Bargains are hard to find right now in the U.S. share market. In times like this, I like to look back. Investors, as with practitioners of other trades, are guided by precedent.
And so I spend a good bit of time poring over old books and looking over nuggets of market history, like a geologist picking up bits of rock. In those layers of sediment lie answers.
In this history, you will find investment advice for those times when the rest of the market seems to go nuts. The historical record reminds us that common sense ultimately prevails. Herds, as a rule, make for poor investors.
Let’s look at the U.S. share market of the 1960s, a maddening maelstrom of a market. All in all, it was not so different from the raging tech bubble of the late 1990s.
National Student Marketing was the poster child of the era. Here was a company designed to capture the “youth market.” The company bought everything and anything that might aid it in this quest. It owned youth- oriented travel agencies and insurance companies, college ring makers, college mug manufacturers and more. At its great height, it was selling for 150 times earnings.
Yet look who owned National Student Marketing. Bankers Trust and Morgan Guaranty, as well as General Electric’s pension fund. The endowments at Harvard, Cornell and the University of Chicago.
Yes, the old money of banks, pension funds and endowments. These are the people to whom the uninitiated turn for trusted investment advice. These are the people who are supposed to protect and grow their clients’ wealth.
In 1970, National Student Marketing went from $36 to $1. There were many others just like it.
Adam Smith (the pseudonym of George Goodman, best-selling author of The Money Game) hatched an unusual idea for an investment conference in 1970. Instead of the usual fare in which speakers talk about their successes and favorite ideas, Smith thought it might be good to have something of a public confessional.
His would be a conference at which people talk about their mistakes and misdeeds. Smith thought this would be good for the confessors and extremely instructive investment advice for the audience. Especially after the go-go market of the 1960s met its inevitable bad end.
David Babson, our protagonist, was one of those invited to speak at Smith’s conference. Babson, then turning 60, ran the sixth-biggest investment counseling business in the country at the time.
A little background on Babson sets the stage. He started his firm in 1940. He was bullish then. Babson recommended buying growth stocks, a move that made him a radical in those days when the memories of the Great Depression were still fresh. He bought all the right stocks, it seems — 3M, Honeywell, Merck, Pfizer, Corning Glass and more.
By the 1960s, though, Babson was no longer bullish. The feisty pipe-smoking New Englander was blunt and outspoken in chastising his peers for behaving like tape-watching speculators. He was a trenchant critic of the market at the time, which was a swirling stew of gimmicky malfeasance and excessive speculation. Babson blasted his peers for “outright gambling with other people’s money,” and he called the stock market a “national craps game.”
Just as Babson found himself out of step with the 1940s, so he found himself out of step again in the 1960s.
As Smith’s unusual conference got under way, Smith thought it was going pretty well, as intended. Then he tapped Babson for comments. He took the stage and addressed the crowd. Smith asked if the blame should go to the professionals for the ’60s bubble. Babson said yes, unequivocally, in so many words. “What should be done about this?” Smith asked.
And that’s when Babson, peering over his glasses, gazing down at the audience, delivered his knockout blow: “Some of you should leave this business,” he said.
Smith reports nervous laughter among the attendees. Then Babson practically named names and launched into an accusatory tongue-lashing, lambasting the folly and incompetence of his peers. Smith finally stopped him, but the conference had, as Smith reports, “taken a sour turn.” The audience sat in stunned silence.
Babson could say what he did because he didn’t own any of the nonsense stocks. He also solidified his status as an investment folk hero for his courage and independence. Not to mention the gratitude of his clients, who escaped the 1960s with their money still intact due to his investment advice.
The current surging market surely will provide sins for future confessionals – every market does. After all, what investment adviser could possibly justify putting his clients’ hard-earned money into something as unsound as Research In Motion? The maker of the BlackBerry device posts slowing growth rates, faces numerous competitors and trades for more than 10 times sales and 60 times trailing earnings.
Research in Motion is of a type that is fairly common in the thin air of speculation these days. Look at Google, at 16 times sales and 62 times trailing earnings, or the NYSE, at 10 times sales and 119 times trailing earnings.
Yet these stocks find votaries among the pros. Look at who owns them. All the big houses – Fidelity, Barclays, Wellington, banks and trusts of various types. What are their investors paying them for?
So far, these stocks keep going up. In the latter part of the year, they rallied sharply, as did the market as whole. One day the caffeine will wear off, and with it the temporary illusion that these stocks are worth these prices. It seems only a matter of time.
Markets, though, are notoriously hard to read. People see what they want to see. Bulls will find reasons why these stocks will go higher. Bears will find reasons for them to go lower. The seldom-admitted truth is that most of the time, the market exists in some indeterminate state, like the muddled cherry of a whisky sour.
I think the main lesson from Babson is that you cannot trust consensus. You cannot rely on the “Establishment.” You can’t find refuge in the herd. And you must resist the urge to join the crowd. “Passion of the moment,” as writer J. P. Donleavy observed, “a disaster over the years.”
Babson’s firm, by the way, still lives on. Recently, it published a letter describing five essential truths the firm follows in its advice, laid out by its founder years ago. They are:
- Markets are unpredictable and ill-suited to forecasts.
- Long-term fundamentals are key.
- Investor emotion leads to volatility.
- Valuation discipline should guide investment selection.
- Perspective and patience are rewarded.
That’s not a bad set of self-explanatory truths. They are not sexy, but the best investment advice seldom is. Investors would do well to remember them – and remember Babson -when considering whether or not they should plunge in on the hot stocks of the day.
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