Dennis C. Butler, President
of all guest columns written by Dennis C. Butler, CFA
ising animal spirits in 2017 brought an uninterrupted string of nine positive annual results (including dividends) for the financial markets. The S&P 500, the standard index of U.S. stock prices, set over sixty new record highs over the course of the year, while the popular Dow Jones Industrials beat its previous record about seventy times. For the first time since 1928, the S&P logged a "perfect" year, as each month of 2017 saw gains. Even as the markets climbed, the variability of prices was unusually subdued (the calmest since 1964), producing strong "risk adjusted" returns for those with a statistical bent. For others with a more traditional view of investment risk — the permanent impairment of capital — the relentless advance of security prices caused some consternation as it was accompanied by ever-higher valuations, by some measures surpassed only by the speculative excesses of 1929 and 1999.
Given the strength of the stock market since 2009 and its stretched valuations, it is not surprising that some voices have raised warnings about the possibility of a serious market downturn. While we generally pay little heed to market forecasts, we certainly agree that securities are richly priced. Accordingly, we began to ask ourselves what we would do if this year's calm were in fact to be followed by a period of tribulation. Although we have experienced difficult market conditions before, the circumstances are always different.
We always find history to be a useful source of insight when pondering this question, and by chance, as we began these deliberations, we encountered some excerpts of the old Wall Street Week with Louis Rukeyser Friday night TV show from the 1980s. We were gripped by a wave of nostalgia as the old videos reminded us of our early days in the investment business, a time whose "quotron" machines seem as distant now as the old-fashioned ticker-tape printers did then. To be sure, technology had by that time made significant inroads into Wall Street operations — even computerized trading was well established — but those were the days before the Internet, high-speed trading, and electronic order execution. It was also a time before scandals and investigations changed — probably forever — how Wall Street firms present themselves to the world. In those days the firms seemed to have answers to the ordinary person's investment questions (some may remember the adverts confidently proclaiming that "When E.F. Hutton talks, people listen."), and analysts and investment "Gurus" of that time commanded more interest and respect than their current, largely ignored successors. Wall Street was a very different place thirty years ago, and Wall Street Week was known for giving airtime to some of the biggest names in the business.
Re-watching the shows broadcast immediately before and after the great market crash of October 19, 1987, the events of that day thirty years ago seem relatively minor — especially when one looks at a long-term chart of stock prices. Although beyond Wall Street the event had in fact little economic impact, on "Black Monday," when the Dow Jones Industrial Average fell by 22%, many people were traumatized. On the show broadcast the previous Friday, commentators were suitably impressed by the market declines that had already taken place that week. Caution prevailed, and one commentator even referred to the possibility of a crash (proving that forecasters tend to get it right only after a catastrophe has already begun to happen).
It was the program broadcast after the 1987 crash that we found most interesting. Rukeyser had three guests: the CEO of a big Wall Street wire house, an investment strategist from another major firm, and the founder of one of the largest mutual fund companies, who was known for his long-term take on investing. Having three of the most significant players in the business on the show provided an opportunity to hear their thoughts on the dramatic events that had just taken place.
Their recommendations to average investors were interesting and very instructive from an historical perspective. The CEO counseled "caution," although he did suggest that investors consider buying some stocks, or, at least, "improving their portfolios." The strategist, employing a very reasonable and reasoned argument based on the potential economic impact of the market turmoil, advised buying bonds. It was the mutual fund executive who offered a more philosophical approach, stepping back from the hue and cry of the moment to argue that in ten years or (stunningly for a Wall Street Executive) forty years, the economy would be many times bigger, generating profits that would impel future stock prices to levels many times what they had been even at the peak in 1987. As a matter of fact, he said, the Crash had created a wonderful buying opportunity as long as the investor had the patience to endure the inevitable short-term tumults. Unfortunately, from our own point of view, he weakened his case by advising investors to wait until the markets "settled down" before making any moves. It usually takes a significant recovery for markets to becalm themselves, meaning the investor would pay a price by giving up potential gains in the meantime.
A cynic could argue that these guests on a widely followed TV show were simply defending their own businesses, by trying to discourage customers from defecting at a difficult time. We would agree with this assessment to a certain extent, but with the exception of the strategist, who downplayed the big picture and focused more on short-term moves, the views expressed were basically sound. The views were offered in the midst of a market crisis, and had viewers followed the advice, they would have done fairly well over the long term, or would have at least avoided turning paper losses into real ones at a particularly bad time. Things could always have turned out differently, however, and no one knew what would happen — during periods of discontinuity the future always looks like a scary place. Yet during such times decisions must be made — even doing nothing is a choice — but how?
Here the interviewees offered clues. The strategist relied on speculation — trying to predict what would happen in the future — which was precisely what was not needed at the time. Strategists had largely failed to foresee a crash, so why should they be relied upon to predict the aftermath? The mutual fund executive, with his knowledge of history and historical perspective, was much more helpful. By reminding the audience that over many decades, markets had suffered numerous sharp setbacks and had always recovered and gone on to establish new highs, he was able to convincingly argue that "this, too, shall pass," and that in the long run it has never paid to panic, lock-in losses, and bet against the continued growth of the economy.
So, what would we do? We would not liquidate out of fear of a downturn. The notion that one can sell in anticipation of a crisis is usually misguided, as it cannot be done consistently. Likewise, succumbing to fear and selling in the midst of a panic is a losing proposition; rationally, investors should actually be buying during a crisis in order to lock in low prices and future gains. (If selling is to be done, it should be done when times are good, prices are advancing and the threat of discontinuity seems distant.) Being prepared for untoward events means understanding that in the long run disruptions pose no significant threat to one's investments. Avoiding speculation and relying on sunny prospects that wilt when the clouds of calamity appear is a must. If we can maintain such an investment stance, then we can remain confident, take the ten or forty-year view, and benefit from an economy that most likely will continue, with interruptions, much as it has before.
With the exception of an unprofitable iced tea vendor from Hicksville, NY, whose shares bounded 500% after adding "blockchain" to its name, financial markets were more or less "rationally exuberant" in 2017, producing another bountiful year for investors almost everywhere in the world as total equity market value grew by $9 trillion. This came in spite of various threats in the political and economic spheres, threats that did not materialize as many had expected. U.S. equities were notably strong, rising 15% to 30% depending on your index. If this continues, the power of compounding will mean that shareholders will own the entire planet in a few years. We wouldn't count on that happening, however, as such potential outcomes tend to meet with unexpected difficulties. Just because markets avoided trouble in 2017 does not mean the risks were not there, or that they have simply gone away. The more the markets rise, the more risks pile up as players become complacent in the expectation of continued advances. 2018 could prove to be an interesting year, indeed.. ________________________________:
Dennis C. Butler, CFA, is president of Centre Street Cambridge Corporation, investment counsel. He has been a practitioner in the investment field for over 33 years and has been published in Barron's. He holds an MBA from Wharton and a BA in History from Brown University. His quarterly newsletter can be found at www.businessforum.com/cscc.html.
"Current low valuations reward the long-term view", an article by Dennis Butler, appears in the May 7, 2009 issue of the Financial Times (page 28). "Intelligent Individual Investor", an article by Dennis Butler, appears in the December 2, 2008 issue of NYSSA News, a magazine published by the New Yorks Society of Security Analsysts, Inc. "Benjamin Graham in Perspective", an article by Dennis Butler, appears in the Summer 2006 issue of Financial History, a magazine published by the Museum of American Finance in New York City. To correspond with him directly and /or to obtain a reprint of his featured articles, "Gold Coffin?" in Barron's (March 23, 1998, Volume LXXVIII, No. 12, page 62) or "What Speculation?" in Barron's (September 15, 1997, Volume LXXVII, No. 37, page 58), he may be contacted at
Centre Street Cambridge Corporation
Post Office Box 390085
Cambridge, Massachusetts 02139
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© Copyright 2018 Dennis C. Butler, All Rights Reserved
Revised: January 16, 2018 TAF
© Copyright 2018 Dennis C. Butler, All Rights Reserved