2008: A Dark Night?

The following post is a little lengthy.  We present it here because it was developed as an introspective during the darkest days of the Great Recession.  As we studied company after company with long-term return forecasts of 20-40%, confidence was shaken as the financial crisis brought Wall Street and Main Street to their knees.  The retrospective of what happened during 1974 and 1938 combined to bolster all of us.  The early days of 2009 were a unique moment in time when it truly was time to back up the truck (as many trucks as you could muster) and those who did were rewarded and the long-term perspective fully restored and reinforced.

When would that have been?

I can vividly recall sitting in my office at Better Investing back in late 1998 with Don Danko, the magazine’s sage editor. We were nestled in the middle of that bubbly bull market and Don expressed some concerns that nobody else seemed to be aware of. It had to do with unbalanced, accelerated returns over short periods. In his words, “The comparisons matter … this is going to be tough to compare to … five years — and ten years — from now.” For me, it was an unforgettable moment and lesson.

In other words, the outlook for a roman candle is worst when the audience is going “Oooo … and Ahhh” as the projectile reaches its apogee.

NAIC/BI founder George Nicholson, Jr. CFA had wrestled with these issues a couple of decades ago. The following chart illustrates pretty clearly the last time investors faced a situation similar to 2008:

A nod to MANIFEST subscriber Gary Simon, for providing the inspiration for this graphic. The caption used to say something about 10-year annualized returns basically “never” being negative.

Those words no longer apply.

And Nicholson’s anxiety becomes obvious … the year was 1975.

Check out where the 1985 box “landed” — reflecting the results of the next ten years following 1975. Note the positions of the boxes for 1976, 1977, 1978 and 1979 … ten years hence the Go-Go years of the late 1960s.

Now heed the landings of 1986, 1987, etc. The takeaway is that when roman candles return to ground zero — it’s time to go shopping, even if you have to grit your teeth.

Here’s another look that is eerily familiar as the toppling market in 1974 certainly resembled what we’ve experienced over the last 18 months or so:

Seasoned investors may remember David L. Babson’s cautionary words back in the 1965 and late 1960s as he assailed the gunslingers of the day, market professionals that seemed to be ignoring valuation and chasing momentum stocks. In a speech (attended by a huge crash of rhinos) from March 1968, Babson said and wrote, “The long-range expectations of many investors are becoming increasingly distorted by the speculative atmosphere that pervades the financial community today. Stock trading is the heaviest in history and is a direct result of the growing emphasis on quick profits and rapid portfolio turnover. The successful long-term investor avoids being over-influenced by the emotions of the day. This is the way to achieve really good results without exposing valuable capital to above-average risks.”

Institutional portfolio turnover was approximately 40% at the time!!! (The average turnover for recent years has been closer to 100%.)

In any event, the roman candles of the mid- to late-1960s were setting the stage for malaise ten years later.

Rely on Financial Editors — Nicholson, January 1975

What was on George Nicholson’s mind during late 1974? He was concerned about the irresponsible behavior of the media. Interestingly enough, my colleague Kurt Kowitz brought up the 24/7 nature of the media this very morning: “They’re not helping.” Nicholson wrote a series of commentaries urging patience and responsibility from media leaders … and then he turned his attention on the lessons of history, the environment of 1938 and the experiences of investors as he was just getting started in the realm of investing. Here are some of the highlights:

Paper losses on stocks are no more real than paper profits because prices swing with fickle public opinion.

1830 Prudent Man Rule: “Do what you will, the capital is at hazard.” — Judge Putnam.

Looking ahead to 1975, we know we have to think, work and use self-discipline to make progress.

Look back at 1938, when auto production dropped 50%. (Hitler’s military was nibbling away at Europe)

But 1938 was a good year to invest. The DJIA had fallen 50% from the 1937 high by March and rose 60% before Thanksgiving.

The [stock market participants] who sold their stocks in 1938 missed the boat. 1938 separated speculators from investors.

From 1928 to 1938

By the roman candle logic, the 10-year period following the roaringest of the roaring 20s was destined to be a tough comparison, providing the justification for Nicholson’s retrospective:

Prior to 2008, this was clearly one of the toughest sledding 10-year periods in stock market history.

Here’s a closer look at the 1-year results for 1910-1940:

I think few people realize that some of the best years (including the #1 all-time, 1933) in stock market history came during the Great Depression. One of the things weighing heavy on Secretaries Paulson and now, Geithner, is the entry we see here for 1931. The theory is that too much time lapsed between October 1929 and the ultimate corrective actions attempted. Whether or not we agree with the intervening efforts made to date — this image should help to drive home the import of expedience.

1929, even with the Crash, was not the ugliest year. That “honor” belongs to 1931. 1930 and 1932 (and 1937) were nothing to write home about either. Ted Brooks covered much of this and shared some solid perspective, along with this data. Thanks, Ted!

But pay special attention to 1934-1936 and 1938. This was part of Nicholson’s focus.

The corollaries appear to be strong. His mention of the 1938 auto production swoon is nothing short of “haunting” for those of us at our own version of Ground Zero near Detroit. It also adds fuel to my commentary about when executives lean on “unprecedented” as an excuse. As I’ve suggested before, there is very little “unprecedented” about the situation that the American automotive firms find themselves in. (What appears to be unprecedented is the lack of reserves to sustain during the cycles.)

Investment is Keystone — Nicholson, February 1975

Nicholson continued the prodding of the financial journalism world a month later, along with a reminder to the citizens of Better Investing nation that investing is crucial to the generation of future freedom:

In this year of crisis, learning investment has new meaning — that is, restoring the capital markets and the economy.

Has America forgotten to invest? How important is investing to individual Americans? The [media] in their anti-business, anti-investment crusades have overlooked the role of investment [in achieving and maintaining a peaceful balance.] Investing is indispensable to mutual survival …

Three months ago, the media would jump on [Alan] Greenspan for his remarks on the jobless plight of investment personnel. Now both construction workers and auto workers know in general that, when the investment industry breaks down, some of their workers go from private to emergency government payrolls at greatly reduced rates.

(Yes, he’s talking about the same Alan Greenspan that you’re thinking …)

The financial community — institutions … and analysts — are as open to criticism as the media for their shortcoming of wanting too much regardless of consequences. Their standard guideline should henceforth be “better” not “more.”

But in the final analysis the individual investor, not the institutions, has the responsibility for supplying money for big and small businesses. American investors, through individual action and moral persuasion, must make investment work in the world.

Sound topics for your February 1975 club meetings: 1. [Our time-honored principles] 2. [Quality companies] and 3. Triple Play Investing as particularly applicable to today’s market.

I have been investing proceeds in Triple Play situations during 1973-1974 in preparation for the next bull market. If past performance is a guide, the performance should exceed the DJIA by a wide margin.

Triple Play Investing

My instincts on this stuff are generally pretty good … but I have to admit that I smiled a little when encountering this reference to Triple Play investing — considering our recent presentations and efforts at MANIFEST.

Restoring the Capital Markets — March 1975

“Bank director, officers and financial analysts, if they want to avoid another debacle, should understand the 1830 Prudent Man Rule … in its entirety and grasp its essence — which is, that finance must back prudent businessmen, if the Nation is to prosper.

“Manufacturers and labor should speak up — impress their views on the financial community — finance all industries or perish.

“Restore broad and vigorous capital markets. We all need to do our part — savers, investors, labor, management and bankers.

“Thirdly, examine critically Benjamin Graham’s article of Sept-Oct 1974. Does he fail in not separating income from value in a period of inflation?

“Does he stick with the technique of comparison of income to the detriment of using common sense as to value in light of the facts of inflation?

When Harvard Lost But Won — Nicholson’s World, April 1975

In 1831, Harvard lost a law suit. Now it has over a billion dollars.

From 1823 to 1828, the Harvard account balance had declined from $50,000 to $38,000. John McLean died (10/23/1823) and Harvard attempted to recoup the loss via litigation.

The ruling was made in favor of the trustee : “All that can be required of a trustee to invest, is, that he shall conduct himself faithfully and exercise a sound discretion. He is to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital invested.”

The Harvard Trust was 100% invested in common stocks and in fundamental industries essential to the industrial growth of a Nation: banking, insurance and manufacturing.

Justice Putnam’s decision was far-sighted and good for the Nation.

Prudent Investing

Nicholson wrote often of the Prudent Man Rule, celebrating his alma mater’s defeat in the courts and their victory in learning more about successful long-term investing and accountability.

Diligence matters and Nicholson was convinced that returns could be enhanced by paying attention to the characteristics of opportunistic growth, excellence in management and superior profitability — the very essence of our continuing quest to this day.

For those paralyzed by watching too much media :), bear down … complete your studies carefully — and when you discover a high-quality company that is appropriate for you, with relatively high projected annual returns, become a watchful owner.

Bull Market & Boom Ahead — Charles Allmon, July 1975

Charles Allmon is nearly unequaled as a stockpicker. His commentaries are among my favorites in the Better Investing archives. He was notoriously bearish on any given day. His portfolios achieved high relative rates of return and his outstanding results have been chronicled and hailed by the Hulbert Financial Digest. That he did this — often with massive amounts of cash equivalents — was an irritant to some of my professional investing colleagues and I’ve witnessed some gnashing of teeth over the years. 🙂

His words here are a timeless testimonial to an exemplary Community of investors. Take a bow.

Is this bull market for real? Probably. There are sufficient doubters around to assure that a generally rising stock market might endure into 1977 or even longer.

One particular group of NAIC investors rate high marks in my book. They’re the experienced investors (20 years or more) in the 60-80 age bracket. It was something of a revelation to find that a surprising number held a contrary view during October 1974 … and generally agreed that better days — even happy days — might lie immediately ahead. I spoke with scores of investors at the 1974 convention. Only the “oldsters” seemed to be tuned to my wavelength on this matter of investor psychology and where they thought we’re headed.

So what else is new?

Sticking to the Knitting, 1973-1983

I’ve written previously of the outstanding stock selections made during the 1970s test of the investing mettle of our Community. We’ll take a closer look at some of the specific selections from the monthly stock features in another “report.”

I’ve also written about the virtues of investing regularly in carefully chosen stocks. Much is made of the “flat spot” in the market from 1969-1982. But we don’t invest in markets, we invest in leadership companies when the price is right. And investing regularly has incredible virtues versus tracking a lump sum invested in 1969 in an attempt to suggest that equity investing is futile — or dangerous.

Hog wash. It’s an UGLY urban myth. One of the ugliest.

In the “Throwing of Towels”, I documented the difference between investing regularly and shared that a return of 11.5% was achieved, during a period when the stock market notoriously gained ONLY 2%.

I’ve experienced similar encounters with the multi-decade crowd that Mr. Allmon salutes — and trust me, they’re thinking about the opportunities presented today a whole lot differently than the media is doing lately.

Do you buy the Bowl or the Goldfish? — Nicholson, August 1975

The goldfish bowl appears to have been an oblique reference to the Prudent Man Rule at the time … We’ve had some discussions about the threat of inflation and its impact on our studies — and we’ll continue that in earnest. Gerald Ford was focused on inflation and it would wreak havoc over the next few years and Nicholson spent considerable time on “inflation investing” during the period. He starts with an extremely contrarian view from Benjamin Graham:

At the midway point of 1975 …

Moreover, the economy seemed to be saucering out and ready to climb. Inflation was weakening. So what was there to worry about?

Price: Another aspect of the moral question is price and inflation. Ben Graham (10/1974) Financial Analysts Journal on “The Future of Common Stocks” emphasized the importance of common stocks and the need to buy at appropriate prices.

Forbes interview (6/15/1975): What about inflation? Doesn’t it wipe out the growth value of common stocks?

Graham replied, “I’m not ready to accept that, after 100 years of being a bullish argument for stocks, inflation could turn out to be a bearish argument. Through inflation, businesses have tremendous assets selling at a discount from their replacement costs. I think it shows the shortsightedness of the financial community not to recognize it.”


Buffett’s 12-Year Horizon & Expectations

The financial media has been picking on Mr. Buffett again, attempting to spew meaningful conclusions over recent investments in General Electric and Goldman Sachs … and assailing his positions in Wells Fargo and American Express. (Will they ever learn?)

His horizon is different and exceeds the comprehension of those assigned to fabricate reasons for market gyrations on a daily basis. I don’t envy them. We’ve seen them use the same reason on different days to explain market direction in opposing directions. 🙂

Morningstar’s Bill Bergman recently shared an outstanding perspective on a very long-term put option purchased by Buffett’s Berkshire Hathaway last year. In a nutshell, Buffett only has to pony up if the stock market is lower 12 years from now than it is right now. In the meantime, Warren gets to “play” with a few billion dollars. ($4 billion, if you’re keeping score)

Bergman’s commentary provides an excellent perspective to wrap this discussion of our dark night, 2008. It includes the answer to, “How often have returns been negative for a 12-year period for as far back as we can measure?” In other words, has Buffett lost his mind?

“Since 1950, using daily data on the S500 (adjusted to include dividends), there are roughly 11,850 days to compare where the index was relative to where it was 12 years earlier. The average 12-year return on the S500 since 1962 was 165%. In other words, since 1962, the S500 has on average more than doubled over any 12-year period. The S500 actually fell below where it was 12 years prior on 58 days over that time frame, or about one half of 1% of the time. The average 12-year change in the S500 for those 58 days was negative 3.5%. In other words, the S500 declined over a 12-year period only one half of 1% of the time, and when it did, the decline was less than 5%.”

“Looking at these data also reinforces how infrequently the 12-year returns have been below zero—and when they were, declines were modest. A single three-month period in 1978 accounts for almost all of the 58 times the 12-year return came in negative. In turn, given that we’ve had a few instances of negative 12-year returns in recent months, a naive look backward suggests the conditional probability of a negative 12-year return from 2007 to 2019, given that longer-term returns have collapsed since 2000, might be even lower than our experience on average since 1950 would suggest.”

Looking Forward

It’s hard to look forward without looking backward. Our expectations are products of experience. In capital markets and economics, one set of tools includes predictive models based on complex math fed with historical data. But the most complex tools are not necessarily the best things in the tool chest. Simpler, wiser judgments can easily trump complex math. On that score, an observation Buffett recently shared with a network TV audience may provide some valuable perspective:

“Ever since 1776, betting against the American people hasn’t been a good idea.”

As Ben Graham suggested, if the math involves anything more than algebra … it’s probably of not much utility in the realm of investment analysis. Stow the tools. Lean on Buffett’s instinct.

Buffett has also mused about the current bear market — sharing openly that he’s seen several of these — and he only hopes to live long enough to see a couple more.

Somewhere in Omaha, an accomplished long-term investor is taking another sip of Cherry Coke and putting his feet on his desk again. He’s thinking about opportunities, closing his eyes, and visualizing where that company seems to be headed over the next five years. Sound familiar?

If Warren is shopping and you’re paralyzed, I’d argue that it’s time to join him. Dark nights are no joke but Nicholson would encourage us to see the opportunity, instead.

Mark Robertson

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