Why the markets will always be crazy

Earlier, we listed five important purposes of an investing framework. If you are wondering why we are making a fuss about having a framework, then you are in the right place. The reason is that markets behave crazily. What is crazy? Many define crazy as doing the same thing repeatedly and expecting different results. In that regard, the markets fit the bill. In fact, Indian and global equity markets were born out of frenzy and madness. A frenzied birth Equity markets in India were born in the frenzy of a fevered bull run, dubious fly-by-night companies and then a massive crash, all orchestrated in the shade of a banyan tree in Horniman Circle in Mumbai. It's an amazing story and one which speaks directly to how we deal with our investments today. In 1861, the outbreak of the American Civil War severely disrupted the global cotton supply chain. Britain relied heavily on American cotton produced by slave labour to supply its massive textile industry, which met 77 per cent of Britain's total cotton needs. With this supply now under threat, Britain scrambled to find alternative sources of raw cotton. The cotton cultivators and traders of India stepped into the gap. By 1862, India was supplying almost all the raw cotton imported by Britain, and the value of Indian cotton exports jumped from Rs 16 crore in 1861 to Rs 40 crore in 1865. Much of this cotton was grown in the hinterland of Bombay and that's what led to the initial rise of the city as India's commercial capital. The boom generated enormous profits for traders, brokers, and businessmen. Seeking outlets to invest their surplus capital, they turned to the stock market. Share prices of newly established companies skyrocketed, with The Back Bay Reclamation shares going up from the issue price of Rs 5,000 to Rs 50,000 and Bank of Bombay going from Rs 500 to a peak of Rs 2,850. A lot more people started trading and the number of stockbrokers swelled from just a handful gathering under that banyan tree in 1855 to over 250 members in a few years. This informal group of brokers formally organised into The Native Share & Stock Brokers Association which eventually became the Bombay Stock Exchange and now BSE. The Bombay Gazetteer newspaper noted that as of 1864, the city had seen the emergence of 31 banks, 8 land companies, 16 press companies, 10 shipping companies, and 20 insurance companies that had issued shares. Remarkably, none of these entities had been in existence just a few years prior. Moreover, banks were freely lending money against shares to clients for the purpose of buying yet more shares. Then came the news that the war in America had ended and everyone attempted to offload their shares. The Back Bay Reclamation fell from Rs 50,000 to below Rs 2,000 and Bank of Bombay from Rs 2,850 to Rs 87. Both these companies, along with hundreds of others, went bankrupt. The city went into a decade-long depression and its population actually fell by about 20 per cent. In South Mumbai, a monument to the riches of those boom years still stands tall - the Rajabai Clock Tower was built with money donated by Premchand Roychand Jain and named after his mother. Jain was the 'Cotton King' and 'Bullion King' of those years as well as a leading stockbroker and a director of the Bank of Bombay. Obviously, Jain too went bankrupt in the crash. One interesting aspect of the cotton crash of Mumbai is that it feels very modern. With some modifications, it could be happening today. The South Sea Madness was not like that. A tale of madness In 1711, The South Sea Company was founded by an act of the British Parliament. The company was set up as a public and private partnership, and investors could buy its shares on the exchange. Its purpose wa