Rogue Missives - History and the Market, by Jim Surowiecki

Rogue Missives

ROGUE ARCHIVES

Monday, January 20, 1997

History and the Market
by Jim Surowiecki (Surowiecki)
In recent weeks, as the Dow has risen almost without pause and each day has seemed to bring us a new record high, individual and mutual-fund investors find themselves in a curious position. They appear to be confident about the future, secure about the long-term potential of equities, and thoroughly convinced that the bull market of the last fifteen years will continue for the foreseeable future.
Yet, if we are to believe the growing host of bearish critics, these investors are also skittish, inexperienced, and liable to bolt at any minute. More than that, the bolting is depicted as a kind of foregone conclusion. Eventually, the correction *will* come, we are told, and if the market gets too far ahead of itself now, that only means the necessary crash will be all the more painful.
An example of the pervasiveness of this notion was the January 19 episode of "The Simpsons," which began with a neighborhood investing club, made up of homemakers, talking about their love of high-risk, high-yield investments. The show suggested that investing in the market was no different from becoming a "Fleet-a-Pita" franchise owner.
While "The Simpsons" isn't exactly a reputable market-watcher, there are certainly numerous market watchers who espouse the same views. Drawing analogies between the market as a whole and high-flying stocks like Iomega, these naysayers portray investing as a kind of wave upon which you can surf happily until it breaks unexpectedly and sends you hurtling from your board.
To be sure, speculators and day traders and get-rich-quick schemers are active in this market, just as they have been active in every successful market. And it is also true that an uninterrupted stretch of success like the one U.S. stocks have enjoyed since 1987, and in meaningful terms since 1982, makes it easy for people to forget that a short-term rise in the market is not inevitable. Even if the Dow stayed flat for the next three years, after all, the rise in the Dow between 1982 and 2000 would still be well ahead of the historical average.
If you enter the market looking to double your money fast, then you're probably doomed to fail. Further, if it were true that most of the new money in the market was there because people thought they could double their money fast, then invocations of the Dutch tulip craze might not be out of line. The truth is, though, that there is very little evidence that this is what new investors are looking for, whether they are handling their own money or letting Fidelity manage it. Every investor, of course, wants to find the magical eight-bagger, but that is very different from saying that if these investors don't find eight-baggers they're going to start running for the doors.
In any case, the point about the demonization of this new money is an obvious one. What's perhaps less obvious is the way in which bearish thinking depends upon a curious misuse of the idea of history, a misuse of that idea which allows critics to neglect the specific economic and political conditions of this historical moment in favor of parables drawn from the past. Because these critics use the past to reach their conclusions about the future -- along the lines of "this has always happened before, so it will happen again" -- they depict themselves as historically aware, and not as people who think history began in 1982. But their use of the past is, in fact, thoroughly ahistorical, and depends upon a "people-are-always-the same" sensibility that won't stand up to scrutiny.
The argument from history, in simplest terms, runs something like this: We have had speculative booms before, and they have always ended. Eventually, people -- for one reason or another -- lose confidence in the game, and panic. The market is essentially a house of cards, and once a few of those cards start to shake, the whole thing comes tumbling down. Over time, the house will be built again, but in the interim people are seriously hurt.
The cardinal examples cited here are the crash of 1929, the downturn of 1973-1974, and the early 1980s. When 1987 is mentioned, it's only an example of how skewed everything has become, since "nothing happened" when the market fell 500 points in a single day. Investors picked themselves up and went back to buying -- someday soon, we're meant to understand, it won't be that way.
Even the brilliant Michael Lewis, author of "Liar's Poker" and a columnist for The New York Times, seems to have fallen into this mindset. In a piece last week for The New York Times Magazine, Lewis argued, quite perceptively, that the boom of the 1990s has not hit America the same way as the '80s did because it has not resulted in the ostentatious displays of wealth the 1980s brought us. Investing seems safer because it seems somehow more down-to-earth. In Lewis's estimation, though, this is dangerous, because the new face of investing is a deceptive one. The wealth of the 1990s, he argued, is just as speculative as that of previous decades, and just as prone to having the carpet pulled out from under it. Ostentation is preferable to restraint, then, because the former makes us aware of its tenuous nature, and thus makes us hesitant about being involved.
For Lewis, too, the end of the boom is inevitable, because that's just the way people are. At some point, they decide to pull out, and the run on the bank begins.
History, in this argument, teaches what will happen, in teaching what *has* happened. In a curious way, of course, the same attitude toward history informs approaches like Beating the Dow or, for that matter, the insistence that over the last 70 years stocks have outperformed all other investments. In the long run, all of these arguments suggest that things are pretty much the same. People can be trusted to act in the same manner. The economic system is relatively consistent. New companies come and old companies go, but the fundamentals remain the same.
What's curious about this attitude is that although it looks to history for examples and instruction, it is in fact resolutely opposed to the essence of historical thinking, which depends on the insight that things are always different, and that the particular economic and cultural factors that define reality at any moment are, in fact, crucial.
One can certainly look back at the last 70 years of American history, now that they're over, and say that at the beginning of that period the Dow was at a certain number and at the end of that period -- that is, today -- the Dow is at a different number, and that means the Dow rose, on average, 10% annually over that period of time. But that doesn't mean, on the one hand, that the Dow will continue to rise at that rate for the next 70 years, nor does it mean that the Dow *had* to rise at that rate over the last 70 years. Those 70 years, after all, included the Great Depression, World War II, the Cold War, American dominance of world markets, the oil shocks, stagflation, the growth of global competition, the invention of the computer, and the worldwide triumph of capitalism. It's simply not meaningful to treat those 70 years, in that sense, as *one* period.
Similarly, but even more crudely, the idea that people are basically the same, and will eventually bolt and run, relies on facile generalization instead of real analysis. Yes, previous market booms have ended, and it is likely that at some point this one will slow down, at least once American corporations stop turning in such good earnings numbers. But there is a crucial element in this bull market that distinguishes it from all previous bull markets, and that has gone virtually unremarked, namely the end of the Cold War.
The transition of Eastern Europe to a market economy, the fall of the Soviet Union, the gradual embrace of capitalism by China and Vietnam: taken together, these changes have created a qualitatively different situation for multinational corporations (most of which remain American). The sheer number of new consumers alone represents a previously unheard-of opportunity. More than that, though, the disappearance of an institutional base for Communism has strengthened the hand of free market advocates at home and abroad, which has given corporations more of a free hand than was customary through much of the post-New Deal period. Capital can go almost anywhere now with the greatest of ease. The power of currency markets to dictate national policy has helped create more accommodating environments for business.
The social consequences of these changes have not been universally beneficial. There has been a meaningful increase in the inequality of wealth and income both within the industrialized countries and between developed and underdeveloped nations. Workers in the G-7 nations have had to give up the idea of job security, while workers in newly industrialized countries are already feeling the pressure of global competition before even having a chance to enjoy the fruits of their national success, as the strikes in South Korea suggest. Further, a successful model of capitalist development for Latin America and Africa has yet to be found.
Nonetheless, from the perspective of business, the end of the Cold War was of enormous long-term benefit, of such benefit, in fact, that it's hard to see how analogies from the past can be taken at all seriously. This is a unique moment in the history of American capitalism, a moment in which there is no serious opposition to the system or its representatives. And in that respect, it's hard to imagine why the bull market *should* end, let alone why it would end. Investing in the market, after all, is at its heart a statement of faith in the future of American business. When, exactly, have the conditions for a bright future for American corporations been better?

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ROGUE ARCHIVES

Monday, January 20, 1997
History and the Market by Jim Surowiecki (Surowiecki) In recent weeks, as the Dow has risen almost without pause and each day has seemed to bring us a new record high, individual and mutual-fund investors find themselves in a curious position. They appear to be confident about the future, secure about the long-term potential of equities, and thoroughly convinced that the bull market of the last fifteen years will continue for the foreseeable future. Yet, if we are to believe the growing host of bearish critics, these investors are also skittish, inexperienced, and liable to bolt at any minute. More than that, the bolting is depicted as a kind of foregone conclusion. Eventually, the correction will come, we are told, and if the market gets too far ahead of itself now, that only means the necessary crash will be all the more painful. An example of the pervasiveness of this notion was the January 19 episode of "The Simpsons," which began with a neighborhood investing club, made up of homemakers, talking about their love of high-risk, high-yield investments. The show suggested that investing in the market was no different from becoming a "Fleet-a-Pita" franchise owner. While "The Simpsons" isn't exactly a reputable market-watcher, there are certainly numerous market watchers who espouse the same views. Drawing analogies between the market as a whole and high-flying stocks like Iomega, these naysayers portray investing as a kind of wave upon which you can surf happily until it breaks unexpectedly and sends you hurtling from your board. To be sure, speculators and day traders and get-rich-quick schemers are active in this market, just as they have been active in every successful market. And it is also true that an uninterrupted stretch of success like the one U.S. stocks have enjoyed since 1987, and in meaningful terms since 1982, makes it easy for people to forget that a short-term rise in the market is not inevitable. Even if the Dow stayed flat for the next three years, after all, the rise in the Dow between 1982 and 2000 would still be well ahead of the historical average. If you enter the market looking to double your money fast, then you're probably doomed to fail. Further, if it were true that most of the new money in the market was there because people thought they could double their money fast, then invocations of the Dutch tulip craze might not be out of line. The truth is, though, that there is very little evidence that this is what new investors are looking for, whether they are handling their own money or letting Fidelity manage it. Every investor, of course, wants to find the magical eight-bagger, but that is very different from saying that if these investors don't find eight-baggers they're going to start running for the doors. In any case, the point about the demonization of this new money is an obvious one. What's perhaps less obvious is the way in which bearish thinking depends upon a curious misuse of the idea of history, a misuse of that idea which allows critics to neglect the specific economic and political conditions of this historical moment in favor of parables drawn from the past. Because these critics use the past to reach their conclusions about the future -- along the lines of "this has always happened before, so it will happen again" -- they depict themselves as historically aware, and not as people who think history began in 1982. But their use of the past is, in fact, thoroughly ahistorical, and depends upon a "people-are-always-the same" sensibility that won't stand up to scrutiny. The argument from history, in simplest terms, runs something like this: We have had speculative booms before, and they have always ended. Eventually, people -- for one reason or another -- lose confidence in the game, and panic. The market is essentially a house of cards, and once a few of those cards start to shake, the whole thing comes tumbling down. Over time, the house will be built again, but in the interim people are seriously hurt. The cardinal examples cited here are the crash of 1929, the downturn of 1973-1974, and the early 1980s. When 1987 is mentioned, it's only an example of how skewed everything has become, since "nothing happened" when the market fell 500 points in a single day. Investors picked themselves up and went back to buying -- someday soon, we're meant to understand, it won't be that way. Even the brilliant Michael Lewis, author of "Liar's Poker" and a columnist for The New York Times, seems to have fallen into this mindset. In a piece last week for The New York Times Magazine, Lewis argued, quite perceptively, that the boom of the 1990s has not hit America the same way as the '80s did because it has not resulted in the ostentatious displays of wealth the 1980s brought us. Investing seems safer because it seems somehow more down-to-earth. In Lewis's estimation, though, this is dangerous, because the new face of investing is a deceptive one. The wealth of the 1990s, he argued, is just as speculative as that of previous decades, and just as prone to having the carpet pulled out from under it. Ostentation is preferable to restraint, then, because the former makes us aware of its tenuous nature, and thus makes us hesitant about being involved. For Lewis, too, the end of the boom is inevitable, because that's just the way people are. At some point, they decide to pull out, and the run on the bank begins. History, in this argument, teaches what will happen, in teaching what has happened. In a curious way, of course, the same attitude toward history informs approaches like Beating the Dow or, for that matter, the insistence that over the last 70 years stocks have outperformed all other investments. In the long run, all of these arguments suggest that things are pretty much the same. People can be trusted to act in the same manner. The economic system is relatively consistent. New companies come and old companies go, but the fundamentals remain the same. What's curious about this attitude is that although it looks to history for examples and instruction, it is in fact resolutely opposed to the essence of historical thinking, which depends on the insight that things are always different, and that the particular economic and cultural factors that define reality at any moment are, in fact, crucial. One can certainly look back at the last 70 years of American history, now that they're over, and say that at the beginning of that period the Dow was at a certain number and at the end of that period -- that is, today -- the Dow is at a different number, and that means the Dow rose, on average, 10% annually over that period of time. But that doesn't mean, on the one hand, that the Dow will continue to rise at that rate for the next 70 years, nor does it mean that the Dow had to rise at that rate over the last 70 years. Those 70 years, after all, included the Great Depression, World War II, the Cold War, American dominance of world markets, the oil shocks, stagflation, the growth of global competition, the invention of the computer, and the worldwide triumph of capitalism. It's simply not meaningful to treat those 70 years, in that sense, as one period. Similarly, but even more crudely, the idea that people are basically the same, and will eventually bolt and run, relies on facile generalization instead of real analysis. Yes, previous market booms have ended, and it is likely that at some point this one will slow down, at least once American corporations stop turning in such good earnings numbers. But there is a crucial element in this bull market that distinguishes it from all previous bull markets, and that has gone virtually unremarked, namely the end of the Cold War. The transition of Eastern Europe to a market economy, the fall of the Soviet Union, the gradual embrace of capitalism by China and Vietnam: taken together, these changes have created a qualitatively different situation for multinational corporations (most of which remain American). The sheer number of new consumers alone represents a previously unheard-of opportunity. More than that, though, the disappearance of an institutional base for Communism has strengthened the hand of free market advocates at home and abroad, which has given corporations more of a free hand than was customary through much of the post-New Deal period. Capital can go almost anywhere now with the greatest of ease. The power of currency markets to dictate national policy has helped create more accommodating environments for business. The social consequences of these changes have not been universally beneficial. There has been a meaningful increase in the inequality of wealth and income both within the industrialized countries and between developed and underdeveloped nations. Workers in the G-7 nations have had to give up the idea of job security, while workers in newly industrialized countries are already feeling the pressure of global competition before even having a chance to enjoy the fruits of their national success, as the strikes in South Korea suggest. Further, a successful model of capitalist development for Latin America and Africa has yet to be found. Nonetheless, from the perspective of business, the end of the Cold War was of enormous long-term benefit, of such benefit, in fact, that it's hard to see how analogies from the past can be taken at all seriously. This is a unique moment in the history of American capitalism, a moment in which there is no serious opposition to the system or its representatives. And in that respect, it's hard to imagine why the bull market should end, let alone why it would end. Investing in the market, after all, is at its heart a statement of faith in the future of American business. When, exactly, have the conditions for a bright future for American corporations been better?