January 7, 2016

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Fortnite has Shown Us the Future

The most interesting thing I saw SuperBowl weekend had nothing to do with football.  It was something I saw while my son was playing Fortnite with two of his friends.  Saturday afternoon the game hosted a live, in-game virtual concert by famous DJ Marshmello.  According to at least one report, there were over 10 million players in the game at the time. That does not include the millions more who were watching online.

The Marshmello concert was the coolest thing I have seen in a video game by far.  My son and his friends were absolutely geeking out as their characters used ‘emotes’ that were earned or purchased in the game, to dance along to the music.  They were each sitting in their own homes, on their own devices, and yet were able to experience this live event together.  While this is not the first ever virtual concert or live in-game event in a video game, it has definitely taken the concept to the next level.

This concert was unreal

What is Fortnite?

For those of you who don’t know, Fortnite is a battle-royale style shooter game.  It started in 2017 and has grown to a freakish level of over 200 million users.  For context, Netflix has 148 million subscribers.  It is the most popular video game in history and it isn’t close.

The popularity of the game comes from a combination of easy game play and the ability to play together with people across many different game consoles.  My son plays on my MacBook, while his friends play on X-box or Nintendo Switch.  It is a shooter game but it doesn’t have blood and you don’t “kill” opponents, they get “eliminated” and sent back to the lobby.  It has enough cartoony humor, and fun dance moves (according to my wife), to make it palatable for most parents.

hype - Where do the Fortnite dances come from

What made the virtual concert on Saturday afternoon so fascinating for me, was that this was the first time I really understood what some other commentators have already been saying.  Fortnite is not just a game that kids play – it’s a place they go to hang out. 

This article from Quartz compares the game to a skate park.  Kids get home from school, log-on and hang out with their friends in a virtual world. The actual game aspect serves as the backdrop.

And, if Fortnite is a skatepark, then the gamer known as Ninja is their Tony Hawk.  Professional gamers making money on platforms like Twitch (owned by Amazon) and YouTube (owned by Google) has been a growing trend for years now, but Ninja (primarily playing Fortnite) has taken it to another level.  If you haven’t heard of the gamer with brightly colored hair, you can read about him here.

Oh yeah, he also made a cameo appearance in the SuperBowl NFL greats commercial.  Here is one of the teasers…

 

The Trend

So why do I care?  Pokémon Go experienced a ton of growth and was supposed to have ushered in some new age of ‘augmented reality’ (AR) gaming.  I don’t see anyone playing that anymore.  What makes this different than any other passing fad? 

Fortnite is not a unique concept, but rather it’s an evolution of many emerging trends.  The “Free-to-play” model with in-game purchases, the battle-royale style of game play have all been done in the past and will continue to get done.  Games are now utilizing the same playbook that social networks did a decade ago - grow the user base as fast as possible and then monetize it.  It’s all about engagement.

Just like Apple did not invent the smart phone, it just made one that capitalized on growing trends and became more popular than the others.  Whether it was Apple, Nokia, or Blackberry that won the contest, it was clear that smart phones were the wave of the future.

Virtual hang-outs and live video game events are today’s future.  Whether it’s Fortnite or the brand new Apex Legends (which hashit 25 million players in its first week), or even some platform which allows players and their avatars to travel between multiple games, that’s not the point.  The potential has been seen, and money and attention will continue to flow into this space.

Promotional photo for Apex Legends

 

Implications

Gaming and esports are big business and only getting bigger.  Gamers streaming their matches on sites like Twitch are attracting huge audiences.  For instance, Ninja streamed a Fortnite match playing with Drake, Travis Scott, and JuJu Smith-Schuster, andattracted over 600,000 concurrent viewers. The video has been seen millions of times since.  Gaming has its own tribes, its own superstars, its own elder statesmen, and now it’s even getting its own college teams.

Advertisers are taking serious notice.

Sponsorship deals, esport tournaments, and ad-pop ups on popular streams are all normal right now, but what happens when Pepsi starts sponsoring the next in-game concert, or Apple pays to have virtual posters of Beats headphones put up in the Retail Row section of the Fortnite Map?  Will kids be able to buy ‘skins’ of their favorite movie characters for the next big blockbuster. Disney already agreed to let Fortnite use Thanos from their Marvel Universe as a special character in the game for a short time (Disney is a minority investor in Epic Games).  The possibilities around this are endless.

Even Reed Hastings, CEO of Netflix, recognized that the competition for attention is heating up and videogames are gaining ground.  In his 2018 letter to shareholdershe wrote, “We compete with (and lose to) Fortnite more than HBO”.  That should tell you enough.

 

Bottom Line

Gaming is evolving from something kids (and adults… I’ve gotten sucked into playing Fortnite) do, to a place they hang out.  That dynamic has changed the business aspect of the industry.  Events like the Marshmello concert are only going to become more impressive and more mainstream.  The future is “live experiences” and these video games are figuring out how to make them on a scale that has never been seen before.

Will Fortnite become like the Oasis from Ready Player One? It’s already getting there.  Whatever the case, this trend is something you should be paying attention to.  We aren’t far off from political candidates getting campaign followers by streaming Fortnite battles on Twitch.  It's a brave new world.

 

Fortnite has shown us what the future looks like.  It’s time we start paying attention.

 

Until Next Time....

“For a bunch of hairless apes, we've actually managed to invent some pretty incredible things.” - Ernest Cline, Ready Player One

 

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The Five Best Books I Read in 2018

The 5 Best Books I Read in 2018

While I did not read quite as many books as I would have liked last year, (I never do), I did read some great ones.  I started the year continuing a divergence into gilded age and 20's American history.  From there, I moved into brain science with some financial crisis, personal finance, and non-fiction mixed in. I try to read several books on a topic that I'm interested in in order to get some varied perspectives.

I heard somewhere that if you read 5 books on a single topic you will know more about it than 95% of the population.  I have no idea if that's anywhere close to the case, but it makes for a good aiming point for me.  Sometimes I mix it up a little.  And, if I pick up an interest mid-stream I have been better about leaning into those instead of fighting them.  I can be much more productive when I go with the flow.

Here are the 5 best books I read in 2018.

 

 The Robber Barons by Matthew Josephson

What I loved about Robber Barons is that it was written in 1934, the depths of the Great Depression, and in some cases just a generation removed from these subjects.  It went beyond the most famous profiles of Vanderbilt, Rockefeller, Carnegie, and Morgan with studies of other fascinating players like Jay Gould, Jim Fisk, Jim Hill, Ed Harriman, and Henry Frick.  Each of these characters had their own peculiar stories but all had some hand in shaping the course of the US capitalist system.

This book is fantastic for people who are already familiar with this time period and some of these actors.  The stories in this book are not necessarily the same that are popular today, and the focus on some of the other players will offer a broader picture of the era.  That being said, if you are new to these subjects and this time period, you would do well starting on more contemporary work.

Favorite quote: As the rail lines of Henry Villiard started failing, "His securities continued to sink.  As his grip weakened his former associates stabbed at him from behind with the stiletto, according to the traditional ethics of their trade in Wall Street."

 

Once in Golconda: A True Drama of Wall Street 1920-1938 by John Brooks

This book is a classic of Wall Street history.  It opens with the bombing of the JP Morgan offices on Wall Street and ends with the incarceration of Stock Market hero.  The stories in here are amazing to read, as this time period was so volatile.  It goes from the highest highs of the roaring 20's to the lowest depths of the Great Depression, with all kinds of good and bad actors playing their roles.  You do not need to have much background in order to enjoy the story.  The author does a good job of putting all these characters in a place where you can follow along.

Favorite Quote: "But it was not only money power that Morgan & Co. exercised over Wall Street in the 1920's.  In addition it was the style setter, the court of last appeal, and to a certain extent, the conscious of the place."

 

All the Devils are Here: The Hidden History of the Financial Crisis by Bethany McLean and Joe Nocera

If you want to get to the core of the financial crisis, there are three real must reads.  Too Big to Fail by Andrew Ross Sorkin, The Big Short by Michael Lewis, and All the Devils are Here by Bethany McLean and Joe Nocera.  Each book has its focus and this one turns more toward the history of the companies and people who were at the center of the crisis.  It looks back to see how each of the players got to the role they eventually played.  Anyone who thinks they have a grasp of the financial crisis but hasn't yet read this book is missing key parts.

Favorite quote: "That was precisely the problem.  The issue wasn't actual cash losses.  It was uncertainty.  No one knew where the subprime problem would pop up next, no one could figure out what any of this stuff was worth, and no one believed that anyone who was supposed to know something actually did."

Oh and I was thrilled to get a chance to meet Bethany and she was gracious enough to sign my book.  Needless to say, it is now a prized highlight of the collection.

 

Behave: The Biology of Humans at Our Best and Worst by Robert Sopolsky

This book took me a very long time to read, but was so worth the time.  First of all, it is a bit of a monster weighing in at around 700 pages.  Next, I took so many notes.   Reading this felt like taking a graduate level class on neural biology.  Every time I picked this book up I felt like I was getting smarter, and I ended up filling half of my notebook up with notes.  I was writing something down from every other page.  It is so full of useful lessons on how your brain works and it is organized in a cool reverse chronological order.  I starts from a behavior that happens.  It then jumps back one to two seconds to the functions that prep the initiation and working back in time minutes, hours, days, months, decades, generations... to how your brain works to get to that behavior.  Anyone interested in human behavior (which should be everyone) should read this book.

Favorite Quote: "Repeat the mantra: don't ask what a gene does; ask what it does in a particular context."

(I love that line because it speaks to the error people make when asking nature or nurture.  Is it your biological make-up or your environment?  Like everything in life, it is your biology within a specific environment... in other words, it's always both.)

 

The Geometry of Wealth by Brian Portnoy

This book was a regular recommendation of the fintwit community (for the uninitiated that just means people on Twitter who talk about finance) so got on the radar pretty quick.  It is so easy to read full of smart lessons for everyone from professional investors to the novice just trying to get a better understanding of their personal finances.  The geometry angle provides a great structure to hang all of this information on, allowing you to better understand and retain it.  If you want to be smarter about money and life in general, this is the book you should pick up.

Best Quote: "...if there were a reliable relationship between greater risk and bigger reward, then technically you wouldn't be taking more risk."

Also I love Chapter 5 - Yes, Not Really, It Depends.  The title to the chapter is the answer to the question "can money buy happiness?"

And if you just want a quick "what should I learn about investing as a beginner?" Pick this book up at Barnes and Noble and read Chapter 7 while you drink a latte at the café.

Finally, follow the author on Twitter @Brianportnoy.  He is a super smart, and super nice guy.  You will learn a lot from his book and you can learn even more by reading his content on Twitter.

Bonus Pick

The Square and the Tower: Networks and Power from the Freemasons to Facebook by Niall Ferguson

Niall Ferguson is a prolific writer and financial historian.  If you haven't read his book The Ascent of Money, then your education on finance is woefully short.  Go see the PBS documentary if you don't have the book and your short on time (link here).  The Square and Tower is similar but instead of profiling the rise of money through history it documents the relationship (and conflict) between network power (the town square) and hierarchal power (the lord's tower).  If you want to understand power structure and understand it in historical context this book is the place you should start.

Favorite Quote: "Indeed our species should really be known as Homo Dictyous ('network man') because - to quote the sociologists Nicholas Christakis and James Fowler - 'our brains seem to have been built for social networks.'"

The first book I am reading in 2019, Social by Matthew Lieberman, backs up this idea of 'network man' with a quote that says "Having a poor social network is literally as bad for your health as smoking 2 packs of cigarettes a day." !! With the need to connect so deep and innate within us you can see how the holders of the keys to the network can amass such large amounts of power.

 

For the rest of 2019 I think I am going to finally get to revisiting the classics of economic study.  Books like Wealth of Nations by Adam Smith, General Theory of Employment, Interest, and Money by John Maynard Keynes, Road to Serfdom by Frederich Hayek, and then maybe Human Action by Ludwig Von Mises (to see if I can better understand all my Austrian school, libertarian friends) and Capitalism and Freedom by Milton Friedman.  I'm sure that even though I am highly interested in the topic I will need to take a break so will have to insert a fiction book or two to spice things up.  I have Snow Crash by Neal Stephenson on order.  I have no idea what it is about by it was recommended by a friend so interested to check it.

On a final note, it has been too long between posts and I have fallen short of some goals in that department.  Life has been so great, but also very full. I am in a constant state of prioritizing and time managing and go through periods of time where I don't do as well.  Sometimes I just realize the energy and time isn't there and I simply decide to step away for a while.  I appreciate everyone who gives me feedback on these posts when they do come back.  I can't begin to explain how much it means to hear from people who liked a post or have an opinion on one of the books I read.  I treasure that interaction more than I can say.  Thank You!

So here's to a healthy and wealthy 2019. Get started with a great book!

 

Until next time,

"The mind needs books like a sword needs a whetstone" - Tyrion Lannister (Final season opens on my birthday!)

 

 

Give the gift of learning ---

 

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Folding Aces

Imagine you are sitting at a poker table in a Las Vegas Casino.  It is a tournament that you have dreamed of playing in for years, and by some crazy stroke of luck you got in this year.  All the great famous poker players from TV are here playing.  You realize this is a once in a lifetime opportunity and you are just thrilled to take part.

The first hand gets dealt and you get Ace, Ace.  Pocket aces, the best possible starting hand.

The action goes around the table, fold, fold, fold, ….and then, All in.  Someone has just pushed all their chips into the pot.

You can’t believe your luck!  Some sucker decided to push all-in on the first hand and you are loaded with Aces!  The next three players quickly fold, and the action gets to you.  You're ready to put all your chips in and call - but then, you hesitate.

You're odds of winning with pocket Aces against one other player is somewhere between 70 and 80% - dominating odds.  The right move is to call and its not close.

But, this is the first hand.  If you lose here your dream comes to an end.  It's a very high probability of winning, but its not a certainty.  80% means you would lose that hand 1 time out of 5.  What do you do?

Most people here make the 'right' decision and call; and very likely, they would double their chip stack and be in a better position for the rest of the day.   But you are also taking a 20 - 30% chance of being the first one eliminated.  Everyone would understand - "I had Aces, I had to call."  But just because its excusable does not make it easy to spend the day watching from the sidelines.  'Bad beats' happen all the time - and not just in poker.

A few months ago I posted the following tweet about my investment process.

It got a lot more reaction than I expected, including some great questions so I thought it worthwhile to expand a bit on this premise.

Too often the investment world thinks in black and white.  Right and wrong.  You either did the work, read the research, crushed the Excel models, and came to the right assessment, or you screwed up.  It's what Annie Duke, who recently made the podcast rounds to promote her book Thinking in Bets, calls 'resulting'.  'Resulting' is where the outcome determines whether you made the right move.  Did the trade make money?  Then you were right and did a good job.  If it lost money, you did a lousy job.

What is the probability of being right?

Some investors can move beyond the world of right or wrong.  They understand that a lot can happen and you cannot know anything for certain.  This is why my favorite definition of risk is the one quoted by Howard Marks in his great book The Most Important Thing.

"Risk means more things can happen than will happen." - Elroy Dimson

Single minded people believe that things are bound to happen - that you could figure it out if you were just smart enough or had enough information.  Investors thinking probabilistically understand that nothing is certain.  There are only degrees of likelihood.

Nassim Nicholas Taleb sums it up even further in Fooled By Randomness -

“Probability is not a mere computation of odds on the dice or more complicated variants; it is the acceptance of the lack of certainty in our knowledge and the development of methods for dealing with our ignorance.”

The future is unknowable, and thinking otherwise is folly.  When people become certain that something will happen that is when they get into the most trouble.  Indeed it is one of the most consistent market inefficiencies in history - People will treat as certain something that has a very high probability of happening, and treat as impossible something that has a very low probability of happening.

What is the consequence of being wrong?

I've had this post (A Long Chat with Peter Bernstein) by Jason Zweig saved because I think it is so fundamental on how people should be approaching the investment process.  The late Peter Bernstein is one of my favorite financial writers (Against the Gods is a must read) and Jason Zweig is one of today's foremost investment commentators.  You should really read the entire thing (and read again if you already have) but for our purposes, Peter Bernstein goes through the biggest errors investors make.  The first one is 'extrapolation' (which is a topic that deserves it's own discussion ... another time perhaps), but the second one is  Thinking of probabilities without regard for the potential consequence.

Peter Bernstein on the most famous investor mistakes

To quote Mr. Bernstein:

Pascal’s Wager doesn’t mean that you have to be convinced beyond doubt that you are right. But you have to think about the consequences of what you’re doing and establish that you can survive them if you’re wrong. Consequences are more important than probabilities.

Even if you have a very strong probability of being right, if the consequence for being wrong is unbearable, you should not take the risk.

Imagine you face a wager with 90% odds of paying you $1 million with a 10% chance you have to pay $750,000.  That is an easy bet to take if you have the money.  But what if your net worth is only $200,000 and you have three kids that play travel soccer and are enrolled in private school?  You would face a 10% chance of losing your entire retirement savings, your house, any personal property of any value.  The statistician would say there is no question you should take this wager.  The estimated value is positive $875,000 (90% x $1m plus 10% x -750,000).  C'mon!  Take the bet!  It is the mathematically appropriate thing to do!

But can you afford to lose?  If the answer is no, walk away, avoid the possibility of ruin.  That is appropriate risk management.

Are you thinking about folding those aces yet?

Today's lessons

Tesla, that polarizing electric car company ;-), has been in the news a lot lately.  The stock has a very large, and very loud, group of short sellers (betting that the stock will go down).  The rationale is logically sound - the company cannot hit production targets, there is a huge amount of turnover among executives, they are burning cash at an alarming rate, not to mention the craziness of CEO Elon Musk.

However the risk of being in a short position was on full display in recent weeks.  Even if all the arguments of the short sellers are ultimately true, there are still things that can happen which make a short trade disastrous.  The following tweet was a case in point.

While this is tweet is now under investigation by the SEC (ultimately strengthening the short case), were he able to take the company private at $420, all the short positions would have locked in a loss.  It is a case of being right in theory but wrong on the outcome.

Even still, the stock has dropped down to around $300, and the short sellers believe it has much farther to go. But the cult following around this company and their enigmatic leader, mean that there is a meaningful chance that even with the difficulties the company faces, it could still continue to rise - defying logic or financial common sense.  It could simply rise on the faith and enthusiasm of its sycophantic followers.

I highlighted the risk of short selling most recently in this profile of Cornelius Vanderbilt's take-over of the Harlem and Hudson rail-lines.  The point being that when you own a stock (are long) the most you can lose is your investment.  When you are short, the stock could rise theoretically into infinity and cost you much more than your original investment.

Stocks that do not trade according to fundamental valuations are particularly dangerous. When the consequence of being wrong is unknown and potentially huge it is a dangerous risk to take.

Back to the Poker Game

First hand of your dream tournament.  The bet is to you for all your chips and you have the best possible hand.  You know your probability to win is very high, but your consequence of being wrong is to go home before you even get a chance to order a drink.

The poker players out there would say call.  It's the right move and poker is a game of exploiting statistical advantages.

Me?  Perhaps this reinforces why I would never be playing in a high stakes dream tournament, but I would probably fold them - face up just to let everyone know I was nuts.  The pain of hitting a bad beat and going home would be far worse than the benefit of doubling my chip stack.

But then again.... it would be a good story to tell.

Until next time......

"The word ‘risk’ derives from the early Italian risicare, which means ‘to dare’. In this sense, risk is a choice rather than a fate. The actions we dare to take, which depend on how free we are to make choices, are what the story of risk is all about.” -  Peter L. Bernstein

 

Feature photo credit: Poker Photos via Flickr.com

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The Best Stock Trade I Ever Made

I fell in love with the stock market when I was in college. I became president of my university’s investment club and also decided to start investing the small amount of money I had personally.

One stock I analyzed had a solid business with great numbers.  Its dividend was high but well covered by earnings and had been raised every year like clockwork for the previous 20. This stock would go into my portfolio as the rock and cash cow.

I bought it at $42 and six months later it was up to $47 - and churning out a 7–8% yield on top of that. I was ready to hold that stock for years.

Unfortunately, my priorities in college were not where they should have been and I wasn’t careful with cash. As I got to my last semester I needed to buy textbooks and didn’t have the funds. I ended up selling my stock, painfully.

The year was 2006 and the stock was New Century Financial, the second largest sub-prime mortgage lender in the country.  By early 2007 the company got into serious trouble and in April it filed for bankruptcy.  It was the first major casualty of the financial crisis.

The stock went to $0. I sold it a few months before to buy textbooks.

That was the greatest stock trade I ever made.

I learned some important lessons from this.

1)            The numbers are important, but they can’t predict the future

New Century Financial was the second largest sub-prime mortgage lender in the country.  (For more on the companies and CEO’s involved in the financial crisis check out the excellent book All the Devils are Here by Bethany McLean and Joe Nocera.)  Of course the numbers were great while the housing market was booming, but once house prices started declining, their business imploded. 

If you are looking at projections for a stock, you have to ask yourself – what could make this story blow up?  I looked at the numbers and just expected the trend to continue. 

The number one error investors make is to extrapolate trends indefinitely into the future.

 

2)            Sometimes you are better lucky than good.  Acknowledge it and learn from it.

My investment would have been wiped out if I didn’t need the cash.  I got lucky and dodged a bullet.  When analyzing how a trade worked or did not, you should not focus on the result, but on the process.

 

3)            If a trade looks like a slam-dunk, the radar needs to go up.

My analysis of New Century Financial made it look like a no-brainer.  Anyone who has done a discounted cash flow model knows that high dividends, high growth, and high return of equity will make a stock look like it’s worth a ton.  That may be the case, but it depends on those numbers continuing on into the future.  You need to be skeptical when the analysis looks too good.

 

Just because I got lucky, it doesn’t mean I can’t learn something.  The close calls can still give you valuable experience, with the added benefit of less bruises.

Until next time….

“Don’t confuse luck with skill when judging others, and especially when judging yourself” – Carl Ichan

 

 

Photo Credit - Luis Villa Del Campo via flickr.com

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Vanderbilt and the Greatest Corner Never Told

“He was to finance what Shakespeare was to poetry and Michelangelo to art.”

Financier and Statesman Russell Sage said these words of Cornelius Vanderbilt after the Commodore laid his enemies low with a brilliant double corner of Harlem and Hudson Rail stocks.  The ploy not only made him a small fortune, but also control of the only two rail lines offering service to Manhattan Island.  The historian John Steele Gordon described it as such “…Cornelius Vanderbilt played Hannibal at Wall Street’s battle of Canae.  His double envelopment of the bears netted him and his allies $3 million and was recognized immediately as a masterpiece of financial manipulation.”

Despite the fact that this is arguably the greatest coup in Wall Street history, it isn’t widely reported in popular history.  Here is the story along with a couple of lessons we can take with us a century and a half later.

 

The Man

“Vanderbilt, then, combined in himself the new and the old social traits at once.  Something of a sea-dog and a pioneer, endowed with physical courage and high energy as well as craftiness, he was the Self-Made Man, for whom the earlier, ruder frontier America was the native habitat.” – Matthew Josephson, Robber Barons

Vanderbilt got his start in business as a teenager, working as a ferry-boat captain.  He quickly gained a reputation as a slick operator and a ruthless business competitor and started making a fortune. He was constantly hustling, constantly working and competing.  As T.J. Stiles reports in his biography The First Tycoon, the New York Times thought Vanderbilt was a destructive force for business as someone who “competed for competition’s sake.”  Even his leisure time was taken up with such things as drag racing chariots down the streets of New York and other dangerous, competitive pursuits

He was already the country’s wealthiest man (or close to) by the time he decided to switch his energies towards rail in the 1850’s.  John Rockefeller, Andrew Carnegie, Jay Gould, and JP Morgan were all young men just getting started in the world at this time.  Vanderbilt’s tough reputation was only enhanced by the fact that he was involved in one of the first deadly rail accidents.  Every single passenger aboard that railcar died except him.  He was not deterred and continued to acquire rail properties, expanding his venture.  In the early 1860’s, he set his sights on a couple lines in New York City.

The Play

The Harlem and the Hudson were both poorly run, lightly traveled rail lines that were not thought of as highly valuable.  Vanderbilt saw that these lines were the only rails allowed to come directly onto Manhattan island.  Sensing an opportunity, he started to accumulate shares in Harlem.

At the same time Vanderbilt was buying, there was a large contingent of players who were selling the shares short.  That is, they were borrowing shares, and selling, with the hope to buy them back at a lower price, netting the difference.  This group of sellers (bears, in Wall Street parlance) included members of the New York City council as well as members of the board of directors for Harlem rail!  One of those board members was long-time Vanderbilt rival, Daniel Drew.

With all these inside interests betting on the price of Harlem to go down, there had to be something going on.  Sure enough, a franchise bill that authorized Harlem to lay a double track was suddenly rescinded.  The price dropped suddenly on the news and all the short sellers expected to clean up and declare victory – except that Mr. Vanderbilt was still on the other side, buying everything that was being sold.  Not only did the stock stop going down, but it started to rise quickly.

Now for those that do not know, shorting a stock can be a dangerous business.  When you buy a stock (go long) you only have your investment to lose.  If you pay $100 for a stock, it can only go to $0, thereby wiping out your investment.  However, if you borrow a stock and sell it short, there is technically no limit to high it could go before you must buy it back to cover your borrowing.  If you borrow shares and sell them at $100 and the price goes to $200, you have lost your entire investment.  But if the price goes to $300 or $400, you would be on the hook for more multiple times your initial position.

Now imagine one person owns the entire supply of stock.  If you sold it short at $100, and now you have to buy it back to cover your position, what price does the owner set?  This is the danger of being caught short when someone has ‘cornered’ the market.  As John Brooks explains in his classic “Once in Golconda:

“Since a successful cornerer may theoretically set an infinite price, any finite one is a theoretically a bargain.”

This is what happened to the short sellers of Harlem stock.  Vanderbilt and his allies had purchased the entire supply and had them at their mercy.  In order to escape complete ruin, the city council gave back Harlem’s franchise which now Vanderbilt owned outright.

Already, this was one of the most successful corners of a market in history and made the Commodore a ton of money in the process.  However, this was just the beginning.

Watching this epic battle unfold, some Wall Street speculators decided to attack the neighboring Hudson rail line.  This group thought that Vanderbilt must be short of cash (after all that buying) and attention, and so went heavily short hoping to drive the price down and make themselves a tidy profit.  What they did not know, was that Vanderbilt was already one step ahead and actually perpetuated the rumor that he was short on cash by weakly buying Hudson shares using futures.  This was a common strategy for buyers short on cash because it was merely a promise to buy at a later date.  The intermediaries Vanderbilt used were actually part of the short-selling group, who would gladly accept the options from the Commodore and then turned around and sold the stock into the market.

Little did the bears know, they were selling this stock to allies of Vanderbilt, who far from being short on cash, still had plenty of powder left.  When, finally, he demanded delivery of the stock he purchased, the sellers had to go into the market to buy it back and found no sellers except Vanderbilt himself.  Mercifully, instead of raising the price to infinity, Vanderbilt let the short-sellers off relatively easy.  They weren’t ruined, merely badly burned.

Within the span of a couple months, Cornelius Vanderbilt acquired full control of the only two railways with access to Manhattan and made a substantial fortune in the process.

Daniel Drew, still stung from his losses in the failed Harlem short, decided he wanted one more crack.  He convinced a few law makers in the state capitol of Albany to revoke the franchise for Harlem, overriding the city council.  If they revoked the license and shorted Harlem stock, they could make a bit of money as well.  This turned out to be a fateful mistake.

From The Great Game:

“Drew’s scheme was, of course, a carbon copy of what cost the members of the city council so dearly the previous spring.  One is at a loss to explain how they could have been tempted. ‘The statesmen at Albany,’ E.C. Stedman, a veteran of Wall Street in the 1860’s, wrote at the turn of the century, ‘in the spring of 1864, were well aware of the misfortune into which the statesmen at New York had plunged themselves, less than a year before, by their bear campaign against this stock.  Yet they rushed fatuously into a similar attempt, as if Vanderbilt has proved an easy victim.’”

Interestingly, the timing on this second attempt to ‘bear raid’ Harlem stock was in favor of the shorts.  The price went from $140 down to $101.  The greed of speculators who always hope to make more money was on full display here.  Instead of covering at a net profit of almost $40 per share, the shorts tried to press their advantage.  “They held on, hoping to see it drop to $50”

Despite really not being very liquid this time around, the Commodore was still not easily defeated.  He rallied his allies and raised cash to buy up the last remaining supply of the stock.  The price rose to $109, then to $125, and by the end of April was all the way to $224.  Feeling less charitable than the last time, Vanderbilt was asked by his brokers where to set the price.  “Asked what to do, he bellowed, ‘Put it to a thousand!’”

Fortunately for the shorts, (and their brokerage houses, who also would have been decimated at that price), Vanderbilt relented and settled at $285.

“The second Harlem corner was over and there would not be another.  Indeed, for a full generation on Wall Street, the phrase, ‘short of Harlem’, meant much the same thing as ‘up the creek’”

The Lessons

Obviously, the stock market is a very different entity today than it was 150 years ago.  Electronic trading, stronger regulation, mark-to-market, all make bear-raids and corners a much rarer occurrence today than they were then.  People, however, have not changed.  Fear and greed still very much drive the market.

  1. Know your risks

Before you enter into any investment, you need to know the upside and the downside.  Trying   to short a stock may present a good chance for gain, but the downside is technically unlimited.  The upside, meanwhile, is capped at 100%.  The stock can only drop to $0.00.  Even when you have inside information (now very much illegal to act on material, non-public information), there is risk that things do not play out as you hope.  The city council members in this story knew they were going to revoke the street car license for the Harlem line, but they still got wiped out because they failed to properly assess all their risks – specifically on the next point -

  1. Know your opponent

When you enter into a trade, you have to remember that if you are buying, that means someone is selling.  There is a counterparty to every transaction that happens.  Those city council members under-estimated the pockets and the resolve of the Commodore, to their detriment.  If you think a trade is a slam-dunk, try to find out who is on the other side.  Why would someone bet in the other direction?  If the opposition is strong enough, even if you are right on your thesis, you may be better off to take a pass.

  1. Know when to take a profit

If the state legislators in the second Harlem corner would have booked their gains when the price fell from $140 down to $101 they would have been able to chalk up a good win with a nice gain.  However, they did not know when to stop.  When you are long, it can often pay to keep your winners running, because your upside is not capped.  On the short-side though, every day you do not cover is another day your position could be crushed.  Making a successful trade is so hard because you have to be right twice.  You have to be right on when to buy and also when to sell.

History can be a valuable teacher.  For those interested in finance and markets, there is much that can be learned from past events.  The best place to start is probably from the book where the bulk of this story comes from.  The Great Game: the Emergence of Wall Street as a World Power 1653 – 2000 by John Steele Gordon.  Vanderbilt’s corner of Harlem and Hudson are but one chapter of a book filled with fascinating episodes of market history.  Each has its cast of impressive characters winning and losing fortunes, and all have valuable insights which can be gleaned from them.

Vanderbilt did finally get bested in market manipulation years later in the much more famous ‘Erie War’ over the Erie rail line.  Daniel Drew finally got some bit of revenge as he was, per usual, on the opposite side of the Commodore’s.  The victory, however, belonged squarely with Drew’s tentative ally, Jay Gould, known as the ‘Dark Genius of Wall Street’.  Gould was one of the only people who could match Vanderbilt in stubbornness and the willingness to do whatever it took to win a battle.

Until next time……

“I don’t care half so much about making money as I do about making my point, and coming out ahead” – Cornelius Vanderbilt

 

 

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