By Ken Fisher, 2011 (240 p.)
This is an excellent book that professes the merits of sticking with what works best instead of allowing oneself to get tripped up by behavioral biases and trying to time the market in order to avoid pain. Bear markets have always happened and they always will, but “being bearish and wrong,” explains author Ken Fisher, “can be much more damaging to long-term results than being bullish and wrong.” Fisher uses a dictum often cited by stock market bears (that “this time is different are the four most expensive words in history”) to make the case that people repeatedly forget that the world does not end, and that stocks keep rising over time because “through it all, the profit motive is strong, and human ingenuity never dies.” He provides hard data from many examples in history when people forgot this simple fact, just when it would have been most beneficial to remember it.
While Fisher is not universally popular among professional investors, and neither is he known to be humble, his success as an investor and businessman is undeniable. Son of the famous investor and Stanford graduate Phil Fisher, Ken is the founder of Fisher Investments, which manages over $200 billion for institutions and individuals globally. Fisher’s column for Forbes ran from 1984 to 2017, making him the longest continuously running columnist in the magazine’s history. He has also published 11 books on investing and personal finance, four of which were New York Times bestsellers. For many years I dismissed him as a pop-finance marketer, but my respect for him has grown over the years, especially after reading most of his books. I also reviewed The Making of a Market Guru (2010), which compiles his Forbes columns into a single volume, and while I am not a fan of the “market guru” label, it’s hard not to be impressed by how prescient his calls have been over the years.
Ken Fisher (age 72)
Fisher is witty in his writing (often too much), and I don’t agree with all of his opinions, but there are so many precious lessons in this book that I classify it as a must read. For instance, he does a fantastic job in debunking the notion that it matters to the stock market which political party is in control. He dismisses pundits who announce near every market bottom that the world has entered a “new normal” or that a “new paradigm” is upon us. He also observes that volatility is a bad gauge or predictor of stock market returns, that volatility itself can be volatile and cyclical, and that “confirmation in general is expensive in capital markets.”
There are several other insightful arguments in this book, but my favorite – and most applicable to the current juncture- is his assertion that the notion of average returns (such as, “the market returns 10%, on average, over the long-term”) can be terribly misleading. “A major reason investors overall don’t achieve long-term equity averages,” he observes, “is because they [get] in-and-out at the wrong times and don’t stick with a strategy. … Most folks understand when stocks fall 25%, rising 25% doesn’t get them back to breakeven— stocks must then rise 33% for that. To recoup a 40% drop, stocks must rise 67%. So when stocks fall big, as world stocks did from October 2007 to March 2009— down 57.8% — that takes a 137% rise just to get back to previous highs. A common refrain I heard in 2009 and after was, ‘If stocks rise an average of 10% a year, it could take eight years for me just to break even— never mind growing beyond that!’ That would be bleak, indeed. Except that, stocks typically don’t rise an average of 10% in bull markets, they have risen an average 21.2% annually.”
Another insightful example of something people seem to forget every cycle is how employment data lags, on the way down as well as up. “Pretend you’re a CEO.” Fisher writes. “Sales of your widgets are slowing. Maybe a recession is coming or already here—you may not know it yet for sure because, of course, recessions are officially dated at a lag. Sales are plummeting. You don’t want to cut staff—no one does. So you hunker down. You cut costs. No more air travel, everyone has to do conference calls. You find ways to make your widgets cheaper. Sales keep falling. You pull out all the cost-saving stops.” His main point is that unemployment starts to rise and fall long after the recession starts and ends. This makes perfect sense and happens every cycle, but somehow people, including those who run the Federal Reserve, seem to forget.
All told, I believe that this is an excellent book that anyone afraid of a bear market should read. Even though it was written more than a decade ago, the arguments and data that Fisher provides are timeless.
People forget. So much! So often! So fast! Stuff that happened not long ago—and more often than not. And it causes investing errors—pretty commonly humongous ones. Maybe Hope should have been singing, Pranks for My Memory. Because for a fact, our memories play pranks on us in markets, and always have and we never learn.
History does not, in fact, repeat—not exactly. Every bear market has a distinct set of drivers, as does every bull market. But human behavior doesn’t change—not enough and not very fast to matter. Investors may not remember how panicked or euphoric they were over past events. They may not remember they had the exact same repeating fears over debt, deficits, stupid politicians, high oil, low oil, consumers spending too much, consumers not spending enough, etc., etc., etc. But markets remember very well that details may change but behavior generally doesn’t.
But if you point out to someone that his opinion-stated-as-fact is actually false, you will run into a brick wall because he simply won’t believe it. They know. They read it in the media or online. Their friends agree. It’s a fact to them. It may also be a false fact and one easily known if we didn’t simply forget so easily. But because we forget as individuals, we do so as a society, too.
They get head-faked by what later turns out to be normal volatility—because they forget they’ve lived through volatility many times before. They overreact—either too bearish or too bullish—based on some widely dispersed media report that later turns out to be highly overstated or just plain wrong and often backward. Why? They forget the media is often and repeatedly wrong for the exact same reason—it’s made up of humans.
Presumably, if you say with certainty some condition leads to some other condition, that’s because you’ve observed that in the past or can otherwise measure it historically. Either that, or sound economic fundamentals says it must be so. Fair enough? And if a lot of people say Event X must cause Outcome Y, there’s no harm in checking to see if that’s what happened historically most of the time. Because if it hasn’t happened before, it’s unlikely to happen now whether most folks think it will or not.
If you suffer memory loss, that gets very tough to do. But if you remember that you have a lousy memory and can train yourself to use history to understand probabilities, you can better understand what’s likelier (or not at all likely) going forward. And you can begin reducing your error rate.
Further, more investors are prone to be naturally skeptical—bearish—than are prone to be naturally optimistic. Not always and everywhere, and even the most dug-in bears can have times when they’re euphorically bullish (though it’s usually a bad sign when dug-in bears become bullish). But overwhelmingly, since stocks rise much more than fall (over two-thirds of history), folks counterintuitively tend to be bearish more than bullish. That concept—that people overwhelmingly tend to be fearful when they shouldn’t—is at the very core of why so many fail to get the long-term results they want. It’s behind the quote Warren Buffett is famous for (though it’s not his—he just made it broadly popular): You should be greedy when others are fearful and fearful when others are greedy.
…in history, people have the same exact fears we have now and will have 1, 3, 7, 23 and 189 years into the future.
I’m a firm believer in capitalism and the power of the capital markets pricing mechanism.
Chapter 1: The Plain-Old Normal
Sir John was simply an all-around great guy. He gave heavily to charitable foundations (many he established himself), among other things the world’s largest financial prize, the Templeton Prize in Religion. He was thrifty—preferred driving junky used cars instead of being chauffeured in a limousine. He flew coach.
This isn’t to say history repeats perfectly. It doesn’t—not exactly. That’s not what Sir John meant. But a recession is a recession. Some are worse than others—but we’ve lived through them before. Credit crises aren’t new, nor are bear markets—or bull markets. Geopolitical tension is as old as mankind, as are war and even terror attacks. Natural disasters aren’t new! And this idea that natural disasters are bigger, badder and more frequent now simply isn’t true. Only human arrogance allows us to believe we’re living in some new, unique age. Sure, we are—just like every previous generation did.
Anyone who thinks the 2008 credit crisis was history’s worst knows zero about nineteenth-century history.
For all the 2000s being frequently referred to as a “lost decade,” somehow the global economy doubled.
One reason folks fall prey to the notion of long-term stagnancy now, I believe, is the death of journalism. …most of the folks writing news today haven’t been around the block. Maybe 2007 to 2009 really was the biggest thing they’d ever seen. Maybe they were in college during the last recession and bear market or (eek!) high school. Maybe they weren’t even born for the one before that! They have no context. To them, the world really is ending and they can’t fathom how we get past this bad time (whenever it is) because they’ve never seen that happen before—not as an adult.
To do well at money management—whether for yourself or others—means being right more than wrong over long periods. That means you will still be wrong a lot and frequently in clumpy patches of wrongness. But being right more than wrong is easier if you see the world more correctly.
Just because people think, “This time it’s different,” doesn’t mean they think all is terrible! Sometimes they are overly, dangerously bullish. Sometimes bearish.
Every recovery is jobless—until it isn’t anymore. No one remembers this.
Fears about a “double dip”—which is always talked about but rarely seen.
Starting early 2009, the term new normal (a same-but-different way of saying, “This time it’s different”) started ping-ponging through the media. The new normal was specifically the idea that the bad problems newly emerged or envisioned in the recent recession were insurmountable—resulting in a new era of below-average economic growth, poor market returns, maybe even a double dip. The basis for the new normal was a litany of ills—some real, some vastly overstated: A housing crash that hadn’t recovered, too much US federal debt, too much consumer debt. Many believed greedy bankers had pushed our financial system beyond the brink and it was irrevocably broken. The economy couldn’t recover because banks wouldn’t lend. And tapped-out consumers couldn’t spend!
Following are just a few historic examples from the media:
September 2009—“The applicable word in New Normal is, of course, ‘new.’” This was from the latest round of new-normaling.
December 13, 2003—“The Industry is starting to settle on a new normal where growth is more muted but sustainable.”
April 30, 2003—A F@stCompany headline said, “Welcome to the New Normal”—calling it a “slightly awkward, slightly odd place” where corporate profitability is more challenging.7Except when this was published, a recession had ended about a year and a half earlier, and a massive bull market run-up from the recent bear had started a month before.
November 2, 1987—A Time magazine cover said, “After a wild week on Wall Street, the world is different.”8Not the new normal, but a variation of “this time it’s different.” (And no, it wasn’t different. The world recovered from the October 1987 crash and subsequent bear to finish the decade strongly.)
January 7, 1978—“The ‘new normal’ is here and now.”9Same new normal, different country—from a Canadian newspaper. June 15, 1959—“We could expect the country to return to the New Normal of the depressed Nineteen Thirties.” You could expect it, but it didn’t happen. Annual GDP growth was 7.2% in 1959, 2.5% in 1960, 2.1% in 1961 and 4.4% in 1963. Normal, fine economic growth. A bit volatile, but normal normal, not new normal.
October 20, 1939—“Present conditions must be regarded as ‘normal’—a ‘new normal.’”12Sure, if new normal meant GDP annualized 8.1%, 8.8%, 17.1%, 18.5% then 16.4% as it did in 1939, 1940, 1941, 1942 and 1943.
This isn’t to say every period following widespread use of new normal had fine (sometimes great) GDP growth. It’s just the phrase tends to pop up most around the end of recessions and in the few years of recovery thereafter—when people are bleakest but the actual future is brightest. Regardless, it’s never a very novel concept—or very prescient.
The National Bureau of Economic Research (NBER) dated the recession’s end as June 2009—but that announcement wasn’t released until September 2010, which is normal. NBER always dates recession start- and end-dates at a big lag.
More damaging if you’d acted on new normal fears: The stock market bottomed in March 2009, before the economy. Then stocks boomed—world stocks were up 44.1% three months off the bottom, and US stocks 40.2%.16 Twelve months later, world stocks were up 74.3%, US stocks 72.3%—the biggest initial 3- and 12-month bounce since 1932. From the market bottom through year-end 2010, world stocks surged 93.3% and US stocks 93.1%.
This isn’t unusual, either. It’s normal—normal normal—how it almost always happens. Stocks typically fall before a recession officially begins, pricing in glum times ahead. Then when most folks envision only the worst possible outcomes, the market knows (we forget, the market doesn’t) that things aren’t ridiculously rosy, but it isn’t Armageddon. Stocks start moving sharply higher on that disconnect between reality and perception, bottoming before the economy does.
For those common bear markets that do overlap recessions in the traditional way, stocks almost always rise first—and by a lot. It is the normal normal.
Another normal normal occurrence: As it becomes clear things aren’t so bad, folks who heralded a new normal don’t wave white flags and say, “Oops, we were wrong.” Instead, the definition can just morph! This was on full display in 2009 into 2011.
I don’t know when the next recession will be. I can’t predict that with certainty. But I can near-guarantee that after it hits—when the stock market is maybe already bottoming and bouncing back strongly, and the recession is almost over (or maybe already over but people don’t know it, see it, feel it or believe it yet)—you will hear some variation of the new normal concept again. And that likely goes on for another one to three years, even well past the point at which the recession is officially acknowledged to be over. That’s the way it works—almost always.
In every single recession—as far back as we have good data on both economic cycles and unemployment—improvements in unemployment lagged the recovery. Again, this is normal and healthy, not weird and worrisome. Journalists probably wouldn’t write so many alarming headlines—and investors wouldn’t get so alarmed—if they simply remembered how it all happened the last time (and the time before, and the time before that).
But forget about unemployment for a second and think about employment, which is more important and something NBER does consider in deciding when we have a recession and when we don’t. Pretend you’re a CEO. Sales of your widgets are slowing. Maybe a recession is coming or already here—you may not know it yet for sure because, of course, recessions are officially dated at a lag. Sales are plummeting. You don’t want to cut staff—no one does. So you hunker down. You cut costs. No more air travel, everyone has to do conference calls. You find ways to make your widgets cheaper. Sales keep falling. You pull out all the cost-saving stops. But after a quarter or two, you know: You must cut staff. If you don’t, your entire firm could implode. To preserve your firm, keep your customers and keep some staff, you cut. Things keep getting bad for a while, but you have a bare-bones staff and they keep innovating ways to be more productive. And you barely get by. Then, one day, sales level off. Maybe you’re through the worst, maybe not. Maybe you fear that double dip everyone talks about (but rarely happens—we’ll cover that in a bit).
Confirmation in general is expensive in capital markets.
NBER defines a double dip as . . . just kidding, they don’t define it, nor identify one. Not at all. A double dip is rather like stagflation—a term without an official definition that a lot of people fear and think is frequently just around the corner but doesn’t show up as often as media headlines imply. Still, you’d think we’d know a double dip in some official way when we see one.
An average recession (since 1854—as far back as NBER has data) lasts 16 months.
The Great Depression was two distinct recessions (and two distinct bear markets, by the way). The first recession was brutal—43 months starting in August 1929—way above average (and skewing the average higher, mind you). Then we got over four years of uninterrupted growth—50 months. The average growth cycle lasts 38 months (which is skewed down by some shorter cycles in the nineteenth and early twentieth centuries), so that mid-1930s growth cycle was markedly above average in duration! Not a double dip. Overall and on average a miserable period—but not one long period of uniform stagnation.
To summarize: People tend to remember and expect things that never or rarely occurred. They forget things that happen regularly. They look for a concept like the new normal at the same stage of every cycle. They always fear unemployment in every new economic expansion. They regularly fear double-dip recessions that rarely seem to happen. There is much more, but the central problem is: Our memories are faulty. There is a lot more we fail to remember correctly, and all of it leads to the truth of Sir John Templeton’s utterance, “The four most expensive words in the English language are, ‘This time it’s different.’”
Chapter 2: Fooled by Averages
Market averages are useful tools, but individual weeks, months and years are anything but average—in both bull and bear markets. In this chapter, we look at how investors forget: Bull markets are inherently above average. Early bull markets are really above average. Normal returns are extremely extreme. Even within bull markets, annual returns can be wildly variable—including up a little and, yes, down a little. Because annual returns aren’t average, achieving average returns is tactically easy, but mentally very, very difficult.
Bull Markets Are Inherently Above Average One common way market-average amnesia manifests: Almost uniformly for the first stage of a new bull market—the first year or even two—headlines claim, “No Bull!” or something similar. Many (maybe most) pundits don’t want to look silly by being too optimistic. It’s not a new bull, they say, but a countertrend in a longer bear. “It’s just a bear market rally!” cries occur most often during the first, initial, massive bounce off a bear market bottom—though such booms are perfectly normal (people just forget). And they can go on long after we get confirmation from the economy (which almost always lags).
But fears normal bull market upward volatility (and yes, volatility can go up, too) is really a bear market rally can occur at any point—and have through history. For example:
March 26, 2009: In this article, a financial services CEO warned, “This is a bear market rally, not something more.” Oops—it was something more. Globally, the bear market bottomed 17 days earlier, and the bull market runs still as I write.
May 8, 2003: “Hochberg of Elliot Wave also says this is just another bear market rally.” But it wasn’t. The global bear market double-bottomed just two months earlier, and another bear market didn’t materialize for another four-plus years.
August 3, 1996: “My feeling is this is simply a bear market rally.” This one’s strange—it was smack in the middle of the decade-long bull market. No bear in sight. Stocks had pulled back a bit in July—not even enough to be a correction—and then rebounded strongly. Normal bull market volatility and not a bear market.
December 28, 1990: “The market has generally adhered to our bear-market rally forecast since the September-October bottom.” Actually, the 1990s mega-bull market started in October—two months before this quote.
May 6, 1985: “I still think the recession lurks . . . but continually falling interest rates could ease recession fears enough to cause a healthy bear market rally.” The bull market that started in August 1982 would run through August 1987, pause for that short 1987 bear, then run to July 1990.
November 1, 1962: “. . . the simple fact that sudden violent advances of this type represent typical bear market rally action.” Or rather, new bull market action. The bull market that started in June 1962 ran through February 1966. And so on . . .
Interestingly, people frequently think being cautious about a new bull market is prudent. They believe it’s better to be wrong and too bearish rather than wrong and too bullish, even though history shows being wrongly bearish can be more harmful to long-term returns if you’re growth oriented. (Read more in Chapter 7.) Big bull market returns at any stage shouldn’t surprise or frighten you. Why? Bull markets are inherently above average. I hope that seems beyond basic to you—tautology to the nth ridiculous degree.
…when investors experience down years (which happen—fact of life), it’s common for them to feel that one or two bad years ruined it all and they’ll never experience anything like long-term equity returns. And maybe they won’t! But probably not because they were hurt by a down year.
A major reason investors overall don’t achieve long-term equity averages is because they in-and-out at the wrong times and don’t stick with a strategy. Long-term returns have always included down years and will continue to include down years. Down years are a fact of life.
So if you’re a long- term growth oriented investor and are reasonably diversified, you shouldn’t be overly focused on the occasional down year. Why? Because bull markets are longer and stronger— they are by their very nature above average.
Bear markets average 21 months. Remember: An average is just an average, always! Bear markets can be both longer and shorter. And on average, they fall about 40% cumulatively. Now look at bull markets in Table 2.2—they average 57 months (some more, some less) and on average rise a whopping 164%! That’s price return—returns are higher still if you include dividends. (I don’t here because we don’t have good daily data on total returns back to 1926. But price returns tell the story well enough.)
Folks get particularly freaked out by big returns when bull markets start. It seems like too much, too fast— and particularly so since they’re still fearful of all the things that freaked them out in the prior bear market. If they can’t remember that stocks don’t return a safe, predictable 10% each year, then new bull markets (no matter how many they’ve been through) really send them into a tailspin of myopic fear. People are basically and naturally afraid of heights, and when the market rises more than they expected right after a scary bear market, they fear it will fall back. And since humans hate losses more than they like gains, that fear of heights is doubly scary.
Most folks understand when stocks fall 25%, rising 25% doesn’t get them back to breakeven— stocks must then rise 33% for that. To recoup a 40% drop, stocks must rise 67%. So when stocks fall big, as world stocks did from October 2007 to March 2009— down 57.8% — that takes a 137% rise just to get back to previous highs. A common refrain I heard in 2009 and after was, “If stocks rise an average of 10% a year, it could take eight years for me just to break even— never mind growing beyond that!” That would be bleak, indeed. Except that, stocks typically don’t rise an average of 10% in bull markets, they have risen an average 21.2% annually.
History also suggests the harder and faster the bear market, the swifter the initial return off the bottom usually is. For example, world stocks soared 74.3% and US 72.3% in the first 12 months following the March 9, 2009, bear market bottom. Huge—and vastly more than anyone would have guessed during that very trying bear-market-bottoming period.
The first three months of a bull market average 23.1%. Three months! And the first full year averages 46.6%. So basically, the first year of an average bull market about doubles an average bull market year (which is still historically above average overall), and half of that can come in the first three months! Not always, but enough to let you know you don’t want to miss a second of it. Plus, that erases a chunk of bear market losses fast.
Many investors today should remember the hard fast surge off the October 2002 bottom (which retested lows in March 2003 and then exploded up again). Maybe they got fooled by the 1990 surge—just 6.7%. But the full year would have made up for that, not to mention the entirety of the 1990s. More grizzled guys (and gals) should remember the super-swift rebounds from the 1987 bear and the one ending in 1982.
It’s true through history about two-thirds of bear market losses tend to come in the final third of the bear market duration—the left side of the V. Bear market losses in the final stage are also above average.
If you’re a long-term investor with growth goals (i.e., most reading this book), you should utterly ignore arbitrary benchmarks like breakeven, high water, round-number index levels, etc.Focus instead on whether your strategy makes sense for your long-term growth goals without thinking about what stocks did last week, last month or last year.
History shows bull markets start with a bang. So if you miss that, should you sit out the rest, avoid the next bear and get in for the fireworks next time? No way.
My guess is if you’re sitting out, you may not be so keen to get invested again during the deeply dark, terrifying days of a bear market–bottoming period—which are only evident after the surge is well underway and are actually great times to get all in. Whatever scared you last time likely scares you next time.
How can remembering big bull market returns are normal and not inherently scary be useful to you? You know to beware the “too far, too fast” concept you hear frequently during bull markets. It particularly pops up in the first year or two, during bull markets’ initial massive surges—but any stage of a bull market can be plagued with “too far, too fast” fears. It doesn’t mean the bull must stop. Why? Because, say it with me, bull markets are longer and stronger than people remember and above average by nature.
That stock prices have gone up a lot doesn’t mean they always must fall. In fact, more often than not, they just keep rising in irregular fashion, but people forget—always. For example:
October 18, 1958: “Among the country’s top industrialists, apprehension over the business outlook has been replaced by high optimism and even some fear that the recovery may go too far, too fast. . . . The stock market already has gone wild.” Nope! This year-old bull market still had over three more years to run.
April 19, 1959: “Securities and Exchange Commission through its chairman, Edward N. Gadsby, warned that it suspected the stock market was going too far, too fast.” Again, the 1957 to 1961 bull was still alive and well.
July 13, 1962: “Looking at that and other statistics, some analysts were inclined to feel that the market had moved too far, too fast.” A new bull market had begun just a month earlier and would run into 1966.
January 29, 1975: “The sale of borrowed shares in expectation of price declines—by traders apparently convinced that the market had gone too far, too fast.” This bull was a little more than three months old and ran for fully 74 months and 126%.
August 14, 1982: “Analysts said many traders concluded that the recent rallies in both the bond and stock markets had gone too far, too fast.”17Already? This bull market was just two days old! It ran until the famously short, sharp bear in 1987, rising 229%.
August 13, 1984: “Analysts said many traders appeared to believe that the stock market had come too far, too fast in its rally of the past two weeks.”
January 2, 1986: “Johnson said both the bond and the stock markets have come too far, too fast and some backtracking is overdue.” Nope—this bull still had more than a year and a half to go. Also, US stocks rose 18.6% in 1986, and world stocks a big 41.9%.
May 20, 1992: “Investors are troubled. . . . They believe the market is overvalued. They’re worried that the stock market has come too far, too fast.” The famous 1990s bull ran for over eight more years, rewarding investors with a total 546% in US stocks, 242% in world.
March 29, 1995: “It has been clear for a couple days now that investors, particularly institutional investors, were becoming increasingly edgy that the market had gone too far, too fast.”
February 27, 1997: “Federal Reserve Board Chairman Alan Greenspan suggested Wednesday that the tremendous increase in the stock market over the last two years may have gone too far, too fast.” People credit Alan Greenspan for crying, “Irrational exuberance!” about stocks. Trouble was, he spoke those words December 5, 1996. The bull had over three years and another 75.7% to climb in world stocks, 115.6% in US.
July 1, 2003: “The market has gone too far, too fast, so investors can expect a 7% to 8% correction.”27This was four months into the new bull market, in a year global stocks rose 33.1%. Overall global stocks rose 161.0% from 2002 to the 2007 peak.
September 19, 2009: “The stock market has been soaring. It may have gone too far, too fast.”29Not so—the bull that started in March kept running and runs still as I write. October 15, 2009: “Despite the celebrations on Wall Street on Wednesday, analysts said the rally may have gone too far, too fast.” (You see how the same phrases pop up over and over again, yet we always seem to think they’re new.) There’s no such thing as “too far, too fast.”
At sentiment extremes, you do get euphoria—and it’s typically a very bad sign. But it’s as bad a sign as extreme, uniform bearishness is typically a good sign of better days soon ahead. Stocks prices can get high and then fall for a time. But they don’t fall just because they are high. Investors have witnessed that repeatedly and simply forget. When someone says, “Too far, too fast,” ignore it. Unless the assessment is rooted in negative fundamentals that are little appreciated and capable of outweighing existing positive fundamentals, someone saying, “Too far! Too fast!” is just showing you how short their memory is.
Normal Returns Are Extreme, Not Average: I’m sure you’ve heard or read that, after a period of volatility (which is normal, more in Chapter 3), investors should wait to invest until markets behave more “normally.” I’ve been in this business for nearly 40 years. I have much less of my career before me than what’s behind me. I’ve written a regular investing column in Forbes for over 27 years and counting. I’ve written academic papers and books and managed tens of billions of dollars for individuals and institutions. I’ve done speaking engagements, seminars, TV. I’ve written, now, eight books on investing and personal finance. I’ve been exposed to capital markets and investors in every which way you can. And I have never, ever seen the market behave normally.
…the most common outcome (37.6% of the time) is for stocks to be up over 20%.
Since 1926, US stocks have landed smack dab in the average range (9% to 11%) just three times—in 1968 (stocks up 11%), 1993 (10.1%) and 2004 (10.9%). World stocks have done it just two times since 1970—stocks rose 10.0% in 2005 and 9.6% in 2007.32
The Great Humiliator, TGH, that perverted trickster, likes to humiliate as many people as possible for as long as possible for as many dollars as possible. Bear markets are TGH at its finest, but TGH finds ways to humiliate investors all the time, in all ways. Corrections are a great way to terrify people into losing money when they otherwise shouldn’t—when markets quickly drop 10% to 20% or a bit more, then quickly reverse, moving to new highs—punishing those who panicked and sold low.
Knowing returns are variable—knowing it in your bones and not forgetting—can keep you from panicking from fear or heat chasing in greed. But there’s a more useful application. If markets return around 10% on average over long periods, and bull markets are above average, it must be easy to get 10%-ish annualized returns in your portfolio, give or take—right? Actually, that’s very tough. Tactically, it’s not—it’s quite easy. But emotionally and psychologically, there are few things tougher. Many investors have a stated goal of beating the market. But the truth is, on average, investors not only don’t beat the market, they don’t even come close to it.
Each year, Dalbar Inc., a research firm based in Boston, releases its study of investor behavior, specifically as it relates to performance. In 2011, its research showed the average equity mutual fund investor got an annualized average return of 3.83% for the 20 years ending in 2010—inclusive of all transaction costs.
Let me put that another way. Had you put $100,000 in the S&P 500 20 years ago and let it ride, you’d have about $571,000. But the average equity investor after 20 years had just $212,000—only 37% as much.
Dalbar estimates the average mutual fund investor holds a mutual fund for just 3.27 years. (If you want more on this, I describe this more fully in my 2010 book Debunkery.) Most long-term growth-oriented investors buy into the general concept of buy and hold. They bicker about what exactly that means and how it’s done. But few would argue holding a mutual fund for 3.27 years on average (sometimes less!) is buy and hold. Many investors I speak with say, “Why do I need to hire a money manager when it’s so easy to buy and hold an S&P 500 ETF? Set it and forget it!” And I agree! But in my experience, precious few can actually do that. And that’s just what Dalbar observed—overwhelmingly, people can’t set it and forget it, especially not when they think they can and that it’s easy. This is an underappreciated value of working with a good professional. Not every money manager can beat or even meet the market. Few have done it long term. But a good professional should be able to guide you to an appropriate long-term strategy and then help you stick with your goals and not in-and-out whenever the going seems tough, or conversely, when you feel like you’re missing out on hot performance elsewhere (i.e., heat chasing). Maybe you don’t average 10% a year—maybe with some professional help you have the discipline to stick with a strategy that nets you an annualized 7% or 8% long term. That’s still much better than what Dalbar observed average investors doing.
Big down years frighten investors into thinking long-term equity averages aren’t attainable. They panic and radically reduce risk (inconsistent with their longer-term goals). Big up years do damage, too—instilling overconfidence and perhaps greed, so they ratchet up risk (also inconsistent with their longer-term goals), usually in time to get hurt worse than they otherwise would have been in the next downturn. Repeat, repeat, repeat. All of which ultimately dings returns.
They forget chasing heat in the late 1990s hurt bad, then getting excessively risk averse after 2002 also robbed them of returns. And then they chased heat again and reflexively overreacted after 2008, in time to miss a historic bounce off the bottom. They don’t learn from past mistakes because they forget: Market returns aren’t average. Return variability is huge—and normal.
Chapter 3: Volatility Is Normal—and Volatile
Is “now” a more volatile time? Read the news, watch TV—odds are someone is saying it is. And that has been true almost every year forever. (It’s a twist on “this time it’s different” and more evidence investors have faulty memories.) But if you took a time machine back and visited any point 1, 5, 10, 17, 32, 147 years ago, you’d probably still hear folks saying, “Well, now is just more volatile than before!” This belief—that stocks are increasingly more volatile now—doesn’t need a bear market bottom to pop up. Undoubtedly, fears stocks have become more inherently volatile do increase in the intensely volatile bear-bottoming periods. But even in relatively less volatile years (and yes, volatility is itself variable) you get folks feeling like stocks are increasingly careening out of control via volatility. First, stocks are volatile. Can’t escape it. Volatility can be terrifying, but the fact the market wiggles wildly shouldn’t be surprising. It is now volatile, always has been, always will be, forever and ever, world without end, amen. And you want it to be.
Fact is, some years are more volatile than others—always been that way. Some weeks and months are more volatile. But despite ever-present conventional wisdom over the decades that the present is more volatile than the past, there’s no discernible trend the market is getting more volatile overall—just the same normal variability of volatility there’s always been. Plus, whether a year is more or less volatile than average isn’t automatically indicative of trouble—stocks can rise or fall on above- and below-average volatility. There’s no predictive pattern. It’s always been this way, yet people routinely forget. So let’s use some history to correct this memory impairment.
October 1, 2010: “On top of that, the market is more volatile than usual. An Associated Press–CNBC poll taken in August and September found about three in five investors less confident about buying and selling individual stocks because of the volatility.” Remember, stocks were up huge in 2009 and had another fine year in 2010. Further, polls are about feelings and feelings aren’t good forward-indicators for stock markets. July 31, 2009: “Though it is undeniable that all of these much-ballyhooed innovations have made markets more efficient, there’s good reason to suspect they also make markets more volatile, less stable and less fair.”3I’m not sure what “less fair” means. But there’s no evidence stocks are inherently more volatile. That’s just a variation on “this time it’s different.”
Maybe you’d prefer a world without volatility. But a world without volatility is a world where returns on investments likely can’t even beat the eroding power of inflation. To get return, you must take risk—felt frequently as volatility. Maybe your investment goals don’t require much growth—fine! But if you want more return, you must steel yourself to tolerate some volatility. If you want less volatility, that’s fine—you simply must adjust down your return expectations. And if you want no volatility at all, then you must be satisfied with whatever low interest rate your bank is paying on deposits.
The idea there’s some silver bullet—a magical investment—that gets market-like returns with materially less-than-market-like volatility is bewitching. If it existed, everyone would know it, and every money manager in the world would invest in it. Heck, there would be no money managers—everyone would do it on their own! But history doesn’t support the existence of such a thing. Not legitimately, at least.
Volatility is good because it’s required to get you superior returns over time—history teaches us that. But true volatility is also a pretty darned good indication your investment is at least legit—not tied up in a Ponzi fraud.
Fact is, the world has always been a dangerous place—and people have always feared it’s becoming more so “now.” We’ve always had geopolitical tensions, volatile commodity prices, supply disruptions, hurricanes, tornadoes, earthquakes.
Wars, terror attacks, nuclear emergencies, natural disasters—these aren’t black swans. They are and can be devastating—and we hope they’re rare in the future—but they’ve happened throughout history. They are unpredictable, so you can’t forecast them or build a portfolio strategy around them—but they aren’t wholly improbable. The good news is, though markets are volatile, history shows they are also resilient. Markets know (though people forget) as terrible as these events are, we always rise above. We dig out and rebuild and go on. Through it all, the profit motive is strong, and human ingenuity never dies. So no matter how trying a setback overall, humanity carries on—and so do our economies and capital markets. This isn’t just my optimistic view of human nature. This is, in fact, demonstrated through history. People think “now” is more trying than ever before—but the fact is, there’s never been a dull moment in history.
People complain inflation is high in 2011 (though it’s well below its long-term average). How about 1979 or 1980 when high, double-digit inflation was seen as a fact of life and almost universally expected to rise from there? Stocks were up 11.0% in 1979 and a huge 25.7% in 1980.
Even if you’ve lived through massive volatility a number of times, it’s so easy to forget within just 5 or 10 years. But you forget at your peril. You might end up knee-jerking at what’s otherwise some normal volatility in an overall fine year and robbing yourself of who-knows-how-much future return.
History teaches us. Memory fails us.
Chapter 4: Secular Bear? (Secular) Bull!
I just can’t find secular bear markets in history.
…even the very longest bear market on record lasted just over 5 years—and that was 75 years ago.
Though secular bear markets are hard to find, secular bears, as individual people, aren’t—you can find them easily on TV and in print.
…it’s just easier to be a dug-in bear. If stocks are up big, you can say, “It’s just a correction in a secular bear.” The higher they go, the more they might fall—and the prospect of falling frightens people more than opportunity makes them feel good. And for some reason, people are more forgiving if you’re wrong and miss upside than if you’re wrong and expose them to the downside—though history shows over time, being bearish and wrong can be much more damaging to long-term results than being bullish and wrong. I think it’s because of what behavioralists have proven—that people hate losses fully twice as much as they enjoy gains emotionally.
it’s true, from 1965 to 1981, stocks annualized a scant 0.01%—if you measure using the bizarrely constructed, price-weighted Dow Jones Industrial Average (aka, the Dow) and exclude dividends. But why would you? When you do include dividends, the Dow annualized 4.5%—or 111% cumulatively over that supposedly flat period. Below average, but not a bear market and still 111%! Put another way, over those 17 years, your money doubled, plus some!
Where are the 10-year negative returns in stocks? Historically, there are just a very, very few—and if you wait just a bit after that, they disappeared as stocks bounced back. The only one that really endured for any long period is the one that began in 1929.
Where are the 10-year negative returns in stocks? Historically, there are just a very, very few—and if you wait just a bit after that, they disappeared as stocks bounced back. The only one that really endured for any long period is the one that began in 1929.
The positives and negatives tend to come in clumps, too, so when in the throes of an overall more negative period, it’s easier to forget stocks like to be positive more than negative.
you must have a very short memory indeed to not remember calendar years are positive 71.8% of history. Well over two-thirds! Rolling 1-years have been positive 72.9%, rolling 5-years 86.9%, 10-years 94% and every single rolling 20-year period historically has been positive. That is a heck of a lot of upside volatility, and some pretty bad memories most investors have—even professionals. Especially professionals! And don’t forget, even within those few longer periods that were overall negative, they included shorter interludes of hugely positive returns—they weren’t 10-year periods of nonstop consistent downside.
…for many investors, it potentially robs you of superior returns—meaning maybe you must seriously dial back your lifestyle later on. Your time horizon shouldn’t be how long it is until you retire. In my view, a more appropriate way to think about time horizon is how long you need your assets to last—which, for most, is their entire life and that of their spouse. (For gents reading this, remember, odds are your wife lives longer. Plan for that, too, and you’ll increase the odds she remembers you fondly rather than spends her widowhood cursing your name.)
In myriad ways, it’s easier—emotionally—to be bearish always than bullish most of the time. If you’re bearish and wrong, you can say “Oh well, at least I didn’t lose money.”
Chapter 5: Debt and Deficient Thinking
The fear the world is overindebted is one of the more common, most repeating fears in investing history. It is nothing new. Always through time, debt fears cycle in and out—people just forget today’s fears aren’t so unique:
September 15, 1868: “The colony is already greatly overindebted; most of the wealth of the country is absorbed in the payment of interest of public and private debts to English capitalists.” From a New Zealand newspaper. They (and we) seem to have done ok since.
March 12, 1972: A Time magazine cover asked, “Is the US Going Broke?” Well, we didn’t then. 1983: Another Time magazine cover warned, “The Debt Bomb: The Worldwide Peril of Go-Go Lending.”
February 18, 1988: “The overindebted consumer is likely to be cutting back his spending this year. This sets the stage for a recession.” What happened was another two years of expansion, a shallow recession and a huge market and economic boom for the entirety of the 1990s.
November 22, 1991: “Yet, corporations generally also are seen as overindebted.” Again, the 1990s were an overall pretty darn good decade—globally—for corporate profitability, economic growth and stocks.
April 2, 2001: “There are risks in the boom—overindebted homeowners could be taking on too much debt.” Mind you, the 2001 recession ended a few months later, and the bear market about a year after that. The start of the 2007–2008 bear market was more than six years away.
March 15 2011: “This is the conundrum, the potential economic catastrophe, confronting the overindebted developed world right now.” We shall see. . . .
This book isn’t about preaching how much debt you or anyone else personally should have. That is up to you, your spouse, your creditors and whatever spiritual adviser you cotton to. But it’s the same concept as corporate debt—used responsibly, the benefits are real. You (probably) used leverage to buy a house, a car, a college education maybe. Debt for a college education can be very economic. Yet we all know there are real-world consequences to having too much debt—but despite widespread assumption, there’s no fact-based evidence society overall is recklessly over-indebted.
…people fear budget deficits, but history shows it’s the surpluses they should fear.
Reflexively, most expect stock returns to do much worse after very big deficits and much better after surpluses. An important lesson: Never reflexively believe anything! History, that useful lab, shows it’s actually the reverse. Twelve months after surplus peaks, stocks returned 1.3% on average. They returned just 0.1% cumulatively after 24 months and just 7.1% cumulatively after 36. And that’s not just a few big negatives dragging the averages down—there’s big return variability after big surpluses. Much more so than after big deficits. Returns 12, 24 and 36 months after deficit troughs are nearly uniformly positive. And the returns are much better—20.1% after 12 months, 29.7% after 24 and 35.1% after 36. If your instinct is to sell when deficits are exploding higher—just because you fear the deficit—you’re likely making the wrong move. The reverse is true: A huge surplus isn’t necessarily a sign all is clear ahead.
Another key lesson: Don’t make market moves based on one factor—capital markets are much too complex.
In my 2006 book, The Only Three Questions That Count, I showed the same relationship between deficits, surpluses and the stock market is true in Germany, Japan, and the UK.)
Investing is a game best played in an ideology-free zone.
Chapter 6: Long-Term Love and Other Investing Errors
There’s a school of investors who believe, with their very souls, small cap stocks are inherently best for all time. There’s another subset that feels the same about small-cap value. Who’s right? There are those who believe large cap is best; no, large-cap growth is best—steady and safe; no, Tech; no, high-dividend stocks; no, German mid-cap Industrials. Name a category, no matter how big or narrow, there are adherents—rigid in their orthodoxy, absolute in their canonical beliefs. But it’s not blind faith (so they’ll have you believe)! They can show you data proving their category is best! And sometimes they can—if they use shorter time periods. Or oddly define the category. Or use faulty indexes. Or do some other bogus calculation. There are myriad ways data can be altered (or tortured) to get there—false nonetheless.
Anything that becomes widely known loses power—this includes information but also investing tools, methods and valuations. Why promote it? I didn’t think I was so smart that I’d figured out something no one else could, so I expected PSR to lose power. It still remains useful in evaluating stocks against their peers—like the P/E, price to book and any number of valuations. And at certain times, it has more power as a forecasting tool than at others (usually when people think it has none). But on its own, not the PSR nor any other valuation can tell you when a stock is more or less likely to outperform.
Many believe if a bull market runs too long—i.e., longer than average—the bull market must end. No! (See Chapter 2.) Averages have huge variances underneath, and any single category can have fundamentals—even shifting ones—that support outperformance for far longer than average.
Believers in forward ERPs (and other long-term forecasting models) usually suffer from myopia. I’ve never seen any model that stood up well to back-testing consistently. If it did, it got a few periods right, not the majority, and only by happenstance.
If you want an excellent history on bubbles, and why we will always be prone to them periodically, read Charles MacKay’s excellent book, Extraordinary Popular Delusions and the Madness of Crowds. My guess is speculative bubbles existed back to the earliest marketplaces in Mesopotamia. As long as humans exist, we’ll have bubble manias from time to time. And we’ll have heat chasers.
The problem with housing, even during the best of times, is it’s a large single transaction with huge transaction costs and ongoing deferred maintenance costs and taxes. Then, too, if a significant portion of your net worth is tied up in a single type of asset—a home—with no geographical diversity, that can be risky. You wouldn’t put all your money in one stock, would you?
In 1980, I remember folks having the same feeling they had in the mid-2000s—that real estate was an ironclad investment. I remember a 19-year-old kid who did some maintenance work around my office giving me tips on where to get some cheap land. He quoted Will Rogers to me (19 years old!) saying, “Buy land; they ain’t making any more of it.” Which brought to mind another famous quote from investor Bernard Baruch, “When beggars and shoeshine boys, barbers and beauticians can tell you how to get rich, it is time to remind yourself that there is no more dangerous illusion than the belief that one can get something for nothing.”
…the truth is, real estate has always been a pretty lackluster long-term investment. Since we have decent data (1978), a dollar invested in real estate would have grown to $16.65. However, that same dollar in world stocks would have grown to $23.22 and in US stocks to $32.99—almost double!
Yes, there’s value to owning real estate. For most of us, it may be the value of a roof over our heads. There are other intangibles to real estate, of course. And yes, there are many successful real estate investors—but the best I’ve seen have very diverse portfolios, both in product (commercial versus residential versus mixed use versus industrial) and geography.
…to invest in gold well (as well as most industrial metals and indeed most commodities), you usually must time the boom/busts well. And if you want to give it a try, ask yourself, “What was the last, good, short-term timing call I made?” Then ask yourself—and be honest, “What was the last, good, short-term timing call I got wrong? Have I been wrong more often than right? Or right more than wrong?” For example, did you buy US Tech stocks in the mid-1990s? Did you then short Tech in March 2000? Did you short global stocks in 2001, then buy them back in March 2003 and hold through 2007? Did you buy oil in January 2007, right before its last steep surge, and sell in July 2008? Did you buy Emerging Markets in Fall 2008? Or global stocks in early 2009, when sentiment was black? Did you sell euros and buy dollars in April 2008? Then reverse that in March 2009? Were you overweight Materials, Energy and Consumer Discretionary for the year or so following the bear market bottom, because they fell most in the bear and then bounced the most in the new bull? If you didn’t get those right—some pretty big swings in some fairly broad categories—then what makes you think you can time the next gold boom? Or the next gold bust? If you aren’t a proven, more-right-than-wrong hot hand at market timing, don’t bother with timing gold.
…history teaches, at the end of a bear market, you want to own those narrower categories that fell most in the late stages of a bear. They tend to bounce huge in the early stages of a bull.
History (and fundamentals) also says, generally, if you expect the spread between long-term interest rates and short-term rates to narrow (a so-called flattening yield curve) growth stocks tend to do better than value stocks. And if you expect the reverse to occur—so that the spread between long-term interest rates and short-term rates gets wider (a so-called steepening yield curve)—value stocks typically do better than growth stocks.
…an environment when banks are less eager to lend tends to favor growth stocks.
Chapter 7: Poli-Ticking
Want to see investors’ memories utterly fail? Ask them about their politics. Folks have myriad reasons (misguided or not) for liking one political party over another. And something you commonly hear is Party X is better for stocks and/or the economy while Party Y is disastrous. Simply ain’t so. And investors blinded by partisan preference may miss very real patterns driven not by ideology but by very fundamental factors.
…by stretching your memory a bit longer and studying a bit of market history, you can overcome this problem. Do that and you discover: No one party is materially better or worse than the other for stocks long term. Folks blinded by ideology miss a useful forecasting tool that can help shape better forward-looking expectations. No one party is better, but sometimes party does matter—it just flip-flops. This isn’t a quirk; other nations can be similarly impacted by politics.
I’m occasionally accused of being both a strong Democrat and a strong Republican by people who don’t like something I say. I’m neither—nor do I identify as Independent—and haven’t claimed allegiance to a political party for a long time. I prefer neither party and find plenty to criticize (and, very rarely, applaud) in both.
As a money manager, my aim is to be ideologically agnostic. Why? A political preference is just another bias. Biases are deadly in investing. They color your analysis, making you blind to certain things while giving others undue weight.
You may love your political party, and they, in fact, may love you back (in their perverse way)—particularly if you frequently donate. But neither party loves your portfolio.
History shows neither is materially better for stocks long term. However, that doesn’t stop folks from misremembering this:
September 10, 1992: “Some analysts suggest getting out now because a win by Democrat Bill Clinton in November will send the market plunging for six months. (Wall Street prefers Republican administrations, which are perceived to be better for business.)” Except stocks boomed for nearly the totality of Clinton’s administration.
August 16, 2009: “Measured by simple price appreciation on the Dow Jones industrial average, Democratic presidents have been better for the stock market than Republican ones.” Oops—just the opposite of the previous quote. Also, as discussed in Chapter 4, if you must use a faulty index (like the Dow) and ignore dividends, your hypothesis probably doesn’t hold much water.
December 12, 1971: “If the Dow-Jones industrial average is higher on the Monday before election day than at the start of 1972, President Nixon will undoubtedly be reelected. But if the average is lower than on the first of the year, then the Democratic party will most likely take over the Presidency.” This . . . makes no sense.
October 31, 1996: “A USA TODAY/CNN/Gallup Poll finds Democrats were rated better able to handle most key issues, such as the economy, education and Medicare.”4Fine, but a poll just measures people’s feelings and faulty near-term memories. And feelings change fast.
September 21, 2010: “Additionally, public opinion about which political party is better for the US economy has swung in favor of the Republicans, according to the Pew poll.”5See? Feelings change—fast. Don’t trust them—not yours or anyone else’s.
I can’t tell you how many Republicans told me as Barack Obama took office that the market had to do terribly under him because of what he and the Democratic party would do. Note, the market bottomed within a few weeks of his taking office and has done markedly better than average under his tenure.
ObamaCare (or any other piece of legislation) may make you giddy or may make you want to shake your fist at the sky. But leave all that out of your investing decisions because it doesn’t much matter. I know that is hard for you to believe. Maybe impossible. That’s your problem.
So stop thinking in terms of, “I like this guy. I think he’s tops for the economy. That other guy is an idiot and possibly hates puppies!” You can say those things at home, at cocktail parties, at political rallies, on Twitter, wherever. But when it comes to making investing decisions, drop the ideology. It’s deadly.
Now look at individual years. The back half of presidential terms—years three and four—are nearly uniformly positive. Year three doesn’t have a single negative since 1939, which was barely negative. Year four has just four down years. And returns are not always but frequently are double-digit positives.
Folks love finding patterns in charts and price graphs. A pattern is nothing more than a quirk and you shouldn’t make market bets based on it—unless there’s a good explanation for it, rooted in sound fundamentals.
Politicians like to sell legislation as a marvelous societal improvement. However, all they’re really doing is taking something from someone who had it or will soon have it and giving it to someone (or someones) else.
…when legislative risk aversion decreases—as it typically does in years three and four—stock returns historically have been more uniformly positive.
The word politics, as you may know, comes from the Latin poli meaning many, and tics, meaning “small blood-sucking creatures.
Head Tics may not understand how capital markets work at all (never seen one yet who did) but surprisingly, they know political history pretty darn well. They know in the history of modern presidents, the president almost always loses some relative power to the opposition party in mid-term elections. (George W. Bush was the first Republican president in 100 years to buck this trend in the 2002 mid-term, but his party lost badly in 2006—as history would suggest.) Therefore, the president knows that whatever he would pass that is most monumental—the crown jewel of his administration—must be passed in the first two years of his term (I say his because they’ve all been male so far), because he’ll likely face a bigger uphill battle in the back half when he loses relative power.
This isn’t mere theory—it holds up in history. Most material legislation gets passed in the first two years of any president’s term, whereas the back halves have much quieter legislative calendars. And as the Head Tic loses relative power and can pass less, we move from the highest level of political risk aversion in the front half to the lowest in the back half. Stocks overall like that—which is why market returns historically are nearly uniformly positive year three with the best averages, and very good averages in year four.
A key takeaway if you’re a Republican: Don’t make the mistake I saw so many make in 2009 and assume that because you so disliked this new Democrat president that the market couldn’t go up big time. It can and usually does, because the fear is front-end loaded into the election year. As we said in Chapter 1, markets move in advance of things, not after them.
In the history of the S&P 500, 14 incumbents have tried for re-election. Only three failed—Ford, Carter, and G.H.W. Bush.
Many of us are very prone to politics and have watched the arena avidly for a long time. But we miss the messages politics sends us because our memories fail us. We miss the most basic patterns—that first and second years of presidents’ terms are hugely variable—big ups or negative—and that third and fourth years are a very bullish factor. We miss that electing a Republican is good for markets in the election year but more bearish in the inaugural year—and a lesser but similar factor if we re-elect him. We miss that electing a Democrat is bearish in the election year and bullish in the inaugural year but also bullish for both when re-elected.
To keep civil unrest to a minimum and keep people generally docile, the government uses all the throttles it can to juice economic growth in election years. This little-known fact drives an economic cycle that is useful to the politicians. They cause it and they benefit from it. To play this game, they always pull down growth and inflation in the year prior so they can add very heavy stimulus in election years without spiking inflation. It’s a little like them inducing a big party with a lot of alcohol and taking the vote just before people get too drunk or start to get hung over. Figure 7.1 shows this effect. Over the past 30 years, China’s compound average growth rate (CAGR) is pretty darn fast—averaging about 10%. But election year averages an additional 0.9% over that, whereas the slowest growth year—the year prior—averages 1.1% under that average. They slam on the brakes, then ram the gas. Personally, I think this is a stupid thing to do but they’ve been doing it a long time and their culture motivates them to keep doing it.
I’m beyond proud of my grandfather, Arthur L. Fisher, MD (1875–1958). He was in the fourth graduating class of the Johns Hopkins School of Medicine (class of 1900). Johns Hopkins, the man, came from a family of means (they owned plantations and some other businesses) and increased that wealth exponentially through entrepreneurship and wise investing. He left a vast fortune at his death in 1873 and made many bequests—including one to start a hospital. He had a few directives—the hospital should seek out the best possible talent and serve as a platform for ongoing research. And the hospital would serve the poor, all races, free of charge—quite an amazing thing at the time. From that grew what is Johns Hopkins today—a world-class institution doing groundbreaking research—saving and improving lives globally for folks from all walks of life.
Chapter 8: It’s (Always Been) a Global World, After All
The Chinese learned this lesson during Mao’s “Great Leap Forward” (which was neither great nor a leap nor forward). He mandated collectivism and self-sufficiency. Instead of importing steel from countries doing it better and cheaper, Mao forced citizens to build backyard furnaces and smelt scrap metal. The result? Tens of millions dead from starvation. You don’t want to live in a non-interconnected world. And in America, you can’t.
But Irving Fisher’s book, The Stock Market Crash and After, constitutes about the worst market call in history. Published in 1930, it contained Fisher’s view stock prices would soon rise. Oops! Thereafter, the public was not kind to him and ridiculed him mightily. Even 40-plus years ago when I was a young economics student, people paid him a limited grudging respect for his earlier contributions while shredding his reputation in all other ways. But fact is he was never a great forecaster—academic economists rarely are. He was also a bit creepy. As a result of a battle with tuberculosis, he was a health nut with a little goatee. An active vegetarian (that’s not the creepy part), he wrote a national bestseller on health, diet and exercise: How to Live: Rules for Healthful Living Based on Modern Science. That was all before 1929. But he believed all kinds of wing-nutty things like focal sepsis—the nonsense view that mental illness comes from infectious material in the roots of our teeth, among other places. And he was a eugenicist. Part of the reason he got so heavily ridiculed as the 1930s evolved was for reasons other than the 1929 crash. As Hitler emerged, eugenicists got very unpopular in America and around most of the world. One irony of his focal sepsis fantasy is that when his daughter was diagnosed with schizophrenia, he had a focal sepsis doctor start taking parts of internal organs out of her until she ultimately died. Wing-nut time and thank God for modern medicine. Couldn’t do that today. Oh, and one final point that didn’t help his popularity in the 1930s—he remained an ardent prohibitionist.
just because something seems reasonably likely to happen doesn’t mean it must happen that way. Capital markets are incredibly complex. Sometimes, some intensely unexpected thing or things happen. And sometimes your reading of history will be wrong! But since investing is a probabilities game, not a certainties game, you must start somewhere in framing reasonable probabilities.
Build into your daily life the reality that your market memory is likely terrible and you need to study history to know what happened despite having lived through a pretty good swath of it. Money and markets may never forget, but surely people do. And that will not be different this time, next time, or any time in your life.