Quote for the Week

To put the matter in another, perhaps more puzzling, framework, we can say that today’s stock prices do not really forecast what investors think business conditions will be like some six months or so hence, but rather what investors think stock prices will be some six months or so hence! If investors as a group think business conditions and therefore stock prices will be higher six months in the future, they will buy stocks now and refrain from selling them until the level of stock prices reaches a point where they agree with what that price level is predicting, and vice versa on the downside. But the problem is really much more complicated than that, because stock prices six months ahead will not only be reflecting business conditions at that moment but will also be reflecting what investors expect one year from now, or six months beyond six months from now, which is even more difficult to predict.

Thus described, and greatly magnified and elaborated in the process of selecting individual issues rather than in making a general market forecast, any type of reliable prediction of stock prices seems like a total impossibility. It is difficult enough to know what we should think on our own about what is going to happen, but that is simple compared with the difficulty of knowing what other people are thinking and will think about a future that never holds still, even for an instant. — Peter Bernstein (source)

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It’s May 28, 1962 and the stock market is spiraling. It was the biggest one day drop since 1929. And it happened fast.

The flash crash that day left the Dow down 5.7% at the close, 26% below the 1962 high near the start of the year, and below 600 for the first time in two years. Many stocks ended the day 30% to 80% below their highs for the year.

A rebound the next day offered respite from the panic. Two days later J. Paul Getty offered encouraging words when pressed for comment, “I’d be foolish not to buy… Most seasoned investors are doubtless doing much the same thing. They’re snapping up the fine stock bargains available as a result of the emotionally inspired selling wave.”

However, the volatility persisted until late in the year. And J. Paul Getty expanded further in an article published that September.

He blamed herd behavior and emotional investors on the irrational prices and crash. He criticized the speculation that drove stocks with little to no assets to trade at over 100 times earnings.

He relayed the message that get-rich-quick schemes don’t work. His “not-so-secret secrets” of investment success: sound companies, bought at low prices, and held for the long run is the way to wealth.

His real secret: not be panicked by market moves. While it’s hard to remove emotion from investing, its necessary for long-term success because emotional buying at ever higher prices leads to emotional selling when markets turn and panic sets in.

Finally, Getty reminded readers of his investing rules which he laid out nine months prior:

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Quote for the Week

Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend. A boom–bust process is set in motion when a trend and a misconception positively reinforce each other. The process is liable to be tested by negative feedback along the way, giving rise to climaxes which may or may not turn out to be genuine. If a trend is strong enough to survive the test, both the trend and the misconception will be further reinforced. Eventually, market expectations become so far removed from reality that people are forced to recognize that a misconception is involved. A twilight period ensues during which doubts grow and more people lose faith, but the prevailing trend is sustained by inertia. As Chuck Prince, former head of Citigroup said during the twilight of the super bubble: ‘As long as the music is playing, you’ve got to get up and dance. We’re still dancing.’ Eventually, a point is reached when the trend is reversed, it then becomes self-reinforcing in the opposite direction. Boom–bust processes tend to be asymmetrical: booms are slow to develop and take a long time to become unsustainable, busts tend to be more abrupt, due to forced liquidation of unsustainable positions and the asymmetries introduced by leverage. — George Soros (source)

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Quote for the Week

The difficult thing for the financial adviser and the client—and I learned this when I managed money—is that no one can really identify how he or she is going to react when surprises come along, and yet surprises are inevitably going to come. Somehow investment consultants need to condition people to this fact. I give a lot of talks where I stand up and say, “We don’t know what the future holds,” and I see all of the heads nodding up and down. But people act as if they do know what the future holds, and that’s what gets them into trouble.

So it’s crucial that consultants try to get through to people that it’s impossible to know the future and that surprise is inevitable. As a result, we have to limit the nature of our bets, we have to be obsessive about diversification, we shouldn’t try to be too smart, we shouldn’t try to shoot the moon. All of these are very simple ideas, and people will accept them ahead of time, but it’s hard for them to live with humbly structured portfolios. However, they have to do so if they’re going to survive. The main thing that an investment consultant can do is to get through this idea that you can’t act as though you know the future if you want to be a survivor. The future may be better than you think, and it’s not necessarily going to be worse. But even if it’s better than you think, that’s also hard to handle. It’s that kind of philosophical teaching that consultants have to understand in their hearts, and then get it into the hearts of investors. Once you’ve got the philosophical grasp, the rest is easy. — Peter Bernstein (source)

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Here’s what I’ve been reading for the past three months:

• My Life and Work — Henry Ford his story from growing up, the beginnings of the Ford Motor Company, and his business philosophy — including an obsession with efficiency — that transformed manufacturing and dominated the early auto industry. (Notes)
• The First Crash — England’s South Sea Bubble in 1720 was one of the first financial booms and busts in history. Richard Dale covers the birth of the South Sea Company, the boom, and inevitable bust. He details the South Sea Company’s financials, the parallels to the Mississippi Bubble in France, and the reaction of commentators and investors of the time. The historical significance and similarities to other bubbles that followed made it a fun, interesting read. Notes to come.
• The Art of Worldly Wisdom — Baltasar Gracian was a Spanish Jesuit priest in the 1600s. He was also a philosopher and collector of maxims on life. The book offers a collection of pithy bits of wisdom and another example of how little human nature has changed in over 300 years. It’s a book you can spend a few minutes browsing through each day.
• The Lords of Creation — I started this over the holidays. Published in 1935, the book delves into the rise of “big business” and the people behind it from the late 1800s to the Great Depression, and how it shaped the American economy, as we know it, today. Notes to follow once I finish.

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