The advantage of market history isn’t so much to see how assets have performed but to see how people reacted to the performance.
Knowing what stocks or bonds returned over the last 10, 20, or 30 years can be helpful. It shows how a perfectly rational being would have performed over those periods.
What it doesn’t show is how an actual person might react to a sea change in technology near the end of the longest bull market in history. Or how that person might respond to a 22% drop in a single day. Or what that person might expect from their bond funds after the greatest 35-year performance ever. Or how they might react to a 5% interest rate spike — a roughly 50% drop in the 10-year bond price — over a measly 16 months.
This is about the battle between rationality (academia) and reality. Academic research plays an important role in understanding markets, but it hardly tells the whole story. Since the 1960s, most research assumed all decisions were rational. That turned out not to be the case.
A good example of this is how Howard Marks explains an academic’s view of the Nifty Fifty versus the real, more likely, outcome. Jeremy Seigel showed how an investment in the Nifty Fifty eventually paid off (some 26 years later). However, the likelihood of a real investor sticking it out that long is extremely low. The numerous rough periods – an understatement – would have driven the most stubborn investors away. Here’s Marks:
I think that the title for Mr. Siegel is academician. In other words he looks at it academically. And I don’t think he’s ever tried to hold a stock for 25 years after it went down 80% in the first year. And most of us have had that experience. But you know, I cut my teeth by joining the equity research department of Citibank in 1968. And the bank practiced something called Nifty Fifty investing. And it invested in the best and fifty fastest growing companies in America. And these were companies where it was believed that nothing could go wrong. So as Professor Siegel would say, any price was okay, it didn’t matter. If the price was a little high, you’d grow into it.
So, if you were smart enough to invest in Merck, Lily, Avon, Coke, Texas Instruments, Hewlett Packard, and that ilk of companies in ’68 and you were smart enough to hold those stocks for 5 years you lost 80-90% of your money. And I would be shocked, actually, to find that — I mean, I haven’t done the work. But I’d be surprised to find that you have an attractive rate of return to today.
The other thing is that, as I said, these were companies where it was believed that nothing could ever go wrong. Well, the list included Xerox, IBM, Polaroid, Kodak, and AIG. And all of those companies either went bankrupt or flirted with bankruptcy. So, you know, it’s cavalier to say a great company. These were companies that everybody thought were great in 1968. Nobody thinks they’re great today. If you had stayed with those stocks from ’68 to today you wouldn’t have anything to show for it as a record. So, I actually feel that joining Citi in ’68 and being part of the Nifty Fifty was a very instructive lesson. It was the first investment lesson in my life.
Now, one very important thing is you learn nothing from success. You only learn from failure. And one of the things I like to say is, “That experience is what you got when you didn’t get what you wanted.” And so, I was very fortunate to learn a painful lesson early. You invest in the best companies in America and you loose almost all your money. Now, 10 years later I joined — I was asked to start a portfolio of high yield bonds. They used to call them junk bonds. Now, I’m dealing with the worst companies in America. So, what I learned from the combination of these two things is that investing is not a matter of what you buy, it’s what you pay. Investing is not a matter of buying good things, but buying things well. And you have to understand the difference between buying good things and buying things well. And I think that’s what we’ve been able to do.
And my whole career since ’78, the last 40 years, has been based on pretty much buying assets that were out of favor because you know when you buy assets everybody hates you get better bargains. So, you know, I think — I could respond on the subject of Professor Siegel but I’ll leave it there. But if you want to learn something you can go back and read his book “Stocks for the Long Run.” It’s instructive. Not necessarily in a good way.
The lesson of history is not that stocks earn 9% over the course of history. The lesson is that just earning the average return on equities – that 9% historical return – over a long period is never easy.
Because what seems obvious or certain to most people at the time, is neither obvious nor certain. It’s certainly obvious in hindsight, which is why research and data make attaining historical (or better) returns seem easy. Except, it never is because it fails to account for human nature.
This post was originally published on September 6, 2017.
Howard Marks: CFA Society India
Marks Memo: It’s Not Easy
Valuing Growth Stocks: Revisiting the Nifty Fifty – J. Siegel
The Nifty Fifty Revisited: Do Growth Stocks Ultimately Justify Their Price? – J. Siegel
Ben Graham on Market Cycles and Second-Level Thinking
Howard Marks on Risk, Predictions, and History
Howard Marks on His Investment Philosophy