a mere blink of an eye...

by Douglas A. Lambrecht, CIMC

Individual perspective is a wonderful and valuable thing. One of the most curious things about it is that it is based entirely upon personal experience which colors the way in which one views the world, thus the saying;…beauty is in the eye of the beholder.  As it relates to investments, both an individual’s view of risk and reward and his or he advisor’s perspective will affect the outcome. Seeking counsel from a conservatively experienced vantage point can mean attaining more predictable returns with a reduction in the overall risk of a portfolio. Conversely, seeking direction from an advisor who is aggressive may require an investor to ingest more Malox to endure the volatility  in pursuit of their objectives. Whether or not an investor is comfortable with risks taken and pleased with the resulting investment outcomes will depend upon the suitability of investments and, more primarily, upon that investor’s individual and unique perspective. 

Historical perspectives are fascinating as well.  Hundreds of books have been written on financial markets and economic cycles. Theories abound on the predictive value of analyzing such hindsight information. Many a million has been invested in attempts to mirror fund advances as reported by the media, solely because the investor or advisor perceived that such stellar performance was likely to be repeated. Management Consultants refer to such hindsight investing as “chasing the hot dot”. Relying on such techniques to invest is a bit like driving while using only a rear view mirror for one’s traffic perspective. Ironically for those type of investors, recent studies from Morningstar, Dalbar and others confirm that the latest top performing mutual funds are rarely the following year’s winners. Contemplating the underlying meaning behind such facts will help investors understand that good investing is more a function of foresight than hindsight.  

An objective step back to an even broader perspective reveals that the stock market is actually a relatively recent experience within the context of man’s existence on the earth, representing a mere blink of an eye in evolutionary terms. While money, currency exchange, lending and commerce have certainly been around for thousands of years, the funding of business enterprises through the issuance of equity instruments is a more recent permutation of man’s financial relationships.  

Consider the fact that the most talked about measure of stock market activity in the world is only now reaching the ripe old age of one hundred years. The first full year of statistics for the famous DJIA, which was founded in New York’s wall street financial district, was 1897. The then new index of twenty individual issues (18 rails & 2 industrials) was tracked along with its predecessor index, the slightly older Dow Jones Rails Average, as the only existent measures of the broad value of “the market."  The DJIA began that year at 40.74, hit a high of 55.82 in September, a low of 38.49 in April and ended the year at 49.41 for a gain of 22.2%  

So, just how and why was America’s stock market ever created in the first place?  In a word, the formation of the financial markets was all about liquidity.  Domestic and foreign industrial capitalists like the Baring Brothers of London, who had close business and historic ties with New York, clearly played significant roles.  Merchant bankers, anxious to reinvest earnings accrued from successful ventures they helped finance, also looked with favor upon the idea as a way to free up capital. Like many of the financial and economic ideas of the era, a select group probably hatched the concept over brandy and cigars. After all, early transactions essentially represented  swaps of private ownership of various firms between these ultra rich players.  

In the early market days of the late eighteen hundreds, market information was spread through insiders to their closest friends. The public found out about corporate news after the fact via market movements. The most reliable statistics came from the railroads. They comprised over two thirds of the issues then listed on the NYSE. A wild-west type of banditry basically ruled the stock exchanges which remained essentially unregulated until the emergence of the Securities and Exchange Commission decades later. The most trusted published record at the time, the weekly Commercial & Financial Chronicle, was 44 pages when first published in 1890.  The Wall Street Journal was then a four page daily.  

Manipulations and rumors were said to be quite common. Market bulls would buy in hopes of advances while so-called bear investors would sell suspect (or manipulated) issues short in anticipation of price declines. Volatility, by comparison, was even more prevalent then than now.  It was not at all unusual for an issue to more than double in value, only to crash, all within the course of a single year. Fortunes were made and lost on a regular basis. The summer of 1897 saw Northern Pacific rise from 11 to 22 while Missouri Pacific shares skyrocketed from 14 to 40.  National Lead doubled. Selection and timing were clearly the keys to success during that era.  

The DJIA briefly broke the magical 100 barrier in January of 1906, a level it would not see again for another ten years.  In the interim, the market took the proverbial two steps back, three steps forward,  posting a loss of 37.7% in 1907 followed by a gain in 1908 of 46.6%.  This yo-yo type market action continued well into the early decades of this century. Irrespective of the volatility, scandals, uncertainty, crashes and failures, stock market investing continued to grow in popularity. Fresh new offerings, including automobile companies and other exciting participants, added to the market appeal.  The Dow Jones company regrouped their industrial average into 30 stocks in 1928. Wright Aero and Radio & Victor Talking Machine joined the list. The DJIA ended the year at 300.

The year 1929 will long be remembered for the autumn crash that saw the market fall more than 49%, but it was actually that spring’s volatility that set the stage. Following frightening drops early in the year, which saw Chrysler swing from 135 to 65 and White Sewing Machine plummet over 75%,  a contagious speculative fervor intoxicated investors. Summer buying was apparently giddy with brokerage offices reportedly jammed with business. Dozens of issues soared over a hundred points in value amid frantic buying.  Market participants were oblivious to pending events, despite the growing warning signs. After hitting a high of 381.17 on Sep 3^rd, the great crash saw the DJIA drop to 198.69 on Nov 13. Although the carnage was bad, the DJIA actually managed to rally to end at 248.48 for a loss for the year 1929 of only 17.2%.  

While swings in the indices and individual issues would continue to be the norm for years to come, the market obviously survived and prospered.  Volume increased both in terms of shares traded and the number of issuers. Efforts to increase regulation reduced banditry and manipulation. Though it took many years, confidence in the markets began to replace cynicism, fear and distrust.  

From today’s perspective, the value of the DJIA index has risen three hundred and thirty percent in the last fifteen years without a correction of more than ten percent. In the previous fifteen years, the market remained essentially flat, with the DJIA dancing within a hundred points of the 1,000 mark. This comparison alone is both remarkable and unprecedented. Statistically, we are in an economic period for which there is no historical precedent. 

Where do we go from here?  At one of the country’s top conferences for investment management consultants, held recently at the prestigious New York Athletic Club, Edward E. Yardeni, Chief Economist and Managing Director at Deutsche Morgan Grenfell (North America) went on record in predicting that the DJIA would reach ten thousand by the year 2000 and fifteen thousand by the year 2005. Institutional Investor magazine polls consistently place Mr. Yardeni among the most respected economists in the nation. He has held previous positions with E.F. Hutton, the Federal Reserve and the U.S. Treasury, taught at Columbia University's Graduate School of Business.  

Bear market pundits frequently cite historical perspectives to support their contrasting views.  Most would have us believe that history will automatically repeat itself and that a correction is imminent. Many speak from the vantage point of many years of experience in the markets. But, investors should take note:  just as past performance is not necessarily indicative of the future for an investment,  neither does experience in and of itself necessarily beget valuable perspective.  

Investors necessarily rely upon numbers, statistics and respected advisors to feed their decisions.  Measurements of price earnings, dividend yields, growth rates, cash to book value and other ratios are essential to help provide insights as to fair valuation. But, perspective alone determines how these various bits of information are interpreted. In the long run, it will be investor behavior, not investments, that will ultimately determine performance and investment outcomes. 

Before buying into any bear market arguments, consider these factors: 1) more baby boomers join the ranks of serious savers and investors every day.  2) the growth in retirement funds is positively staggering.  3) America clearly is leading the charge for intelligent corporate re-structuring and management. 4)  yes, consumer debt as a percentage of GDP is rising, but if you check statistics you will find that most of it occurs at the lower end of the spectrum. 5) healthy demand for shares continues and volume grows daily 6) availability and quality of information takes quantum leaps by the minute  6) Volatility and irrationality is mitigated by improved investor education. 

Considering all of this, its a small wonder that a noted economist like Ed Yardeni proffers an opinion that prosperity might be around for a while. Ample evidence supports his predictions.