Image credit: “The Competition in Sittacene and the Placating of Sisigambis,” attr. Master of the Jardin de Vertuese Consolation, Flemish, ca. 1470-1475, detail, The J. Paul Getty Museum
By Jason Zweig | June 17, 2015 10:04 p.m. ET
Combing through my archives the other day, I came across a speech I gave in October 1999 to the Foundation Financial Officers Group, an organization of portfolio managers and other executives at some of the largest private charitable foundations.
In the speech, given in the midst of a raging bull market, I looked back at the worst bear market in memory and urged the audience to ponder whether something similar might happen again.
That kind of thought experiment might not be a bad idea for investors to try nowadays, too.
1974 and 1999:
History Turned Upside-Down
The Foundation Financial Officers Group
New York, NY
October 14, 1999
On Oct. 3, 1974, a few brave souls convened on a cold, cloudy day in Manhattan for the first meeting of what was to become the Foundation Financial Officers Group. Just how brave were John English, Loren Ross, Bob Frehse, and Stewart Campbell, who are with us today; Pat Stewart, who’s stuck in Florida; and their fellow pioneer Ted Frye, who passed away in 1997?
That afternoon, the Dow closed at 587.61, off 2.3% for the day and down 31% for the year. Since the beginning of 1973, the Dow had lost 44% of its value—as badly as it had done in the first 14 months of the Great Depression.
Over the same period, the price of oil had nearly doubled, and by October 1974 the consensus was that it was on its way to $100 a barrel.
As 1974 drew to its agonized close, the compound annual return on stocks for the previous ten years had fallen to 1.2%. That’s right: from January 1, 1965 through December 31, 1974, stocks earned 1.2% annually, even after counting their generous average dividend yield of 3%. Throw in taxes, expenses and inflation, and the typical taxable stock investor had lost at least 6% annually over the previous decade. A really skillful (or lucky) tax-exempt investor might have lost four or five percent annually. The best major asset was cold hard cash, which had outperformed stocks by 4.2 percentage points, compounded annually for a decade, after inflation.
In October, 1974, an New York University fundraiser told the sad tale of a wealthy benefactor who had drawn up his will a few years earlier when he was worth $2 million, leaving $1 million to his daughters and “the remainder” to NYU. When he died in mid-1974, NYU got the remainder—not $1 million, but a grand total of $30,000.
Also in October, 1974, Bob Shannon, an institutional salesman at the brokerage of Newhard, Cook & Co., rented a grizzly bear suit and prowled up and down Wall Street, turning his paw “thumbs down” whenever passersby asked him where the market was headed. Waving his own membership badge, Shannon tried to enter the New York Stock Exchange, but the security desk stopped him under orders from the authorities, who felt that it would set a bad precedent to have a big bear shambling around on the exchange floor.
Business was so bad, in fact, that Wall Street’s exclusive private clubs finally threw in the towel and actually allowed a few women to become members for the first time.
Meanwhile, the November 1974 issue of Institutional Investor asked, “Is relative performance outmoded?” The magazine stated: “[I]t doesn’t matter how a money manager fares vis-a-vis others so long as he doesn’t lose money…and helps [pension plans] meet their actuarial assumptions.”
Many years later, a leading small-stock fund manager recalled to me, half-horrified and half-amused, that he was ranked in the top tenth of his peers in 1973 and 1974. After inflation, he reminisced, he had lost only 85% of his shareholders’ money since the beginning of 1973.
And the inaugural Fall 1974 issue of the Journal of Portfolio Management featured an article by Nobel Laureate Paul Samuelson, who minced no words. “A respect for evidence,” wrote Samuelson, “compels me to incline toward the hypothesis that most portfolio decision makers should go out of business—take up plumbing, teach Greek, or help produce the annual GNP by serving as corporate executives.”
The broader context was no brighter. In a speech at the UN in the fall of 1974, Secretary of State Henry Kissinger intoned, “The strains on the fabric and institutions of the world economy threaten to engulf us all in a general depression.” Meanwhile, the nation’s economic policymakers appeared to have gone completely batty, as Wilbur Mills, chairman of the House Ways and Means Committee, was arrested at 2 A.M. on Oct. 7, 1974, for speeding past the Jefferson Memorial with his headlights off after his passenger, Annabella Battistella, a stripper also known as Fanne Foxe, had slugged him in the nose and jumped, more or less naked, into the pool of the Tidal Basin.
But things did seem to be looking up, at least a little bit. On October 8th, 1974, just five days after your founding members convened, President Gerald Ford declared war on inflation with the defiant slogan “WIN: Whip Inflation Now.” That day, the Dow surged 4.6% on the good news. But protesters chanted, “Rockefeller, Ford, you eat dog food. We can’t take it any more.” By year-end, inflation had hit 12.2%.
And just a few days earlier, a brilliant paper appeared in the Sept. 27, 1974 issue of Science, the journal of the American Association for the Advancement of Science. With the underwhelming title of “Judgment under Uncertainty: Heuristics and Biases,” this revolutionary article by Amos Tversky and Daniel Kahneman, two professors of psychology at the Hebrew University in Jerusalem, introduced what we recognize today as the founding principles of behavioral finance.
Among them were representativeness, or the human tendency to consider short series of data to be typical of long-term trends, and availability, or the natural inclination to let recent and vivid events overwhelm our judgment about normal expected outcomes. Although Kahneman and Tversky’s paper did not point it out, the miserable mood of investors in 1974 was further proof that our perceptions of the future are powerfully distorted by recent events.
And that’s why I was delighted when Bruce Madding and Larry Siegel asked me to compare 1974 with 1999. I think these two times are polar opposites.
- Then, risk meant losing money.
- Today, it means underperforming the average.
- Then, stocks were terrifyingly risky.
- Today, they have no risk at all.
- Then, history showed that a 100% stock portfolio was an asinine idea.
- Today, history shows that anything less than a 100% stock portfolio is an asinine idea.
- Then, broad asset diversification was considered a matter of life and death.
- Today, and I am quoting the treasurer of a state pension plan with more than $25 billion under management, “Asset allocation is crap. It doesn’t make any sense for anyone to have any money in a bond fund.” Close quote.
- Then, a price/earnings ratio for the stock market of 7 to 10 seemed generous.
- Today, a P/E somewhere between, say, 31 and 100 seems about right.
- Then, oil prices were headed sky-high, while stocks were doomed to drift through purgatory for decades.
- Today, inflation is legally dead—and the manager of an Internet stock fund said in a recent interview that he expects to achieve a compound annual return of 35% for the next twenty years. And today, the Dow belongs at 36,000—or is it 40,000?—or is it 100,000?
I think you can see what the conventional wisdom of 1974 and 1999 have in common. In both cases, people have made irresponsible and unjustifiable extrapolations from recent, and probably unsustainable, trends—exactly as Kahneman and Tversky predicted they would.
In such an atmosphere, it is more vital than ever for people like you to keep your heads. Many millions of dollars will be spent this year by folks who want to get you to buy into their particular forms of insanity. (In fact, you may already have hired some of these people!) At a time like this, you must remember to ask yourselves the most basic possible questions: What are we actually trying to accomplish with this money? What is the best way to measure whether we are moving reliably and predictably toward that goal? What is the probability that our assessment is right? How prepared are we for the consequences if we turn out to be wrong? These are some of the ways that you must test your most fundamental assumptions.
So far as I am concerned, history is a poor predictor of what will happen around us in the future. But it is a superb guide to figuring out how we need to test our own weaknesses. I urge you all to think about how you would react if 1974 happened to come back to haunt us again. Next, think hard about how you can prepare your organization for the day when the future surprises us…as it always has, as it always shall.
After all, the only reason we’re here today is because those few brave souls, back in 1974, were able to envision a very different future, when investing returns and attitudes would be far more positive than they were in those dark days. Imagining a future full of surprise was prudent, and far-sighted, then; it still is today. Thank you very much.