Every great bull market hides some level of fraud, unbeknownst to its victims. Its unique in that the fraudster and the defrauded feel wealthier despite it being an illusion.

It’s Enron before everything blew up. The shareholders felt richer, as did Jeff Skilling and his cohorts, until it all unraveled.

The difference between real wealth versus illusory wealth is what John Kenneth Galbraith called “the bezzle.”

To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in—or more precisely not in—the country’s businesses and banks. This inventory—it should perhaps be called the bezzle—amounts at any moment to many millions of dollars. It also varies in size with the business cycle.

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Quote for the Week

The much wider fluctuations in investment common stocks that have come about since World War I have made it practically impossible for buyers of common stocks to disregard price changes. It would be extremely unwise — and hypocritical — for anybody to buy a list of common stocks and say that he was interested only in his dividend return and cared nothing at all about price changes.

The problem is not whether price changes should be disregarded — because clearly they should not be — but rather in what way can the investor and the security analyst deal intelligently with the price changes which take place…

The fact that investors have been willing to pay so much for so-called quality, and so much for so-called future prospects, on the average, that they have themselves introduced serious speculative elements into common stock valuations. These elements are bound to create fluctuations in their own attitude, because quality and prospects are psychological factors. The dividend, of course, is not a psychological factor; it is more or less of a fixed datum. Matters of the former kind — I am speaking now of prospects and quality — are subject to wide changes in the psychological attitude of the people who buy and sell stocks. — Ben Graham (source)

Quote for the Week

Perhaps enough has been said to indicate the principal difficulties which beset the speculator who attempts to profit by the short swings of the stock. For practical purposes the occurrence of ripples and waves in the price movement is unpredictable. To attempt to trade on such movements is mere gambling with the odds against the trader by a considerable margin. It is astounding that thousands of otherwise intelligent persons persist in trying to make money in this way. Commonly accepted figures of somewhat dubious origin are frequently cited to show that 90% to 95% of all margin trades lose money in the stock market. The deep-seated gambling instinct, the well-founded belief that in widely fluctuating markets there must be opportunities for profit nevertheless bring fresh recruits to the brokerage offices in constant streams. A few of them ultimately learn the methods by which money may actually be made in the stock market. — Philip Carret (source)

Quote for the Week

We actually can see and indeed measure how badly investors do at timing. They’re their own worst enemy. As Warren Buffett says, the two greatest enemies of equity investors are expenses and emotions. You can see the expenses in the gap between the market return and fund returns, and the emotions in the gap between fund returns and investor returns. When you look at data on the origin of these shortfalls, it is staggeringly loaded toward the degree of fund specialization; in other words, the biggest gap between fund time-weighted returns and fund investor dollar-weighted returns is found in technology funds, telecommunications funds, aggressive growth funds. We did a study that covered six years, i.e., the last three years of the up market and the first three years of the down market. With the ups and downs taken together, the twenty-five largest sector funds actually returned about 5.5 percent per year, versus 3.7 percent for the twenty-five largest diversified funds. However, while the typical investor in the diversified mutual funds ran about 2 percent behind the funds themselves, the investors in these specialty funds fell short of the fund returns by about 14 percent a year, which, when compounded over six years, is a staggering shortfall of 59 percent. — John Bogle (source)