Market history is full of wonderful lessons. Not the surface-level lessons either.
The trouble is most people gravitate to the long-run data when first looking into market history. Except, that’s where they stop.
While yes, the data is useful — you learn how the different assets performed over the last century — but it’s just averages. And averages tend to smooth out bumpy rides. The interesting stuff is hidden in those bumpy rides.
One thing we learn is that markets are dynamic. It’s in a state of constant change.
Typically, those changes swing around the average, like a pendulum — moving away from it before reverting. On rare occasions, they don’t. Paradigm shifts.
One such paradigm shift happened in 1958. For decades, stock dividend yields always stayed above bond yields. The spread between the two would fluctuate, of course, but anytime the two yields came close they acted like two magnetics repelling each other.
As stock prices rose, dividend yields fell but never below bond yields. Anytime stock yields dipped close to bond yields, stock prices (or bond prices) would fall, and the spread between stock yields and bond yields would widen again. It was a pattern that investors relied on for its consistency. And it worked well…until it didn’t.
Sometime around late August, early September 1958, stock prices rose, stock yields fell, and kept falling past bond yields. It was a first. And everyone was certain the market would quickly correct the matter.
At the time, I had two older partners who were grizzled veterans of the Great Depression who assured me that this was an anomaly that would, in a short period of time, correct itself, and that stocks would obviously have to yield more than bonds all the time. And I’m still waiting… It was a very dramatic moment, and it taught me that anything can happen. — Peter Bernstein
The pattern died. Only nobody knew it at the time. Investors waiting for that pattern to persist before buying stocks ended up waiting a long time.
Market history heavily favors reversion but it’s not absolute. Things change. In fact, even the “norm” that markets revert to is not static.
Future markets are not bound by the actions of their past. They’re driven by the collective actions of their participants. Which isn’t as predictable as we might think.
That doesn’t mean a paradigm shift exists around every corner. Investors just need to be open to the reality that, however unlikely, it’s still possible. That, of course, is one important lesson.
Another important lesson is how people react to those changes. Thankfully, a number of market historians have shared what they’ve learned from studying the ups and downs of the market.
The only thing you can be sure of is that there are times when large numbers of stocks are priced too high and other times when they’re priced too low. — Benjamin Graham
In the history of every great catastrophe, you will find that some masterly bit of stupidity sets fire to the oil-soaked rags. — Edwin Lefevre
While we can learn from the long run about how bonds and stocks respond to changing environments and to each other, the long run can tell us perilously little about what kinds of environments lie ahead. — Peter Bernstein
Of all the mysteries of the stock exchange there is none so impenetrable as why there should be a buyer for everyone who seeks to sell. October 24, 1929 showed that what is mysterious is not inevitable. Often there were no buyers, and only wide vertical declines could anyone be induced to bid. — John Kenneth Galbraith
Hoaxes, frauds, manias, and other large-scale financial irrationalities have been with us from the beginnings of the markets in the seventeenth century, long before the Internet. — Edward Thorp
We deceive ourselves when we believe that past stock market return patterns provide the bounds by which we can predict the future. — John Bogle
The history of markets is one of overreaction in both directions. — Peter Bernstein
The tour we’ve taken through the last century proves that market irrationality of an extreme kind periodically erupts — and compellingly suggests that investors wanting to do well had better learn how to deal with the next outbreak. — Warren Buffett
It is a safe prediction for me to make that, in future years as in the past, common stocks will advance too far and decline too far, and that investors, like speculators — and institutions, like individuals — will have their periods of enchantment and disenchantment with equities. — Benjamin Graham
The lesson of history is that norms are never normal forever. Paradigm shifts belie blind faith in regression to the mean. — Peter Bernstein
I think investors always learn the lessons of the recent past. And that is the lesson. — Seth Klarman
The history of the stock market shows many periods of twenty years or more when stock prices ended up precisely where they began. — Peter Bernstein
We learned in the ’20s that markets with participants playing heavily on margins could be more dangerous than markets where people are dealing in cash. — Warren Buffett
What we do know is that speculative episodes never come gently to an end. The wise, though for most the improbable, course is to assume the worst. — John Kenneth Galbraith
The constant lesson of history is the dominant role played by surprise. Just when we are most comfortable with an environment and come to believe we finally understand it, the ground shifts under our feet. — Peter Bernstein
What you learn from history is the market goes down. It goes down a lot. — Peter Lynch
One thing all of us know for sure is that the stock market doesn’t go down just because a lot of folks think that it has entered the heart of looney land. — Robert Kirby
History shows us, over and over, that bull markets can go well beyond rational valuation levels as long as the outlook for future earnings is positive. — Peter Bernstein
The broad pattern of market action in the past is the best guide to the future — but it is not an infallible guide. — Benjamin Graham
- Math Mandate – The Better Letter
- Losers: The Secret History – J. Zweig
- Business History with Gary Hoover – Neckar’s Notes
- A Walk Down Drawdown Lane – ValIdea
- Rules, Truths, Beliefs – M. Housel
- The Brain Doesn’t Think the Way You Think It Does – Quanta
- Bubbles, Bikes, & Biases (podcast) – Planet Money
- An Immense Mystery Older than Stonehenge – BBC