December 12, 2017, 01:06 / Opinions / Blog

How Isaac Newton got burned by stocks

In pursuit of hot money, the scientist turned from a reasonable investor into a desperate speculator

Jason Zweig , Intelligent Investor columnist for The Wall Street Journal

Was one of the greatest scientists in human history also one of the mediocre investors?

Sir Isaac Newton lost a fortune (more than $3.6 million in today's money) in 1720 when the South Sea Bubble burst in London. He is often credited with saying: “I can calculate the movements of the celestial bodies, but not the madness of the crowd.”

Andrew Odlyzko, a mathematics professor at the University of Minnesota who has studied the history of stock market manias extensively, recently published a study on Newton. It analyzes in detail Newton's actions as an investor. It turned out that the scientist acted prudently for many years, diversifying his portfolio through investments in stocks and government bonds. By early 1720, the size of his portfolio was about 32,000 pounds (approximately 4.4 million pounds, or $5.7 million, in today's money).

It must be kept in mind that Newton was not only one of the world's greatest scientists, but also a pioneer in the field of finance. As Warden of the Mint, he encouraged the British government to change the monetary standard from silver to gold, established the exact metal content of coins, and ruthlessly prosecuted and punished counterfeiters.

South Sea Сompany

The South Sea Company was founded in 1711. The British government decided to exchange £9 million of debt accumulated over several wars into the company's shares and pay it 6% per year, which it paid out to shareholders in the form of dividends. It also received a monopoly on trade in the Spanish ports of South America. For 10 years, the South Sea Company did not send a single ship there (Britain was at war with Spain), but it actively advertised and bribed ministers and deputies. Its shares became an object of desire for wide sections of the population, many speculated on them using borrowed funds. The stock crash of 1720 ruined many, from aristocrats to peasants, and plunged the economy into depression.

He was also one of the first to see the potential of the South Sea Company, which the government brought in to restructure the national debt and subsequently granted a monopoly on trade with South America (see sidebar). According to Professor Odlyzko, Newton began purchasing shares in the company no later than June 1712, less than a year after its founding. And almost eight years before the mania swept Britain, involving in speculation in the shares of the South Sea Company everyone from ordinary investors to representatives of high society, from merchants, farmers and widows to the poet Alexander Pope, the most popular portrait painter of the time, Godfrey Kneller, approximately three quarters of Members of Parliament and even members of the family of King George I.

The shares (which were quoted as a percentage of par value) soared from around 200 in March 1720 to almost 1000 in June-July, before falling below 200 within a few weeks.

Professor Odlyzko estimates that if Newton had held the stock until 1723, when the bubble burst had subsided and stock prices had stabilized, his total return would have been approximately 116%. This is about 6.5% per annum excluding dividends - quite a decent income at a time when the interest rate on long-term government bonds was 4-5%.

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Finance/Markets

However, in this case, Newton did not always follow the “buy and hold” principle. At the beginning of 1720 he had 10,000 shares in the South Sea Company. In April and May he sold 8,000 of them for around £350, making a profit of at least £20,000, Professor Odlyzko estimates. At that time, this was a huge amount, today equivalent to almost $4 million.

But immediately after the sale of shares by Newton, their price soared significantly - up to 800 in late May - early June. “The bubble inflated, and Newton seemed to panic,” Odlyzko writes. Throwing aside prudence, on June 14 he “bummed” in shares of 26,000 pounds at a price of about 700 per share, i.e. buying them for double what he sold for just a few weeks ago. To make matters worse, at the end of August, when they were worth around 750, Newton bought a derivative that was like a call option: it gave him the right to buy 500 shares at a price of 1,000 per share in installments, but the payment of 1,000 pounds was made immediately. “An operation like this requires a strong belief that the security has a good chance of going well above £1,000. Evidence suggests that Newton had such faith. As he soon learns, she was sadly mistaken,” writes Odlyzko.

In the summer of 1720, Newton transformed from a rational investor who spread his assets over several types of securities to a speculator who invested a significant part of his capital in one company. The great scientist was trying to make hot money as desperately as tech stock traders in 1999 or bitcoin buyers in 2017.

Odlyzko estimates that Newton lost about 77%, or at least £22,600, on his worst purchases. At purchasing power parity today it is 3.1 million pounds (almost $4.1 million). Overall, he lost at least a third of his money.

Market Bubbles: From Tulips to Bitcoin

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The first market bubble - in the market for tulips , which had become a luxury item and status symbol in the Netherlands - inflated in 1634-1637. Tailors, artisans, merchants, and officials were involved in trade. In the photo: the painting “Wagon of Fools”, where tailors who have quit their jobs rush after the goddess Flora decorated with tulips

/ Hendrik Gerritsz. Pot

By the way, Professor Odlyzko found out that the phrase “I can calculate the movement of celestial bodies, but not the madness of the crowd” began to be attributed to Newton years after his death, so he may or may not have said it during his lifetime. But in 1720, the discoverer of the law of universal gravitation must have realized the meaning of the law of financial gravity: what rises in value must fall, and what rises the most must fall the most.

Translated by Mikhail Overchenko

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