1937 was the first major market crash since the big one in 1929. The U.S. stock market peaked in March 1937 then sank about 50% over the next year. I’m sure the thought of a repeat of 1929 was in the back of a few investor’s minds at the time.
In fact, John Maynard Keynes may have been dealing with someone who was fighting that last war. Keynes served on the board of National Mutual. He believed the insurance company should hold a higher weighting in stocks than what was typical of the time. Though, not all board members agreed.
The disagreement grew louder as the U.S. market sank from 1937 to 1938 and dragged National Mutual’s portfolio down with it. By March of 1938, F. N. Curzon, the acting chairman in Keynes’s absence, had enough. He pushed to liquate some stock holdings. Then he fired off a letter criticizing Keynes’s investment policy over the previous few months.
Keynes’s reply came a few days later:
I do not believe that selling at very low prices is a remedy for having failed to sell at high ones. The criticism, if any, to which we are open is not having sold more prior to last August. In the light of after events, it would clearly have been advantageous to do so. But even now, looking back, I think it would have required abnormal foresight to act otherwise. In my own case, I was of the opinion that the prices of sterling securities were fully high in the spring. But I was prevented from taking advantage of this, first of all by the gold scare, and then by the N.D.C. scare, both of which I regarded as temporary influences for the wearing off of which one should wait. Then came the American collapse with a rapidity and on a scale which no one could possibly have foreseen, so that one had not got the time to act which one would have expected. However this may be, I don’t feel that one is open to any criticism for not selling after the blow had fallen. As soon as prices had fallen below a reasonable estimate of intrinsic value and long-period probabilities, there was nothing more to be done. It was too late to remedy any defects in previous policy, and the right course was to stand pretty well where one was.
I feel no shame at being found still owning a share when the bottom of the market comes. I do not think it is the business, far less the duty, of an institutional or any other serious investor to be constantly considering whether he should cut and run on a falling market, or to feel himself open to blame if shares depreciate on his hands. I would go much further than that. I should say that it is from time to time the duty of a serious investor to accept the depreciation of his holdings with equanimity and without reproaching himself. Any other policy is antisocial, destructive of confidence, and incompatible with the working of the economic system. An investor is aiming, or should be aiming primarily at long-period results, and should be solely judged by these. The fact of holding shares which have fallen in a general decline of the market proves nothing and should not be a subject of reproach. It should certainly not be an argument for unloading when the market is least able to support such action. The idea that we should all be selling out to the other fellow and should all be finding ourselves with nothing but cash at the bottom of the market is not merely fantastic, but destructive of the whole system…
I do not agree that we have in fact done particularly badly. I have been carrying on for my own benefit a post mortem into results and making such comparison with other institutions as are open to me… As far as I can judge, there is extremely little difference between our results and those of other people… Moreover, if our results are compared with those of the Index, for a period, they are extremely good. We have done a very great deal better than the Index, and have in that way shown power of management and have justified the capacity of insurance offices to undertake constructive investment. If we deal in equities, it is inevitable that there should be large fluctuations. Some part of paper profits is certain to disappear in bad times. Results must be judged by what one does on the round journey. On that test we have come out successfully. If, on the other hand, we do not hold equities, we must either be content with earning a definitely lower rate of interest, or we shall be tempted, in my judgment, into risks which, while they may be less apparent and take longer to mature, are really much more serious than those of equity holders.
Keynes’s response offers some insight into his investment philosophy, along with several lessons to take from it.
First, Keynes warns Curzon about compounding mistakes. Investors who fail to sell at a market top should not make things worse by selling at the bottom. By then it’s too late — as stocks are likely priced below value. At that point, stocks are an opportunity worth owning.
Second, foresight is impossible. Keynes quickly does away with the idea of knowing the market would crash in advance. As Keynes points out, even if someone did know, markets can turn so quickly that knowing is next to useless. Most investors are better off dealing with the market swings rather than trying to time them.
Third, hindsight messes with investors’ minds. It provides investors with all the information to make perfect decisions in the past. The result is a false belief that past events were easier to predict. Instead, Keynes judges his investment process based on what he knew and thought at the time, not in hindsight. Unfortunately, investing is an imperfect game with incomplete information where uncertainty abounds. Results are often out of our control. Investors need to judge past decisions with that in mind.
Fourth, context matters. It’s better to judge results not based on what’s happening here and now or over a year or two but over the course of a full market cycle.
Finally, markets fluctuate. Stocks swing in price. That may be hard to stomach for some people but consider the alternatives. Other investments might be less volatile, maybe have lower returns, but come with other risks to consider. Stocks have historically offered considerably better returns than other investments. The downside is that those returns are lumpy.
The Collected Writings of John Maynard Keynes, Vol. 12
John Maynard Keynes’s Investment Policy
The Downside of Chasing Huge Wins