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Financial History as Teacher

"There is no better teacher than history in determining the future … There are answers worth billions of dollars in a $30 history book." - Charlie Munger


Clearing through old papers in my office, I came across a volume of essays on the 1929 crash, well marked up with my pencil highlights. The Journal of Portfolio Management put it together in 1979, a 50-year retrospective titled “What happened and why?” Some of Wall Street’s sharpest minds wrote pieces for the collection.


After re-reading a few, I thought I’d share some interesting bits below - on investing through a crash, on rate of return as "the bottom line of all investing" and the dangers of extrapolation. A lot of this is especially timely, as the pandemic rages on and a presidential election looms...


Also, if you are looking for a book that could help your writing, I have a book recommendation for you at the end of the post.


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Bernstein on Investing Through The Crash


We know Peter Bernstein today for his classic books such as Against The Gods: The Remarkable Story of Risk and Capital Ideas: The Improbable Origins of Modern Wall Street. But in 1979, he hadn’t written any of that yet -- and remarkably he was already 60 years old, a ripe age on Wall Street at the time.


In fact, Bernstein titled his essay “How I came to be the oldest man around.” He writes he is virtually alone in his age cohort; he knows almost no one 60 or older. Age may not seem to have much to do with the crash, Bernstein admits, “but bear with me.”


The crash acted as a herd thinner among Wall Streeters, Bernstein says. After 1929, few young people decided to get into the investing business. And so a generation gap emerged. The go-go market of the 1960s, Bernstein says, could only emerge when a fresh crew -- lacking the painful memories of the ‘29 -- replaced the banged up and skeptical veterans.


It’s an old idea: frothy bull markets run on the forgotten memories of old bear markets. Maybe. But Bernstein makes a more powerful point later in the same essay -- about the power of sticking to your stocks, through thick and thin.


He believes in the old Wall Street adage that says success comes not from “timing the market” but from “time in the market.” Bernstein shows even the great crash of 1929 did not disprove the idea.


An investment in the Dow in 1924 held until the summer of 1936 meant you bought at ~100 and sold at ~160. Along the way, you earned $82 in dividends. “This meant you would have enjoyed a total annual return of 7.6% before taxes,” Bernstein writes, “not including the reinvestment of dividends.”


He also notes that the cost of living fell ~20%, or nearly 2% per year. Not bad. And remember, you just sat on your hands the whole time. Bernstein plays with start/end times, but even if you held to 1939 -- when the market was less “ebullient” -- the return still works out to 6% annually. “These returns are hardly anything to sniff at,” Bernstein writes.


As we approach a presidential election and the pandemic rages on, we might reflect on Bernstein’s point. I agree with his message, but I will add the ride to the destination was anything but smooth.


Historian Robert Sobel gives us an example to think about. He says, consider the investor who bought shares in Commercial Solvents, a thriving chemical company, in 1923 for $15 per share. By late 1932, the stock traded for $35 a share. Our investor has more than a double. Sounds like a happy outcome, right?


But... the stock traded for $1,400 in 1929. Now how do you think you’d feel?


See what I mean?


Kirby: Author of The Coffee Can Portfolio


Another contributor, Robert Kirby, managed money for the Capital Group. Kirby is a favorite of mine. Every Kirby essay I come across seems wise and witty. Kirby’s 1984 essay “The Coffee Can Portfolio” certainly had an impact on me.


His essay here is titled “Lessons learned and never learned.” He notes, as Bernstein did, that the vast majority of those who experienced the 1929 crash are out of the business by 1979 - and have been for 15 years or more.


And so the lessons of the crash go, too. Kirby complains, in his usual eloquent way, how investors of 1979 are trying hard to make it look like they are investing -- they do research, consult industry experts, talk to management, build models, etc. -- but mostly they wind up chasing performance. They buy what’s hot and then try to justify it.


Kirby thinks if it was harder to sell what you bought, you’d think more carefully before buying:


“When you buy a nonmarketable asset that offers a limited application of the Greater Fool Theory (selling it to someone else at a higher price later on), you have to focus on the internal rate of return that asset is likely to provide internally, should you have to retain ownership for an indefinite period.


“But in a world of very volatile stock prices, internal rates of return tend to be rather prosaic and uninteresting. The impact on one’s ego and one’s standard of living of owning a Boeing or a Polaroid during one of those periods when the stock goes up 100% in six months makes a study of those companies’ internal rates of return seem irrelevant and, at best, a pointless diversion.”


We might say we’re in “one of those periods” now.


Anyway, Kirby liked to say you should run a portfolio of common stocks as you would a real estate portfolio. You try to project future cash flows and expenses, and you focus on the potential cash return you earn against what you paid. Sounds sensible.


Of course, real estate gets crazy too, so his analogy loses some of its force today. (It was getting nutty in Kirby’s time too, and he pauses to note the irony). But I get his point. We should think about what return a business earns (or potentially earns) on its capital. This is what Chuck Akre is talking about when he repeats his favorite phrase: “the bottom line of all investing is rate of return.”


Zeikel on the Follies of Forecasting


The last essay I’ll comment on is by Arthur Zeikel. He had a long and varied career on Wall Street, including a stint as president of Merrill Lynch. Zeikel’s piece is titled “After 50 years, nothing new, nor likely.”


His target is economic and market forecasting -- how errant they are and how investors rely too heavily on them. Most forecasting, he says, is just extrapolation of current trends.


Zeikel draws a funny example from Shephard Mead. The forecast involved pollution trends in New York City c. 1850. The main sources of pollution were chewing tobacco and horse manure. The first sat half an inch thick in the gutters. And the latter half an inch thick in the middle of the street. A little forecasting magic -- extrapolation -- put the depths at two inches by 1880 and 170 feet by 1970. Gosh, what a disaster!


Of course, such forecasts forget that people react and change their behavior. Once spit and manure got to a certain level, people did something about it. Also, cigarettes and automobiles soon replaced chewing tobacco and horses.


It’s an obvious lesson, but are investors committing the same kind of mistakes in different industries today? Oil surpluses forever? Travel down forever? Ad tech growing forever? I don’t know, but probably.


Zeikel ends with a nice bit of wisdom:


“Investors must also appreciate that there is a pattern to events, but no pattern is perpetual. The more widely held the belief in the persistence of a pattern, the less likely it is to continue. Investors frequently make too heavy a commitment to the configuration of trends already discerned.” [Bold added].


It’s funny reading over these old essays. All the same concerns they wrote about still exist today. In 2029, when the books start rolling off the presses marking the centenary of the great crash of 1929, I suppose they will run over the same ground. One of the charms of the trade is the timeless quality of its best wisdom.


Harold Evans (1928 - 2020) - Why Writing Well Matters


Sometimes people like to ask me for a book recommendation on how to improve their writing. I am usually at a loss for an answer. I learned to write by reading a lot of great writers and then writing a ton of stuff myself (much of it, especially in the early going, not very good).


But ever since 2017, I have a book to recommend: Do I Make Myself Clear? Why Writing Well Matters by Harold Evans.


I was thinking of this book recently because Evans died in September at the age of 92 after a long career in newspapers and editing. His 2017 book is the only work of his I’ve read. It is a solid, no nonsense, modern book on writing well. It’s an enjoyable read, too. And at 400 pages, full of good advice. I highly recommend it to anyone who wants to improve their writing.


Thank you for reading!


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Published October 29, 2020

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