Start-up financing: it's the banks, stupid!

When an entrepreneur starts a new firm she often need external funding. For this, the entrepreneur will typically rely on equity, provided by the "three F's" (Friends, Family and Fools), by business angels, and/or by Venture Capital (VC) funds. At least, this is a popular perception of how start-up financing works. For example, Aswath Damodaran describes the financing decision in the start-up phase of a firm as "Equity funding optimal, debt only if desperate". Desparate. Do entrepreneurs really need to be desparate before they use debt finance? Not in the real world it seems. In a recent study that covers basically all independent Belgian firms founded in the period 2006-2009, Tom Vanacker and I find that bank debt is the most important finance source for new firms. More than two thirds of the Belgian start-ups in this period used bank debt at the time of start-up. For the start-ups with bank debt on their balance sheet, it was a (much) more important finance source than equity, trade credit or other debt types. These findings of Tom and me are not unique for Belgium, not even for Europe. Studies of start-up financing find that bank debt also plays a crucial role in the financing of start-ups in the US and Australia.

Access to bank debt is important for start-ups, because it allows them to finance investments, increase their growth and avoid bankruptcy. In our study, Tom and I distinguished between new firms founded before and after the 2008 crisis. During this crisis, many banks got into serious financial troubles and evidently had less money to lend. Not surprisingly, we find that new firms in this period had less bank debt than new firms before the crisis. The reduced access to bank debt negatively affected the growth and the chance of survival of these firms. Start-ups invested less, had a lower growth, and were more likely to go bankrupt if they ware founded during or after the crisis, compared to start-ups before the crisis. Furthermore, this effect was significantly stronger for start-ups in industries which depend on bank financing and start-ups with a lack of equity. This suggests that reduced access to bank debt during the crisis harmed many start-ups.

Where does the idea that start-ups only rarely use debt come from, given the evidence of the contrary? Research on start-ups tends to focus on high-tech start-ups which, due to the nature of their assets (intangible growth opportunities), indeed have limited access to bank debt and rely much more on business angels (I love that word, I wonder who invented it) and VCs for external funding. However in the real world, most start-ups are not about "cool" nerdy guys and girls wanting to become billionaires when the app they are creating is going to conquer the world. Most start-ups are about hard working people in many different industries, for which bank debt is very useful. These start-ups are still very important for our economy. More important than the guys and girls trying to invent new apps. Just not as sexy.

Poor VW shareholders

Last week, when it was announced that VW had produced and sold diesel cars with software installed that manipulated environmental tests, VW shares lost more than 35% of their value. The Dutch investor association VEB has now issued a claim against Volkswagen for the losses incurred by investors. According to the VEB, VW should compensate investors for the losses they made due to the scandal:

'Volkswagen wrongfully claimed that it produces extremely environmentally-friendly cars thereby creating the impression that it could gain a larger market share and thus more turnover. Volkswagen thereby misled investors buying or holding its shares. If Volkswagen had adequately informed public investors, they would not have bought or held the shares, or would have bought them at a lower price'.

The key question here is: who is going to get this compensation and who is going to pay for it? If all shareholders get a compensation, they are paying it to themselves, since they are the firm's owners. Any compensation paid by VW will be matched by an equivalent decline in VW's share value, so it's just an illusion. A compensation can only be 'real' if not all shareholders get it. In that case, the compensation is a transfer from the shareholders who don't get it to the shareholders who do. 

Who should pay then? The controlling shareholders of VW have 50.73% of the voting rights via Porsche Automobil Holding SE, which holds 31.5% of VW's subscribed capital. The VEB will have to convince the judges that the controlling shareholders were well aware of what was going on with the faulty tests, so they should pay a compensation to the other shareholders. I wish the VEB good luck.

Disclaimer: I own a VW (but not a diesel)

Zombie listings

Spadel, producer of the well-known Spa mineral waters, announced last weekend that it wants to delist. This makes it the third Belgian company in one week to announce its intent to leave the stock market. The question with Spadel is not: why do they want to delist?, but rather: why are they still listed? The family Du Bois owns more than 90% of Spadel shares, so the number of marketable shares is limited. Not surprisingly, the liquidity of Spadel shares is very, very low: there are only a few trades per week. The company has not publicly issued new shares for a very long time, and the company has much more cash on its balance sheet  (€ 84 mio at the end of 2014) than is needed to buy out the few remaining outside investors (€ 36 mio).

This is actually Spadel's second attempt to delist. In december 1999, Spadel repurchased 52,249 shares held by minority shareholder Interbrew (nowadays called AB Inbev) and reduced its outstanding shares from 150,000 to 100,000. It also offered to buy the 20,351 shares held by the public at the same price it paid to Interbrew: € 1,115.5. Since this was approximately the price at which Spadel shares traded on the market, the attempt to delist unsurprisingly failed, although they came close to the 95% threshold which in Belgium allows for a squeeze-out. After a first bid in March 2000 and a reopening of the bid in April 2000, 5,358 of the 100,000 Spadel shares remained in the hands of the public, just enough to avoid a squeeze-out.

There are many zombie listings like Spadel: the listing does not serve any real purpose anymore, but as long as the costs of delisting (you have to buy out the outside investors, which costs a lot of money) are perceived to be higher than the listing costs (administrative expenses, information provision to investors, corporate governance rules) the controlling shareholders prefer to let the company vegetate on the stock market. It would be interesting to know how many companies on European stock exchanges have not raised any capital in the last 20/30 years (idea for research).

Note that a listing might still be useful even if the company has not sold shares to the public for a long time. Lotus Bakeries, a Belgian producer of cookies, gingerbread and other sweet things, has been listed on Euronext Brussels since 1988. At the initial public offering, no capital was raised, but the existing shareholders cashed out by selling a minority portion of their shares. Since then (as far as I know) Lotus has never used the stock market to raise new capital. Why is Lotus listed then? The answer probably lies in their takeover activity. Since 1988 Lotus has acquired several firms. When a company is listed, it can pay acquisitions with its own, liquid shares instead of having to pay cash. For Interbrew (AB Inbev) that was a big motivation to go public in 2000 (as noted at the time in the IPO prospectus). See where it brought them.

A final note: a spokesman of Spadel told the newspaper De Standaard that at Spadel they don't know for sure anymore when Spadel shares were introduced on the Brussels stock exchange (if someone from Spadel is reading this: it was 15 May 1922). I find such an apparant lack of interest in its own history remarkable: seems a lack of pride in the company.

What is a 'fair' price for delistings?

This week it was announced that the controlling shareholders of the Belgian shipping company Compagnie Maritime Belge (CMB) and those of the Belgian Pairi Daiza zoo intend to delist their company. When the controlling shareholders want to delist their firm, they have to make a public bid for all outstanding shares. Once they get a sufficiently large percentage of the shares (in Belgium the threshold is 95%), there can be a squeeze-out. In the squeeze-out, shareholders who did not yet sell are basically forced to give up their shares at the bid price. This raises an important question: what price should the controlling shareholders offer to the other shareholders? What is a fair bid price?

For the delisting bid to succeed, the bid price should be higher than the market price before the bid was announced (*). The market price reflects the share value for stock market investors. Why would they sell to the controlling shareholders if the bid price is lower than the price at which they can sell on the market? Then of course the question is: how much higher should the bid price be? Sometimes, the controlling shareholders propose a price which is considered too low, and the bid fails. In September 2012 Liberty Global, which at the time owned 50.4% of the shares of the Belgian telecom operator Telenet, announced that it would offer to buy the other Telenet shares at € 35. This price implied a 12.5% premium compared to the last market quote before the bid. Nevertheless the bid failed. Liberty Global managed to convince only 8% of the shareholders to sell their shares. The Lazard bank, which had been asked by the independent directors to value Telenet, estimated the value of its shares to be substantially higher than the price offered by Liberty Global, between € 37 and € 42. Since then, the market price of Telenet, which is still listed, has risen to more than € 50.

In the case of CMB, of which the controlling shareholder Saverco (an investment vehicle for  the Saevereys family) holds 50.8% of the shares and which has been listed for more than 100 years, the bid price is € 16.20. This is 20.45 % higher than the last market price before the bid. Is this a good price? Opinions are divided. The Belgian newspaper De Tijd estimated the share value by first estimating the value of the ships of CMB.  After deducting the outstanding debts and including the value of some other assets, they obtained a CMB share value of € 14.11, leading De Tijd to conclude that the offered price is 'correct'. Others disagree. According to blogger Alberken, the offer is a joke and the value of CMB shares is much higher at € 21.20. Unfortunately, Alberken does not let us know how he obtained this value.

Who is right? First, any net asset value as the one calculated by De Tijd should be considered an absolute minimum. If the going concern value (i.e. the value if the firms keeps on operating) of CMB is not higher than its liquidation value, it means that CMB is basically destroying value.

If the bid price is substantially higher than the stock price before the offer, there seems to be an inherent contradiction in the argument that bid price is 'too low'  As a shareholder, you had an even lower price before the offer, so what are you complaining about? Well, the market price of a share does not necessarily reflect the 'real' value per share. When the controlling shareholder offers a share price which is lower than the actual value, he gets a larger part of the value than what he is entitled to. (**) Actually, they are very likely to do so. Why would they otherwise offer to buy the shares? This only makes sense if they think the value of the shares is higher than the price they pay. That is, unless the delisting itself creates value. When company is not listed anymore, direct and indirect listing costs are avoided and the controlling shareholders have more flexibility in pursuing whatever they consider appropriate objectives. This might lead them to pay a price which is higher than the value of the stock when listed and still keep some of the extra value for themselves. Fair enough.

Nevertheless, in many delistings there is a worry that after the delisting, the controlling shareholders will take actions that they refrained from doing while the company was listed, even though such actions would have substantially increased the company value. Specifically, they could decide to sell (parts of) the company at a higher price than the one they paid for the delisting. In a previous post, I explained how the Belgian entrepreneur Marc Coucke (who remarkably is also involved in the Pairi Daiza delisting) delisted his Omega Pharma company in 2011, paying € 1.2 billion, and selling it three years later for € 3.6 billion. Of course, we do not know whether it was already the intention of mr. Coucke in 2011 to sell a few years later at a much higher price, but such transactions understandably raise fears among investors that they might get a bad deal at the delisting. It would be interesting to know the extent to which the buying shareholders in delistings in Continental Europe sell their company a few years later at a significantly higher price. If you know of such research, let me know!

While it is unfair that the controlling shareholders pay a low delisting price if they intend to sell at a higher price after the delisting, it gets more complicated when the controlling shareholders delist because they think the market undervalues the company. Controlling shareholders will often be better able to assess the true value of a company than outside shareholders, who have less information about the prospects of the firm. As Pierre Huylenbroeck notes and as you can see in the chart to the right which depicts the CMB share price in the past five years, the bid price of € 16.20 is quite low compared to previous prices. About a year ago CMB shares traded at more than € 20. The delisting decision might be a smart move of the controlling Savereys family to profit from current undervaluation in the market. Is this unfair? I don't think there is a straightforward answer to that question. One could argue that all investors are entitled to a share of the company's real value in proportion to their shareholdings, and no shareholders should benefit from the fact that they have more information about the company than others. But how far can you stretch that argument? If a company decides to repurchase its own shares because the management thinks the shares are undervalued, is this also unfair? Then many share repurchase programs should be considered unfair. The shareholders who do not sell win at the expense of the sellers. Where should we draw the line between acceptable and unacceptable share tradings? In the capitalist system it is accepted that some investors are smarter than others and benefit from this. That is why Warren Buffett is such a celebrated person. A good rule seems to be that no share trade should be based on one party having inside information that is not available to the other party. Inside information is to investors what doping is to athletes: it gives them an unfair advantage. Unfortunately, this is very hard to determine.

Addendum: Gertjan Verdickt points me to a study by Ettore Croci and Alfonso Del Giudice who find that the operating performance of delisting European firms does not significantly improve in the three years after delisting. However, their data do not allow them to investigate whether the firms are sold after delisting which might be an important factor, as Croci and Del Giudice note themselves.

(*) Once the bid is announced, this information will be incorporated in the market price, which therefore does not provide a meaningful comparison anymore.

(**) For the sake of argument, let us assume that the total value of CMB would be € 7 billion. If the controlling shareholders pay € 16.20 per share, this would allow the controlling shareholders to keep € 7 billion - (€ 16.20 * 35 million CMB shares) = € 133 million for themselves, instead of sharing it with the other shareholders.

Investing à la Homer Simpson

If your investing strategy is to actively try to 'beat the market', you should always keep in mind that this is a zero sum game. For any investor who beats the market, there is inevitably another investor who underperforms the market, since the 'market' return is the average of the returns of all investors. The gain of one is the loss of the other. Anyone who thinks that a stock is mispriced should therefore consider the following question: why am I smarter than all other investors out there on the market, whose combined beliefs determine the stock price? What do I know or what do I understand that all these people out there do not know or do not understand? (*) As the behavioral finance researcher Meir Statman put it: 'If you buy a stock thinking the price is going to go up, you have to ask yourself who is the idiot who is selling it. Because, in every trade there is an idiot and, if you don’t know who it is, it is you. The opponent might be more skilled than you, have information you don’t have, be tipped off by an insider and, so, when I feel like trading I ask myself, who is the idiot on the other side? What is my relative advantage?' Make sure you're not the idiot.

(*) This might have something to do with it.

The art (or is it science?) of company valuation

When it comes to valuing companies, some people seem to suffer from what could be called 'reverse number blindness': if there's a lot of numbers and formulas involved, it must be good. However, as Aswath Damodaran points out, 'the test of a valuation is not in the inputs or in the modeling, but in the story underlying the numbers and how well that story holds up to scrutiny'. If the numbers you put in your valuation model do not reflect reasonable expectations about future cash flows and risk, your valuation is worthless however sophisticated your model is. Which raises the question: what are reasonable expectations? As a wise man once said: 'it's tough to make predictions, especially about the future'. When valuing a company, it is important to understand that valuations are only informed guesses, typically based on limited and (very) noisy information.

The Financial Times recently discussed an interesting illustration of this problem. In 2011, a company called Rural-Metro was acquired by private equity firm Warburg Pincus. Afterwards, shareholders sued Rural-Metro's directors for breaching their fiduciary duties, and Rural Metro's bankers - including Royal Bank of Canada - for aiding the directors in selling the company too cheaply, supposedly to get new lucrative financing assignments. While the other parties settled before a trial, Royal Bank of Canada contested the charges in a court in Delaware.

This led to a discussion about the valuation of Rural-Metro. In any discounted cash flow valuation (DCF), expected future cash flows are discounted at the cost of capital. According to the Capital Asset Pricing Model (CAPM) (basic version), the cost of equity = the risk free rate + beta x equity risk premium. In this model, beta measures the 'systematic risk', i.e. the extent to which the equity returns co-vary with the overall market return. There are two big problems with this approach. To begin with, it isn't even clear whether CAPM is a good approach to measure the cost of equity. Basically, people use it because (a) it is very simple to apply, and (b) there do not seem to be any significantly better approaches when it comes to valuation in the real world.

A second problem is that beta can be measured in different ways, and different approaches can lead to very different valuations. In the case of Rural-Metro, both parties made different assumptions with respect to beta. While they both used regression analysis and historical returns to estimate beta, the plaintiffs based their analysis on the weekly returns over a two year period, and the Royal Bank of Scotland advocated the use of monthly returns over a five year period. Both approaches are considered valid ways to estimate beta, but in this case the results were markedly different. The weekly data yielded a beta of 1.2, while the monthly data generated a higher beta of 1.454. It will probably not surprise you that the approach chosen be the parties confirmed their respective view points. The plaintiffs argued that the price at which Rural-Metro was sold was too low, which was disputed by the bank. A higher beta implies a higher cost of capital, and hence a lower DCF-valuation. The higher the DCF-value of Rural-Metro, the greater the damages to which the plaintiffs were entitled. The beta of 1.2, advocated by the plaintiffs, yielded a value of $21.42 per share, while the beta of 1.454, defended by the Royal Bank of Canada, yielded a 21% lower value of only $16.91 per share, decreasing total DCF value by no less than $100 million.

Which of these two approaches is the best? Personally, I would use neither: beta coefficients of individual stocks are often very unstable over time. You may try it yourself: calculate the beta of any stock over different periods of time, and you often end up with very different beta estimates. An extreme example is the beta of bank stocks, which for some banks exploded during the recent financial crisis. (*) A more reliable way to estimate beta is to use the mean or median 'unlevered beta' (i.e. adjusted for differences in leverage) of the industry in which the firm is operating. This is a much more stable measure, and it has been found that the betas of individual stocks tends to evolve towards industry averages.

However, the broader problem here is the reliability of DCF valuations. Any valuation will depend on the underlying assumptions, and a minor change in assumptions can lead to very different valuations. Does this mean that DCF valuations are worthless? According to Marc Andreessen, DCF valuations only serve to justify existing market valuations. I think mr. Andreessen is a bit too cynical here. (**) The big advantage of DCF valuation is that it allows to assess the assumptions on which a company valueis based. Are the underlying assumptions about the cost of capital and growth prospects in any way realistic? Let's say you would consider to buy Apple stocks: what does the current market valuation of Apple imply with respect to growth rates? DCF will help you understand this and will you help to decide whether to buy or sell Apple.

(*) Yes, I am aware that the 2007-2008 crisis was an unexpected, exceptional event, but unexpected exceptional events are basically happening all the time: any approach which does not take into account the possibility of such events is problematic in my view.

(**) Although I do like Andreessens' statement that the 'Efficient Market Hypothesis is correct if for "all information" you substitute "all information, theories, noise, and bullsh*t"'. It's a strange beast, this so-called Efficient Market.

Are stocks currently overvalued?

Many people think that stocks are currently overvalued, because price/earnings ratios are nowadays much higher than historical averages (see for example here and here). Are they right? To answer this question, let's take a closer look at the valuation of stocks. The value (V) of any financial asset is determined by expected future cash flows (CF) and the required rate of return (r), with (simplified): V = CF / r.

If stocks are currently overvalued, this may be because investors overestimate expected future cash flows, i.e. company earnings. While this is probably true for some companies (Tesla Motors comes to mind, but who knows?), it seems doubtful to me that this applies to the overall market. There is currently a broad sense of pessimism about future economic growth (cf. the secular stagnation debate) and it is often argued that firms hold too much cash and don't invest enough. Not exactly an environment in which you would expect investors to be overly optimistic about the growth prospects of firms.

So, maybe then the return required by investors is too low? The required return on stocks consists of two parts: the risk free return plus an equity risk premium which takes into account that stocks are more risky than fixed return investments. Perhaps the equity risk premium should be higher? This is also doubtful: Aswath Damodaran, who is one of the smartest guys around when it comes to valuation, calculated that the equity risk premium for S&P 500 firms did not at all decline in the past five years. And why would the equity premium currently be too low?

Is the risk free return the culprit then? At first sight, this seems to make sense: central bank policies in the US, Europe and Japan (Evil Quantitative Easing) have driven down intrest rates (well, at least that's what is generally assumed, but I'm not aware of any hard evidence on this). The risk free return can be broken down in two components: expected inflation plus the "real intrest" that investors want for parting with their money.

It could be that current risk free returns insufficiently take into account future inflation. Indeed, people have been arguing for years that the QE policies pursued by central banks wil  inevitably lead to high inflation. However, it seems very unlikely that stocks are overvalued because future inflation is underestimated. First, it is doubtful that quantitative easing will lead to high inflation. More importantly, whatever your belief about the impact of QE on inflation, inflation should not matter that much for stock returns. As I have explained in a previous post, stocks seem to provide a pretty good hedge against inflation: if inflation goes up, the firms' cash flows also go up (*). If you expect high inflation, you're better off with stocks than fixed income securities!

This brings us to the last reason why stocks might be overvalued: current intrest rates underestimate the "true" intrest rate, leading to too low discount rates. Central bank policies could temporarily have driven real intrest rates below "normal" levels, and stock investors insufficiently take into account that sooner or later real intrest rates will go up again, which will bring down the value of stocks. Here, Damodaran again provides a very useful perspective. He points out that in the long run, the real intrest rate has to backed up by a real growth in the economy. He finds that the intrest rate on US Treasury Bonds in recent decades is indeed strongly correlated with the sum of actual inflation rate and realized economic growth rate, which is a proxy for the "intrinsic" intrest rate, i.e.  the sum of expected inflation and expected real economic growth. Furthermore, this relation seems hardly to be affected by QE, at least in the US. This suggests that current real intrest rates probably provide a not-so-bad reflection of the "true" intrest rate, irrespective of QE in recent years. Now, maybe investors do underestimate the "true" intrest rate because they underestimate future economic growth, leading to a discount rate being used to value stocks that is too low. However, if this is the case, then expected future company earnings are probably also too low, implying that the value of stocks might actually be underestimated and stock prices are too low.

Bottom line: even stock valuations are currently very high from a historical perspective, there are good reasons to believe that stocks are generally not overvalued. Yes, current stock valutions are based on low discount rates, but (a) low discount rates could reflect a new "normal" (as e.g. Robert J. Gordon has pointed out, we may have entered a new era of permanent low economic growth); and (b) even if economic growth picks up again leading to higher required rates of return, this economic growth should also lead to higher company earnings, increasing the value of stocks. A final point: if stocks would be overvalued, it doesn't make sense to  shift your money to alternative investments such as bonds or real estate, if these alternatives are also overpriced.

(*) And as I always tell my students, you need be careful not to discount real cash flows (which do not incorporate expected inflation) with nominal discount rates (which do take into account expected inflation).

Are stock investments a good hedge against inflation?

In my previous post, I mentioned that stocks should provide a good hedge against inflation. If you don't believe me, consider the following quote taken from "Defying Hitler: A Memoir" by Sebastian Haffner. Haffner (real name Raimund Pretzel) was a German journalist who fled Nazi Germany in 1938 and wrote a memoir in the next year, which was only published after his death in 1999 (facinating book). As you may know, Germany was characterized by a period of hyperinflation between 1921 and 1924 which destroyed the savings of many Germans. According to Haffner, this is how people dealt with this hyperinflation:

Anyone who had savings in a bank or bonds saw their value disappear overnight ... The salary of sixty-five thousand marks brought home the previous Friday was no longer sufficient to buy a pack of cigarettes on Tuesday .. What was to be done? Casting around, people found a life raft: shares. They were the only form of investment that kept pace – not all the time, and not all shares, yet on the whole they managed to keep up. So everyone dealt in shares ... Day-to-day purchases were paid for by selling shares. On wage days there was a general stampede to the banks, and share prices shot up like rockets.

Why would stocks provide a good hedge against inflation? The value of a stock is determined by the profits of the firm. Profit is the difference between revenues and costs. If there is inflation, the costs of the firm will increase, but the price of the goods sold by the firm will also increase. As a result, the profits of the firm will not be affected by inflation. At least, that's the theory. Is this also true in the real world? My colleague Jan Annaert and I checked the relation between yearly real (i.e. adjusted for inflation) stock returns on the Brussels Stock Exchange and inflation for the period 1838-2008. If stocks provide a good hedge against inflation, real stock returns should not be significantly affected by inflation. Indeed, as you can see in the first figure below, there doesn't seem to be a clear relation between real stock returns (y-axis) and inflation (x-axis), except for some years in WW1 and WW2 which were characterized by very high inflation and low stock returns (but also note 1940: very high stock returns despite high inflation).

On the other hand, the second figure below shows that real fixed returns (short-term) are clearly negatively affected by inflation. This makes sense, since a fixed interest does not change when inflation goes up (at least to the extent that inflation is unexpected: if investors expect inflation, they will demand a higher interest rate before they are willing to invest). Note that holders of investments with fixed interest will benefit when there is deflation: the interests they receive become more valuable. This (partly) explains why bond prices have gone up so much in recent years.

Another interesting feature of the figures are the many red dots with negative inflation (deflation). Modern investors are very much conditioned by the high inflation in the 1970s and early 1980s, but before WW1 deflation was quite common. But that's another story.

Is war good for the stock market?

I’m currently rereading “Antifragile” by N.N. Taleb, which I find an insightful book. It’s also fun to read, if you don’t mind his rants against economists, Harvard professors, bankers, journalists … (the list of professions to which Taleb is averse is substantial). In this book, Taleb describes how traders lost millions of dollars when the Kuwait War started in January 1991. They were betting that the oil price would rise when the war started. Instead, the oil price collapsed from around $39 a barrel to almost half that value. Why did the oil price not rise at the start of the war? Because people expected this war to start, and the expectation was already incorporated in the oil prices.

This reminds me of a strange phenomenon I observed in my own research: the outbreak of World War II led to a dramatic increase in stock prices on the Brussels Stock Exchange. The graph below shows stock returns in 1940 (weighted average of all Belgian stocks). The exchange was closed for a few months in the summer when Germany invaded Belgium, but when it reopened stock prices went up by 30% in September, 18% in October and 37% in December! How could WW2 make stocks so much more valuable? As the Kuwait war, this was an expected war. However, the very swift German victory, which apparently was excellent news for Belgian business, was unexpected. So, stock prices didn't go down because the outbreak of war was expected, but they went up because it led to much less fighting and destruction than stock market investors had anticipated (at least in the short run, no one knew what was still coming).

F. Baudhuin, a contemporary Belgian economist, provides another explanation why the stock market boomed after the start of WW2. In a book written shortly after WW2, he argued that Belgian investors had learned from the first World War that war leads to high inflation. Inflation destroys the return on fixed investments such as bonds and savings accounts, while stocks provide a good hedge against inflation. Based on their experiences during WW1, investors at the beginning of WW2 massively invested their money in stocks to protect themselves against inflation, according to Baudhuin. Hence the dramatic increase in stock prices after the war broke out.