I have been having this surreal experience for the past week or so. At night, I am reading Devil Take the Hindmost by Edward Chancellor, which is a fascinating look at some of history's more ignominious financial booms and busts, mostly since the 16th Century. Then I come into the office, read about the latest Internet disaster du jour and I have this odd sense of having heard this story before. Then I go home at night and open the book, and it looks even more familiar.
The first 232 pages make for terrific reading. In fact, they are
reading for investors to gain some sense of perspective on how far out on a limb we really may be -- and what some of the less-than-thrilling consequences of a reversion to a less-highly-valued mean may be.
For those of you who now have your finger poised on the "send email" box with the standard vitriol about how I don't get it, that's OK. The book explains your condition as cognitive dissonance, a psychological state whereby your mind selectively filters out information that contradicts a position you have taken and are determined to hold.
And, yes, while some of this will be a replay of some cautionary thoughts I have discussed in previous installments, I can also reassure you that I will be quoting verbatim from the book, so at least the delivery will be fresh.
What is stunning about this book's message is how utterly ordinary the speculative excesses in the stock market are, as is the inevitable unpleasantness we are experiencing. As that great living English poet
once said, "I couldn't quote you no Dickens, Shelley or Keats, 'cause it's all been said before." Nevertheless, I have culled some of the juiciest quotes, most of which stem from the great financial boom and bust surrounding railroad building in the 1840s in England.
We start with the famed economist
, who observed that "speculative mania commonly occur at the inception of a new industry or technology when people overestimate the potential gains and too much capital is attracted to new ventures."
What few today realize is that while supply-chain-management improvement, instant-messaging capability and the ability to buy consumer goods at all hours of the day are neat things, the steam locomotive, the automobile, penicillin, air travel, air conditioning, radio and television are just a few of the 20th century's seminal discoveries.
When Old Tech Was New
In the 1840s, the steam locomotive was truly a big deal. Chancellor writes, "writers not only focused on the economic benefits of railway transport, but concerned themselves with its more widespread effects on human civilization ... railway time would change forever the pace of human existence; the length of our lives, so as regards the power of acquiring information and disseminating power, will be doubled, and we may be justified in looking for the arrival of a time when the whole world will have become one great family, speaking one language, governed in unity by like laws, and adoring one God."
Let us assume, as it is commonly assumed, that we can substitute the word "Internet" for the words "steam locomotive" in the earlier paragraph and that the Internet is the great leap into the 21st century and will have as big an effect on humanity as the steam engine. Unfortunately, as an investor, that will give you precious little comfort as this great breakthrough, like many others, was accompanied by a short but enormous upswing -- followed by disastrous losses for the majority of investors. We are talking $300-per-share-to-$4-type numbers. Read the book!
Is all this necessary? Yes. Why? At the risk of repeating myself, look back at a previous
column about a
article titled "The Iron Law of Stardom," which explained the inevitability of fashions: "What causes the fadeout isn't the star. It's the large number of moons that get pulled into the star's gravitational field ... the result is a steady increase in wattage that eventually burns out the whole fixture." It's not
; it's the past 10 IPOs. Got it?
It Worked Then -- It Works Now
Drawing an eerie parallel to today's investment bankers, Chancellor details the strategies of the railroad companies and their bankers. The railroads advertised the deal extensively, listed some highly prominent "provisional committeemen" (the equivalent of having
on the board) and sold stock on a subscription basis. If the deal was successful, the directors kept a majority of the shares for themselves and released only a few shares into the marketplace, thus creating scarcity and forcing out short-sellers. When the shares traded at an immediate premium, the insiders would sell. True, the subscription deal has generally gone by the wayside, but doesn't the rest of this ring a bell?
And in case you thought that indexing and momentum investing were recent phenomena, we have one John Martin, a prominent London banker, who is quoted circa 1720 as "gleefully arguing that when the rest of the world is mad, we must imitate them in some measure." Postscript: He lost his entire fortune in the South Sea crash and spent the rest of his life whining about "being blinded by other people's advice."
Getting away from the Internet for a moment, Chancellor also presents an interesting comparison between the flotation of unit investment trusts in the 1920s and mutual funds today. In 1929, a new UIT launched every day for the first nine months of the year, with assets totaling more than a billion dollars, a twentyfold increase over the three years prior.
Yes, I know comparisons between 1929 and today are tiring, but here's a another beauty.
, known in the 1920s as the
Goldman Sachs Trading Co.
, went public in 1928 as a unit investment trust and raised $100 million. The partners promptly reinvested $57 million into their own shares and "frequently dumped stocks into their portfolio that they found it difficult to sell elsewhere." We can be relieved that in 1999, Goldman announced that its new Internet investment fund will not buy any Goldman-led deals.
A Predictable Denouement
Where will it all end? Listen to one local commentator in the aftermath of the 1840s' railroad crash: "The lust of gain which animated all speculators, is now changing into the cruelty of a reign of terror and the ferocity of revenge ... the world of speculation is transforming into a world of litigation." An unpleasant bone to toss to the trial lawyers.
And Chancellor also treats us to some beautiful accounts of market activity, this one from the South Sea bubble of the 1720s: "The initial fall had brought a prodigious number of sellers to the market; one man's selling alarms another; and makes him sell, and thus the stock has run down insensibly, till all the people are put in a Fright; and such has been the panic Fear, that it brought great confusion along with it."
And this from the
of London: "A mighty bubble of wealth is blown before our eyes, as empty, as transient, as contradictory to the laws of solid material, as confuted by every circumstance of actual condition, as any other bubble which man or child ever blew before."
A Lot of Good It'll Do Us
Of course, one of the annoying things about being "right" about the silliness of the Internet craze is that unless you decide to go 80% cash, you will be hurt without owning a single dot-com share. When the bleeding edge gets crushed, it sucks the confidence out of nearly everyone and, as seen last summer -- and today, for that matter -- people get slightly less than rational. After a few losers in a row, people start sitting on their hands, and the result is a 180-degree turn from fighting with your broker over a hot IPO allocation.
Yes, you can make a nice living generating good relative performance in the institutional investment world. But it is a heck of a lot more fun to be up a nice 13% and be adding dollars to your client's accounts than it is to be losing less than the next guy. And that's what I fear we are in for.
And let's not kid ourselves. Yes, the stock market may have predicted eight of the past two recessions, but I think it would be foolish to dismiss the link between the enormous increase in stock ownership in this country over the past decade and our economic performance. Many have made lots of money, and many are spending it just as fast. When many start losing lots of money, the reverse process sets in, spending goes down, investment goes down and the same lack of confidence ripples though the economy.
We close with a classic: Edwin Lefevre from
Reminiscences of a Stock Operator
: "Nowhere does history indulge in repetitions so often or so uniformly as in Wall Street. When you read contemporary accounts of booms or panics, the one thing that strikes you most forcibly is how little either stock speculation or stock speculators differ from yesterday. The game does not change and neither does human nature." That's my thought. Have a nice day!
Jeffrey Bronchick is chief investment officer of Reed Conner & Birdwell, a Los Angeles-based money management firm with about $1 billion of assets under management for institutions and taxable individuals. Bronchick also manages the RCB Small Cap Value fund. At time of publication, neither Bronchick nor RCB held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bronchick appreciates your feedback at
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