Preston Pysh:In January of 1720, the stock rose from 128 pounds to nearly 1 ,000 pounds by August of the exact same year. Now, what precipitated this 8x in its share price? Were there massive increases in revenues, profits, or dividends? No, not at all. So when I looked a little deeper into it, it's kind of hard to not call this a fraud similar to what we just discussed with Bernie Madoff. The South Sea Company didn't have any revenue to speak of, let alone profits or dividends. It was pure speculation with a lot of financial engineering and false promoters. The difference between this and Madoff was that it was perpetrated by the British government and not a random rich person.

27:14Preston Pysh:So here's how it worked. The government helped the company by allowing it to take over national debt. The company, backed by the government, emphasized the company's upside to the public to help increase its value. Part of the reason that the government wanted it to do so well was to entice holders of government bonds to convert those bonds directly into South Sea stock, which would eliminate the government's need to repay bondholders. So the director and founder of this conversion scheme named John Blunt was driven by two things. The first was to drive up the stock price by any means necessary.

27:47Preston Pysh:And the second was to create as much confusion in the conversion process as possible. Note that there's no mention of actually creating value. So you can see how with the government's help, it would be even easier to manipulate the price of the South Sea company. The more people who converted their bonds to the stock would add additional demand to the stock, further increasing its prices. And to stoke the fire, Blunt even allowed leverage to acquire shares in South Sea, allowing new investors to subscribe to shares for only 20 cents on the dollar. Blunt took it even a step further due to the connections that he had with the government.

28:21Preston Pysh:There were, after all, many members of parliament who owned South Sea company stock. So Blunt encouraged parliament to pass something called the Bubble Act, which made it illegal for other businesses to try to take advantage of public markets. You could argue that he was just trying to dissuade competition for fund inflows. If you have one company, then all the inflows go there. If you have 30, then you have to distribute the inflows, albeit unevenly among all of them. Blunt knew exactly what he was doing. Unfortunately, all this fiddling ended up backfiring right in Blunt's face. Instead of dissuading other businesses to try out the open market, ended up scaring investors who were already invested in the market.

29:00Preston Pysh:And that started a domino effect. Margin loans were called in, forcing more selling pressure. International owners sold their stock. Then South Sea Company's own lender, Swordblade Bank, failed. So Newton's involvement was pretty interesting. He actually bought at pretty early, made some decent money, and then he sold it. But as the stock price rose, he actually re-entered the position. Then even as the stock was in free fall, as the bubble popped, his conviction in the business encouraged him to purchase even more shares. Had he just held all his shares and sold near the peak, he would have had 250 ,000 pounds.

29:33Preston Pysh:Instead, he lost nearly everything. So a 2013 paper titled Computers and Human Behavior had a great definition of FOMO, calling it a pervasive apprehension that others might be having rewarding experiences from which one is absent. And that pretty much perfectly defines exactly what happened to Isaac Newton and scores of other investors during the South Sea Company bubble. And that's why protecting yourself from FOMO is just so essential. So here's five quick ways to avoid FOMO. The first, stay disciplined. If you have an idea for an investment, execute it and don't change it because others are making money while you aren't.

30:09Preston Pysh:The second is to take advantage of dollar cost averaging. If there's a position that you like for the long term, add small amounts of money to it over time. This will help you avoid taking excessive concentration risk. Third is to just simply avoid hot tips from people that you know who are not investors. Fourth, if you think that you'll regret selling a stock if the price increases, then avoid tracking an asset's price after you sell it. And fifth is to just focus on the long term. Do not check stock prices daily if you know that large fluctuations are going to cause you to make errors. Now, Hedy Green is one of the best value investors that you've never heard of, probably because she was a value investor before Benjamin Graham was even born.

30:49Preston Pysh:And it also didn't help that she was a powerful woman in a time when men ruled financing and investing. Hedy made her fortune by leveraging the money that she received from her inheritance into investments that paid off. The investing part was nothing that would probably surprise you. She owned things like railroads and not just the company's equity, but also their bonds, giving her a very detailed look at a business's fundamentals. And she invested in railroads during its heyday, along with some of the best railroad titans in American history, such as JP Morgan, Andrew Carnegie, and Commodore Vanderbilt.

31:20Preston Pysh:But Hedy had her hands in all sorts of asset classes. She owned mortgages that paid regular dividends. For instance, she owned property from Boston to San Francisco and between Maine and Texas. She owned steamboats, gold mines, iron mines, and even churches. She is the original value investor. Here's what she said regarding value investing in real estate. I would advise any woman with$500 at her command to invest in real estate. She should buy at an auction on occasions when circumstances have forced sale. If she will look out for such opportunities, she will surely come and she will find that she can buy a parcel of land at about one third of its appraised value.

31:56Preston Pysh:I regard real estate investments as the safest means of using idle money. Here you can clearly see that she had a very firm grasp of price and value and could clearly understand how price and value were likely to converge over time. But she was also a bargain hunter by nature. So at one point, she found a horse carriage that was cheaper than the one that her husband had just purchased. She secured the discount by first finding someone who held a grudge against the seller. She then learned from this person all of the faults in the carriage. Then when she proposed buying it from the seller, she listed off all the faults and bought the carriage at a reduced price.

32:29Preston Pysh:So Hedy was also ridiculously frugal. She was actually in the Guinness Book of World Records for that. So she reportedly bought sacks of broken graham crackers just to save money. When she went to the butcher, she would ask for free bones for her duck. She bargained for incredibly cheap goods such as things like potatoes. house. She would move from boarding houses to hotels to avoid paying city and state taxes as she actually didn't report a residence. Once she had a court appearance because she tried evading a$2 licensing fee for her favorite dog. Now, by the time she'd amassed a$60 million fortune, she was living in a$5 per week boarding house.

33:06Preston Pysh:Now, I think the main lesson from Hedy Green was that you can become very successful investing in income producing assets. An area of investing that I admit I completely ignore. Hedy showed that leverage wasn't necessary. She never ended up buying on margin. And she believed that the secret to business success was to simply buy when nobody wanted the asset and sell when everybody wanted it. I'll leave the section on Hedy Green with some of the lessons that she learned during the panic of 1907. I said that the rich were approaching the brink and that panic was inevitable. There were signs that I just couldn't ignore.

33:39Preston Pysh:Some of the solidest men of the street came to me and wanted to unload all sorts of things, from palatial residences to automobiles. There had been an enormous inflation of values, and when the unloading process began, the holders of securities found great difficulty in getting real money from the public. I saw the handwriting on the wall, and I began quietly to call in my money, making a few transactions and getting my hands onto every available dollar of my fortune against the day that I knew was coming. When the crash came, I had my money and I was one of the very few who really had it. The others had securities and their values.

34:14Preston Pysh:I had the cash and they came to me. They did come to me in droves. So moving on here, how did a series of container tanks holding very, very minimal amounts of oil and a lot of seawater help generate one of Warren Buffett's most successful investments? First, we look at this anonymous tipster, known only as The Voice. So this person reported that tank number 6006 in a warehouse in Bayon, New Jersey, was actually not full of salad oil as it was supposed to be, but was also filled with seawater to give the appearance of being full. So why did he report this? Was he bored, mistreated, or did he have a hint of guilt?

34:54Preston Pysh:Actually, none of the above. He did this purely for selfish reasons as he wanted money in exchange for more information. Now this warehouse was owned by a gentleman named Tino DeAngelis, a brazen but sloppy crook who had clearly been a criminal for probably his entire life and definitely his entire adult life. For instance, his business record included the following, being fined for$100 ,000 for exporting substandard cooking fat to Yugoslavia, being fined$100 ,000 for selling inferior meat products, being fined yet another$100 ,000 for exporting inferior lard to Germany, accused of falsifying documents, tax evasion, and falsifying inventories.

35:34Preston Pysh:So with all these infractions, you'd think that it would have been very, very hard for this guy to find business partners. But after all this happened, he ended up raising$500 ,000 to create the Allied Crude Vegetable Oil Refining Corporation. So Tino created this business to help take advantage of the US government program known as Food for Peace, which was set up to help keep crop prices elevated when there was an excess supply and to provide surplus oil to countries with starving populations. Given Tino's sketchy history, this was a perfect hunting grounds for him. He took 22 employees with him from a past venture and paid them over$200 ,000 annually in today's dollars to do pretty menial labor.

36:15Preston Pysh:So American Express at this time had a subsidiary called American Express Field Warehousing Company or AEFW. And AEFW's mandate was to generate approximately$500 ,000 in profits from the subsidiary. The problem was that it just didn't perform very well. It turned a profit in only 10 of 19 years and had cumulative losses in 1962. AEFW had 500 client accounts, but only two of them actually generated a lion's share of profits. And both of these companies were owned by Tino DeAngelis. So in 1962, Warren Buffett had recently consolidated his 11 partnerships into one creating Buffett Partnerships Limited, BPL.

36:54Preston Pysh:At this time, Buffett was very, very focused on cigar butts, you know, the cheap, beat up small companies that nobody wanted to own, but Buffett felt were mispriced and misunderstood. So the crisis happened because eventually it came to light that the tanks were not full of salad oil as they were supposed to be. And to anyone looking at it, it was extremely obvious that it was a fraud. First, DeAnders bought oil futures, pushing up prices as he knew that demand for oil would be very heavy around the world and that Russia had some failed crops which would disrupt supply. When regulars demanded to see Allied records, they immediately uncovered the fraud.

37:31Preston Pysh:But as Forrester writes in his book, it wasn't really that hard to figure out that this was a fraud. He writes, according to Census Bureau statistics, AEFW's warehouse receipts totaled twice as much vegetable oil as all of the oil in the US. By the end of 1963, warehouse receipts had been issued for 937 million pounds of oil worth 87.5 million, which, while actual quantities were less than 100 million pounds. Now, Amex CEO Howard Clark had decided to sell AEFW, as he felt that the subsidiary was compromised due to the scandal. It was also discovered that the head of AEFW held ownership in one of DeAngelis' companies, which obviously was a massive red flag and conflict of interest.

38:13Preston Pysh:So here's where Buffett went to work. He knew that Amex was a trusted brand, especially in their lending business. And he also followed the story that was unfolding and how it affected Amex's stock price. So eight months after the scandal had occurred, Amex was trading at a 45 % discount. To see if the scandal actually harmed Amex's core business in traveler's checks and credit cards, Buffett and an acquaintance that he hired did their own boots on the ground research. They spoke to bank tellers, bank officers, credit card users, hotel employees, and restaurant employees to figure out if Amex was still being used to buy things.

38:48Preston Pysh:But the conclusion was very straightforward. Amex's reputation was still completely intact. The rest is history, but there are many great lessons from the story. First is that trust is fragile. But the trust that is perceived by the market may not align with the trust that actually exists between a business and its customers. If the market thinks trust is broken and irreparable, then the stock price is probably going to be punished. But as Buffett showed here, if you can generate a valid counter-argument, you can make an excellent investment. And the second big lesson is that scandals can sometimes make brands even stronger.

39:24Preston Pysh:Buffett's experience with Amex showed him the power of a strong brand. He understood that a business might face a scandal, but if its customers still find value in the product and the trust built with the company over many years, it's really tough to break that bond. And the third lesson is that you must do due diligence on the people that you do business with. DeAngelis may have had some unfair advantages as there were many people who believed he had ties to organized crime. In that case, he may have been funded by people who knew that he was going to break the law. But someone inside AEFW could have looked at DeAngelis' laundry list of infractions and easily concluded that he was not a person to do business with.

40:01Preston Pysh:If you're investing in private or public businesses, spend some time trying to learn about the past of the person leading the business or other key people involved in the business. And the final and most important lesson here is simply that greed can cause us to take risky shortcuts. Donald Miller, who headed AEFW, either knew about DeAngelis' character flaws and chose to overlook them, or he decided not to conduct DD necessary to determine that DeAngelis wouldn't make a good business partner. Either way, Miller, who was required to generate profits for Amex, saw DeAngelis as his ticket to continued employment.

40:37Preston Pysh:Now, what do you get here when you mix an AI craze with a SPAC? You might be a business like AI infrastructure acquisition, a SPAC created to advance artificial intelligence and machine learning capabilities. So a SPAC is a special purpose acquisition company. Basically, you can buy a ticker of a SPAC, but all you're getting is a promise to buy a business within a certain time limit, usually 18 to 24 months. Now, one of the earliest SPACs was a business that we've already discussed today, the South Sea Company. Remember I mentioned that this business wasn't really an operating business as it had no revenue.

41:10Preston Pysh:You were basically buying a company that owned the rights to fulfill some sort of narrative at some point in the future. And because other people observed the hype of the South Sea Company, it attracted many, many cloners. Nearly 200 joint stock companies were formed around the same time as the South Sea company bubble. These companies were initially in industries like insurance, fisheries, and finance. But as they saw the market successfully propping up prices, there was the second wave of companies that came that had much more dubious industries related to things such as services and inventions.

41:44Preston Pysh:These were businesses that purported to do things like improve coal trading, sell large-scale funeral furnishings, or even pawnbrokers. One company carried a patent on heat-resistant paint, another manufactured swords. Another notable company was meant to carry fresh fish from a boat into the fish market, but the fish rarely made it to the market alive. Now, since many of these businesses were just pure fiction, investors back in 1720 were very, very hurt by owning their stock, especially once it was discovered that there was no functional operating business behind them. It's similar to many of the SPACs and investors took part in in 2020 and 2021.

42:20Preston Pysh:They bought into an idea and when it didn't pan out, the investors were the ones holding the bag. One story of investors getting especially taken advantage of was outlined in the great book, Extraordinary Popular Delusions and the Madness of Crowds by Charles McKay. So in this story that McKay covers, there's this business that he says is considered, quote, a company for carrying on and undertaking a great advantage, but nobody knows what it is. Sounds like a SPAC to me. The company's prospectus stated that it was seeking to raise 500 ,000 pounds by selling 5 ,000 shares at 100 pounds each. Now here's where the craziness starts.

42:53Preston Pysh:So the unnamed promoter promised that for each year that the shares were owned, the subscriber would receive 100 pounds per year, meaning he was promising a one-year payback time. The promoter promised details about how he would do this within a month after it closed. The morning after the prospectus was released, the promoter opened his office to a crowd of potential investors waiting to just give him their money. In only one day, he ended up collecting £2 ,000, which was about$2 million today. He immediately left the country with all the money never to be heard of or seen again. Now, while this seems like a completely made-up story, McKay wrote, were not the facts stated by scores of credible witnesses, it would be impossible to believe that any person could have been duped by such a project.

43:40Preston Pysh:But let's revisit that McKay quote again. A company for carrying on and undertaking a great advantage, but nobody to know what it is. It's vital to understand the meaning behind this. A SPAC really is pure speculation. In modern times, investors might invest into a SPAC as a form of maybe betting on a jockey. Perhaps there's some sort of investor that you highly respect, who you think is a really, really good and talented capital allocator. So let's imagine a hypothetical world where Warren Buffett gets a second wind and wants to purchase another company for$2 billion and just not include Berkshire Hathaway.

44:15Preston Pysh:I know, bad example as the chances of that happening are probably close to zero, but just bear with me. So if someone like Buffett were to do something like that, my guess is that he would be drastically oversubscribed because people know Warren would probably find an insanely good business to invest in. And people obviously trust him to do a really, really good job. But someone like Warren would never do this because it's antithetical to what he believes in. He wants to be a partner with these investors. And SPACs create asymmetry between the SPAC and the shareholder. For instance, a SPAC creator gets access to a large percentage, usually 20 % of the float at drastically reduced prices.

44:50Preston Pysh:So why exactly should the SPAC creator get to buy shares at reduced prices? Doesn't this really incentivize them to take larger amounts of risk. And in the case that the SPAC merges with another company and that company fails, then investors lose all their money. And the SPAC creators may still be able to exit with a profit due to the discounted shares that they received. So whether you're looking at 1720 or 2021, the story is the same. During times when the market is euphoric, scores of people will come into the markets with promises to make you rich. But in reality, they are mostly focused on just making themselves rich at your expense, which is why I personally have never invested more than a few minutes into SPACs.

45:28Preston Pysh:And the time that I have was purely just to satiate my own curiosity. If there were someone I highly trusted to invest well, I would probably just wait for the SPACs merger to be consummated and find out at that point, whether it's a good investment or not. If it's not an investment that I would find interesting, then I simply don't buy it and it makes no difference to my wealth. And if it's a business that I do find interesting, well, then yes, I'll probably buy it at a premium to if I'd taken part in that SPAC. But still, I'm willing to pay up for that certainty that the business is something that I can actually understand and will have a good chance of creating shareholder value.

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49:22Preston Pysh:All right, back to the show. Now, a few decades after the South Sea bubble burst, an even stranger financial derivative was created to gamble on the future. And it actually didn't involve highly speculative companies, but children. Giane Pictet tragically died at the age of four back in the late 1770s. And while her aristocratic family mourned her passing, the French monarchy ruled by King Louis XIV was secretly rejoicing because her death saved them bundles of money. France had a financing problem for most of the 17th and 18th centuries. They defaulted seven separate times, and the money that they needed was spent on wars.

50:00Preston Pysh:The trigger for the default followed a pretty similar path. The war ends, then France would then convert its high-interest short-term debt into low-interest long-term debt. Then they debased their currency through recoinage, or what we today refer to as money printing. The problem was raising additional funds through measures like taxes, which created all sorts of issues that the monarchy and regional governments preferred to avoid. As a result, a weird, brilliant, and ultimately dangerous financial instrument was created. It was called the tontine. So you may recognize that word from Bill Ackman's failed SPAC named Pershing Square Tontine Holdings.

50:38Preston Pysh:Tontines at its core were very simple. They're an insurance contract that provides the purchaser or annuitant with lifetime income. It sounds similar to an annuity, but with a twist. So there's a very large gambling element to a tontine. So for a life annuity, the payments are fixed. In a tontine, they actually increase in size as you get older. The reason for this was that your money was pooled with other investors into the tontine. And upon passing, their payments will be redistributed to the surviving investors. So the longer you lived, the higher your payments would be. And once the last survivor passed away, there was no principal repaid to any of the investors.

51:18Preston Pysh:The government loved them. They got cash up front and quickly and didn't need to repay the principal unlike Avant. The investors loved them because they could essentially gamble on the duration of their lives to generate future income. The tontine was almost like a proto-spac because you invest in something with very, very uncertain outcomes. But in 1770, tontines ended up actually being nullified and converted to life annuities. So what happened was the royal government claimed that tontines were very costly and could just no longer be issued. This is where the Swiss came in with some brilliant ideas to capitalize on the conversion of tontines.

51:51Preston Pysh:You see, when a tontine was converted to a life annuity at this time, the holders of the tontine could appoint a new nominee for the life annuity. And the best way to maximize the value of the annuity was to nominate someone young, as they're obviously going to have the most years ahead of them, to collect those annuity payments. So a Swiss banker named Jake Beaumont decided that he'd buy up a number of these nullified tontines, then take advantage of the ability to appoint new nominees for the converted life annuity. To reduce risk, he brought in other investors and essentially turned these life annuities into a form of securitization.

52:26Preston Pysh:Since he had other investors and the pool was large, it also created liquidity, allowing investors to get in and out of the investment. Beaumont also did his homework on lifespans. Women, on average, live longer than men, so he decided that nominees should mostly be female. But you couldn't just go with newborns because infant mortality rates were high. Smallpox was rampant and your chances of living were much higher past the infant years. The sweet spot that the Swiss bankers came up with was girls aged between four and seven who had already survived smallpox and other health issues. But they didn't just want girls who fit those criteria from any old family.

53:02Preston Pysh:No, they wanted the ones who had access to the best possible healthcare as well. So the nominees came from wealthy families who could afford the best possible doctors and treatment. These girls were known as the immortals. So when Jian Piktei passed away at four years old, the government was able to save decades of annuity payments that it would have had a hard time servicing. But the need for government funding was still high. At the end of the 18th century, as the government continued to need money and investors became interested in future income streams, the life annuity rules changed. So to collect the annuity, you had to prove that the nominee was alive.

53:37Preston Pysh:This proved pretty inconvenient. So there was a workaround that was created, which allowed you to just nominate anyone as your nominee. And a really good option was to just nominate a famous person. That way, everyone would know that that person was not alive or alive. And so at this time, famous people were people in the French royal family. Nominees included people such as King Louis XIV, his wife, Mary Antoinette, and other family members. But then the French Revolution happened. The king and his family met the same fate, beheaded by the guillotine. And with that, the annuity payments promptly disappeared.

54:13Preston Pysh:This whole story reminds us that humans don't really get smarter with time. They just find new ways to gamble. Now, everybody listening today has probably heard or taken part in take a kid to work day. It's the harmless tradition of taking your kid with you to see what mommy or daddy does every day at work. And it tends to be completely harmless unless you're 33 ,000 feet in the air in an airplane cockpit. This was a situation that a pilot found himself in on Aeroflot Flight 593 on March 22nd of 1994. So one of the backup pilots named Yaroslav Kudrinsky brought his two children up into the cockpit, his 12-year-old daughter Yana and his 16-year-old son Eldar.

54:54Preston Pysh:Kudrinsky first allowed his daughter Yana to take control of the plane and fly it for a bit. Yana flew the aircraft for a few minutes, moving a little bit to the right and a little bit to the left. Kudrinsky was taking advantage of the plane's autopilot feature, So even though Yana felt like she was flying the plane, the autopilot gently guided her in the right direction. Next up was Eldar. Eldar, being a 16-year-old boy, was obviously a little bit bigger than Yana. As he took control, he veered left. But as the autopilot tried to get him to veer back to the right to maintain direction, Eldar actually overrode the autopilot by force.

55:27Preston Pysh:The plane's autopilot was set up for whatever reason so that if the aircraft reached a 45-degree angle, the autopilot would disengage. So this allowed a plane to enter, you know, things like a holding pattern above an airport while waiting for a runway to become available for landing. Eldar ended up flying the aircraft into a 50 degree angle and the plane began to descend. Because they were moving down so quickly, it made it nearly impossible to move inside the cockpit so that Eldar could turn the controls over to one of the actual pilots. As the plane descended and the cockpit turned into pure chaos, the pilots tried their hardest to try to guide Eldar into churning the wheel to stabilize the plane.

56:04Preston Pysh:But at that point, the plane was uncontrollable. They shouted commands to Eldar, but they were just misunderstood. Lights and sounds were going off. The aircraft was stalling and the plane was ascending very fast. At 1 ,000 feet, Kudrinsky was able to get into his son's seat to try to stabilize the plane. The black box that was picked up caught him saying, everything is fine at this point. A few seconds later, the plane crashed into the Kuznetsk-Alatau mountain range, killing all 75 people on board. Now autopilot for airplanes was created in 1912, but it was designed for simplicity rather than transparency.

56:39Preston Pysh:In the Aeroflot disaster, there wasn't really a clear indication that the autopilot had been overridden. If you've ever driven a car with driver assist, you know the feeling when you change lanes. You know, the car may attempt to keep you in your lane, but you can override the autopilot simply by not allowing the car's steering wheel to maintain your current lane. So when Eldar Veard left, he inadvertently disabled autopilot, which caused the entire disaster. This is a case where if we trust our hardware and software too much, we can make very poor decisions. So what does autopilot look like in investing?

57:11Preston Pysh:During good times, it's easy to rely on just how well the market is doing, which can create complacency. You may stay on top of all your positions and actively look for where things could maybe go wrong. You don't want to stay in a bad position just because your other positions and the market are doing really, really well. Hidden risks are still risks. You should take a look at your positions and determine what could really unravel them. Are those events happening today and you're just not paying close enough attention? Overconfidence is incredibly dangerous. 80 % of car accidents happen within 10 miles of people's homes, areas that theoretically they know better than anywhere else.

57:47Preston Pysh:So areas that you have navigated before always require your attention. The moment that that attention goes elsewhere can be catastrophic. In investing, you can't expect a market to continue going up just because that's what it's done for the past few years. You need to plan and strategize for different outcomes to protect yourself when the market turns. That might mean creating scenarios and then using thought experiments to strategize about what you'll do in light of reality. The final lesson here is that when things go wrong, just take advantage of the black box. In the world of investing, the black box is our brain.

58:21Preston Pysh:we can access our previous thinking by tracking it in real time using things like journals. When you make a mistake, look back at your thinking process and why you thought that way. While you'll never eliminate all mistakes, you can reduce the likelihood of repeating the same error, which will have a very significant positive effects through an investing lifetime. So the last story was about the dangers of going on autopilot, systems that can quietly drift you away from your goal, and the lack of notifications that you have drifted so far. And sometimes when you're off of autopilot, there's a lack of notifications and you drift just so far away that you lose all control.

58:58Preston Pysh:Inflation is very similar. It's the financial world's version of autopilot failure. You don't really feel the power of inflation from day to day, but one day you wake up and the dollar that you trusted to help take you safely into the future has just rolled into a 45 degree turn. So in the late 1770s, the Revolutionary War was going very, very badly for the Americans. The British army had a series of excellent victories and the Navy was blockading the East Coast. Troop morale was low, they were freezing cold, poorly clothed, starving, and many were in medical attention. As a result, mutinies were a very real threat.

59:34Preston Pysh:And to make matters even worse, the soldiers had another worry, this time further away from the battlefield. And this was that money that they were being paid to fight this war was losing its value. If you think inflation is a phenomena, you're dead wrong. From a buying power standpoint, the Brits weren't the only villain. Inflation was a real threat as well. It just didn't shoot guns. So here was the problem. The soldiers were out on the battlefield in deplorable conditions, and the money that they were being paid with was losing so much buying power that their families were having a lot of trouble.

1:00:07Preston Pysh:Food prices were skyrocketing, but the soldiers weren't seeing a corresponding increase in their wages. So in 1776, scholars estimated inflation at 14%, in 1777, 22%, and in 1778, 30%. So in 1779, four entire battalions complained that due to the depreciating value of money, they were losing seven-eighths of their purchasing power by taking part in the Revolutionary War. Losing soldiers was a real problem, as many were just deserting to go work on farms. So the government came up with an act to invent a crude type of inflation index. Today, we used a consumer pricing index or CPI. Back then, they used the prices of only four goods to determine how fast money was depreciating.

1:00:47Preston Pysh:So the four goods they used were corn, beef, wool, and leather. In 1870, when the act was passed, they looked at the rate of change in price increases for just those four commodities over the last three years. And the price for the four goods had actually risen 32 and a half times over that period. To make amends for inflation, the army came up with an inflation index bond, the first kind in its history. So the inflation index bond would pay four interest-bearing payments from 1781 to 1784. Basically, the sums were meant to cover five bushels of corn, 68 pounds of beef, 10 pounds of wool, and 16 pounds of leather.

1:01:23Preston Pysh:These cost about 130 pounds of current money. If these goods continue to inflate in price, the payment would increase with inflation. So this eased many of the soldiers' minds because they knew that tomorrow wouldn't be worse than it was today. So CPI today is calculated monthly based on the price of 80 ,000 different goods and services. The Bureau of Labor Statistics, or BLS, estimates these numbers. The BLS does this by regularly contacting stores across the U.S. to collect data. An additional survey is also sent out to 50 ,000 residents as well. So the major categories of modern spending are housing, transportation, food, recreation, medical care, apparel, education, and other goods and services.

1:02:05Preston Pysh:We've moved a long way from bushels of corn and sole leather. And ever since the Revolutionary War, inflation has never left the US. So here are the US stats for each century. In the 1700s, 0.6%. 1800s, negative 0.2%. 1900s, 3.2%. 2000s, 2.5%. But each century has its own story. and inflation has stabilized a lot in the 20th and 21st century due to the formation of the Federal Reserve in 1913. As Forrester points out in his book, moderate inflation is actually manageable and is the goal of monetary policy. Because the opposite, deflation, is a much worse outcome. In a deflationary environment, consumers expect prices to drop, which delays purchasing decisions and leads to economic stagnation.

1:02:49Preston Pysh:Japan has gone through this basically since its bubble popped in the 90s. If interest rates are at zero, there's nothing that the government can do to drop prices further. If they maintain a 2 % to 3 % range though, they have more wiggle room as we've seen here since COVID-19. But no matter what, inflation is basically a silent tax that punishes savers. If you save$100 today, in 10 years, at historic modern inflation rates of 3%, your money is only going to be worth$74. So if we know that cash is a depreciating asset, the solution becomes pretty obvious to savers. Don't keep your savings in cash.

1:03:23Preston Pysh:I think many of our listeners probably know this, but if you're tuning in and have cash hoarded and tax sheltered accounts, please understand that that cash is not a good asset to hold on to. Cash seems neutral, but it's a net negative. You can think of cash as kind of similar to leaving ice cubes melting in the sun. So just like the soldiers who needed wages that rose with inflation, you need to keep your savings and appreciating assets. My asset class of choice is stocks, but there's plenty of other choices out there. Bonds, real estate, commodities, private businesses, cryptocurrencies, or other assets that are tied to real economic activity.

1:03:58Preston Pysh:As long as you have assets that fight inflation, you put yourself in a great position to win. Now, nobody predicted inflation all the way back during the war for independence in 1779. Just like nobody really knew the full effects of inflation that we've had since COVID. But the winners in modern times are investors who prepared properly. When you construct your portfolio, make sure you're looking at a range of outcomes. Ask yourself, will your portfolio be damaged by inflation? Or will it thrive in it? Along the same token, it's important to have the humility not to rely on a single narrative, because then you put yourself at a large amount of risk if you're incorrect on that one story.

1:04:36Preston Pysh:Another vital lesson here is that real returns matter more than nominal ones. If you get a 5 % return with 6 % inflation, you're actually poorer. If you get a 3 % return with 1 % inflation, you're richer. So your goalposts will move on a yearly basis. But if you choose to earn returns and the mid to high single digits are higher, you're probably going to end up coming out on top no matter what. Inflation teaches us that money quietly loses value. And while that's an outcome we'd like to avoid, other events happen on a regular basis that can cause us to lose money and not in a quiet way. Sometimes the market just simply plummets.

1:05:12Preston Pysh:If I ask you what events like this come to mind, you might mention something like the Great Depression. But I want to talk about an event that's even worse, which happened over two days in October of 1987. We start on the Monday, October 19th, 1987, the day known as Black Monday. So earlier that morning, Fed Chair Alan Greenspan is boarding a plane from DC to Dallas. At this time, there is no internet, of course, or mobile phones. So if you got on a plane, you're basically completely insulated while on that plane from the outside world. Before Greenspan had boarded, the Dow was already down 8%, a very bad day.

1:05:45Preston Pysh:But when Greenspan landed in Dallas, he was horrified to see that the market had dropped 22.6 % in that one day. Now to understand a little more about why this happened, we don't really need to go back too far. In 1986, the market had done well and the Dow closed at 1 ,896, up about 23 % on the year. On average, the index gained about 1.38 % per day. By 1987, the year that Greenspan was sworn in as Fed chair, the market continued climbing to 2 ,722. One of Greenspan's first moves was to raise the discount rate. He felt that inflation was starting to creep up, and this is generally not what the market wants.

1:06:23Preston Pysh:And to make things even worse, the market was also expecting the US currency to drop in value in the near future due to some minor geopolitical conflicts. So on Friday, October 16th, this is the Friday before Black Monday, the market was pretty scared. The market was actually down 4.6 % that day. On October 19th, 1987, the Dow, like I said, collapsed 22.6%. The entire year's gain was wiped out after Monday's close, a pretty painful outcome for investors. Now, the interesting thing about Black Monday was that there isn't really a consensus cause for why exactly it happened. There wasn't some large event like COVID that spooked the market and was likely to have a massive effect on businesses all across America.

1:07:04Preston Pysh:A few reasons that have been kicked around were the rise in computerized program trading, portfolio insurance, futures markets, and rising rates of inflation. But there wasn't just one cause. It was a confluence of factors that happened that punished the market. And it's kind of impossible to blame them all on just one factor. The lesser known fact about Black Monday is what ended up happening on Tuesday, October 20th, 1987. So one could argue that the pain was much less on this day, but the events were even more dramatic. So on Tuesday, there were actually rumors that the New York Stock Exchange might close.

1:07:36Preston Pysh:This had occurred only four times in history, when JFK was assassinated for his funeral, when New York experienced an electrical blackout, and for Hurricane Gloria. So it was a very scary proposition. By 8am, credit markets were tightening. Not only were specialist firms rushing to borrow, but larger security firms were as well, because they had grown their stock inventories by accommodating selling by major clients. Trading, borrowing, and government securities sweltered. Arbitrageurs, who were trying to take advantage of pending takeovers, were forced to put up more capital on their borrowings.

1:08:08Preston Pysh:Banks were reluctant to settle trades, fearing they might not get paid. Now, sensing that Black Monday could trigger a collapse of the entire financial system, Greenspan got to work trying to ease investors' tensions. He made a public statement that the Fed would reverse its tightening stance. The Fed would also act as a source of liquidity attempting to drive down interest rates. The market initially jumped, but then sellers took over once again. So in the middle of the panic, a small spark emerged. Ronald Cash Mahinman at the Chicago Board of Trade, CBOT, noticed that the price of major market indexes or MMI futures were trading at a massive discount.

1:08:46Preston Pysh:At 12.38 PM, a sudden wave of buying hit those futures, flipping them from a huge discount to a premium in just five minutes. And that tiny shift triggered arbitrage traders to rush in, buy the underlying stocks, and push liquidity back into the system. And it was a jolt of electricity that the market really needed. Within an hour, the Dow rallied by nearly 6%. So after Black Monday, some say the whole thing was a conspiracy. Doomsayers say that bigger firms coordinated the selling and the Fed's reaction was just too quiet. Others say that it was just unlucky timing, but we'll never know for sure.

1:09:21Preston Pysh:Crashes can happen fast, but recoveries can also be really fast. The Dow was higher than before the crash by June of 1989. So if you panic sell on these types of events, chances are you're going to miss a lot of the recovery. The biggest drawdowns are often followed by the biggest up days. You just never know when those days will actually happen. Liquidity is the market's bloodline. And this is more of a top-down view, but if the market doesn't have liquidity, then situations like this can't be solved. While I don't really have a view on how to play this top-down view, I think finding individual businesses with little liquidity can be a giant advantage.

1:09:57Preston Pysh:When investors with deep pockets want to buy a business's stock with low liquidity, that means that more buying pressure can move the stock up very quickly. And I like to be on the right side of that situation. Now, crashes can also appear to be pretty random. They aren't always easy to identify, such as a tariff tantrum that we just had in April of 2025. Sometimes they come out of nowhere and wreak absolute havoc over very short periods of time. But the best investors prepare for these occurrences. Big corrections happen every year or so. So if you know how to handle them without losing your patience and discipline, you put yourself at a major advantage.

1:10:37Preston Pysh:Having some spare cash lying around can be a massive advantage. If you have cash during these times, you can take advantage of the four sellers by buying the stocks that they're selling at huge discounts. This is a dream scenario for me. So during November, Lumine has dropped nearly 58 % from its all-time high. And to me, this was the market acting irrationally on the stock price. And I took that as an opportunity to add to my position. I love drops like these because Lumen was a business where I wanted to build my position, but it was spending so much time at all-time highs. Now I get an opportunity to add it at a massive discount.

1:11:13Preston Pysh:That's all I have for you today. I hope that some of these stories really resonate with you and stay memorable so that you can internalize some of their lessons. If you'd like to continue the conversation, please follow me on Twitter at IrrationalMRKTS or connect with me on LinkedIn. Simply search for Kyle Grief. I'm always open to feedback, so feel free to share how I can make this podcast even better for you. Thanks for listening, and I'll see you next time.

1:12:03Kyle Grieve:Listeners should do their own research and consult a qualified professional before making any financial decisions. Nothing on this show is a recommendation or solicitation to buy or sell any security or other financial product. Hosts, guests, and the Investors Podcast Network may hold positions in securities discussed and may change those positions at any time without notice. References to any third-party products, services, or advertisers do not constitute endorsements, and the Investors Podcast Network is not responsible for any claims made by them. Copyright by the Investors Podcast Network.

1:12:30Kyle Grieve:All rights reserved. Thank you.