This Time, It Isn't Different

Published in Investing on 27 March 2012

The trend isn't your friend. Says who? The investor Warren Buffett admires.

"When I see memos from Howard Marks in my mail, they're the first thing I open and read. I always learn something, and that goes double for his book," is Warren Buffett's view on Howard Marks, who I've mentioned here before.

Mr Marks is the founder and chairman of Oaktree Capital Management, a value‑oriented American fund management firm, and the author of The Most Important Thing -- one of the best investment books I've read.

The book owes much to Mr Marks' habit of periodically sending pithy, well-argued memos to his clients -- with the memos in question being those that Warren Buffett was referring to.

Handily, Mr Marks has just sent out another memo, prompted by spending a sleepless night on a business trip re-reading The Death of Equities, an article published by Business Week magazine back in 1979.

Yet another lost decade

Cogently argued, The Death of Equities surveyed the investing climate back in 1979, and noted persistently high inflation, low levels of interest among mutual funds for holding equities, a move into fashionable overseas and alternative asset markets, and 10 years of exceptionally low returns by historic standards.

As an investment, it concluded, equities were dead: it was time for investors to find other places to put their money.

Sounds familiar? It certainly should.

Our own present 'lost decade' for equities regularly brings out doomsayers, invariably pointing out that the FTSE 100 is lower now than in 1998, and that buying shares is a mug's game.

Missing the bottom

The trouble is, 1979 didn't mark the death of equities. As Mr Marks observed, it actually marked the beginning of the greatest bull market in history.

And when the author of The Death of Equities was complaining how cheap shares had become relative to the underlying assets in question, he was actually signalling that the stock market was a screaming buy.

But he missed it. Most private investors and the wider stock market missed it. Commentators and business school types missed it. Mutual fund managers missed it.

"Common sense isn't common: the crowd is invariably wrong at the extremes," says Mr Marks. "In the investing world, everything that's intuitively obvious is questionable, and everything that's important is counter-intuitive... Four of the most dangerous words in the investment world: it's different this time."

And, of course, it wasn't different this time. For, as Mr Marks observes, the S&P 500 gained 18.4% in 1979, the year that The Death of Equities was written. It then went on to average 18.9% for the next 20 years.

The trend is not your friend

What are investors getting wrong? Simply put, says Mr Marks, they're extrapolating the recent past into the future, instead of looking at the fundamentals and then applying a little logic.

"Trends that lead up to a point in time have a profound effect on people's thinking," he writes.

The result? They're too pessimistic at the bottom of the market -- and too optimistic at the top. Which is where they went wrong in the late 1990s, imagining that stock market gains of 30% and more a year could continue for ever. Ditto, more recently, March 2009, which saw the FTSE bounce back from 3,461 to 5,602 exactly 12 months later -- a rise of some 62%.

And investors are also getting it wrong today, he argues. While the situation isn't as dire as in 1979, eerie parallels can be drawn:

  • The S&P 500 is 8% below its 2000 high, while earnings per share have nearly doubled.
  • The 30-year return on shares is below the return on bonds.
  • The P/E of the S&P 500 is in the low double digits, cheap by historic standards.
  • Investors are pulling money out of shares, and buying bonds.

History rhymes

Don't be fooled, argues Mr Marks. Take the long view, look at the facts and not the hype.

"The media usually gets it wrong, and the pieces that get the most attention tend to be highly sensational, and get it the most wrong," writes Mr Marks. "Most things eventually prove to be cyclical, and tend to swing back from the extreme towards the mean."

All of which sounds sage advice to me.

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Comments

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jeff700 27 Mar 2012 , 5:30pm

The All-share Index adjusted for inflation, at the end of 1960s bull market, was around 3000. In 1979 it had fallen under 1000. The next bull market was just prices returning to the previous bull level, which it did around 1996. Then it bubbled for 3years and popped!

The point is - The Allshare is now around 3000, How can a bull market start now? Answer - it can't!


Japan is the only stock market which resembles 1979.

seriousmoneyFool 27 Mar 2012 , 6:16pm

Mr Marks' book is a real eye opener and changed the way I thought about investing. His investing experience is priceless and any young investor starting out would undoubtedly learn a great deal by reading his fantastic book, which will probably become an investment classic in the future.

MAACPRIME 27 Mar 2012 , 9:09pm

Why shouldn't it go higher than 3000? The UK and global economy is a lot bigger than it was in the 60s.

ANuvver 27 Mar 2012 , 9:39pm

Who was it came out with the old one about when everyone's thinking the same thing, noone's thinking?

We certainly seem to be reliving some part of the 70s...

spinquark 28 Mar 2012 , 12:24am

"the all share adjusted for inflation..."

inflation is inflation, not economic growth. You need to adjust for economic growth too. In Q4 1969 UK GDP was about £12 billion, in Q4 2011 it was £380 billion. Adjusting GDP in Q4 1969 for inflation gives a figure of £142 billion. The all share index might therefore be expected to be 2.7 times higher today than in 1969 after inflation i.e. around 8000.

Can a bull market start from today's level - most certainly.
When will it happen - when fear turns to greed - and nobody can know when that will be - only that it will happen sometime.

(PS Data found by googling - dont blame me if unreliable)

jeff700 28 Mar 2012 , 10:47am

Why haven't dividends kept up with economic growth then? If it had the yield on the All share would be close to double figures now. Perhaps the economic miracle, of the last 40yrs, has just been expanded with easy credit.

The Motley Fool is a brilliant website, probably the best for learning about shares and I love reading the articles everyday, but I just don't agree that we are anywhere near the start of a bull. Quite the opposite.

I will keep my gold, Japan equities and lots of cash and be laughed at. But sometimes he who laughs last, laughs the loudest.

iMacSurfer 28 Mar 2012 , 1:35pm

While I have respect for the opinions of long term investors that have done well over the years, the investment advice offered varies from sell all your equities and get into gold and bonds, to equities are cheap, dive in now. I tend to think that Howard Marks is probably correct, but not for the those reasons.

It seems that the environment is so unlike other times and the experiments being carried out by governments are on such a large scale, that we can only take a wild guess as to what will happen. The straightjackets imposed by the IMF and ESF appear simplistic and bound to cause future problems, but my crystal ball is very foggy right now.

I like to hold and grow, and will probably do this even with a major euro crisis, on the assumption that international businesses and staples can't all go bust, or we'll all be back in caves and investments won't matter too much then!

cicero101 28 Mar 2012 , 8:48pm

I have been investing many years, and am familiar with buy, sell, hold etc., but what do the rest mean ? Overweight, first buy, underweight, convict buy, only for the brave. Some are self explanatory. Can you provide a brief rundown for amateurs like me ?

Neville P.

sludgesifter 28 Mar 2012 , 10:09pm

More economic growth accrues to business start-ups with fresh capital than to incumbent companies quoted on the stock market. Roughly, the long-term dividend return on the market index portfolio grows at around 0.5%, compared with per-capita GDP growth of about 3--4 times that amount, in real terms.

dukindiva 28 Mar 2012 , 10:10pm

Malcolm

Reversion towards the mean tends to suggest no real progress can be made; maybe timing is much more important after all.

MDW1954 29 Mar 2012 , 8:53am

dukinddiva,

Reversion to the mean trend equates to mean trend progress, not no progress at all.

Malcolm (author)

spinquark 30 Mar 2012 , 9:01am

"Why haven't dividends kept up with economic growth then? If it had the yield on the All share would be close to double figures now."

No, yield is a percentage.
Total dividends paid out have very likely kept up I am sure even without googling for the data itself. It is the absolute amount paid out which will tend to rise with GDP, not the percentage yield on the share price.

jeff700 01 Apr 2012 , 4:04pm

It doesn't matter all that much because no one can predict where the markets going, ya can only take a guess.

In 1979 things could only get better. The Allshare was less than 1000 in real terms with a yield over the 6% mark. Inflation and gilts yields were sky high, gold was approaching the same number as the Dow Jones (it's only around 13% of it today! ) But debt was low. House prices were cheap.

But today sadly we are living in opposite land, big debts, silly house prices, low inflation, and gilts yields that will, eventually, only go up...The problems are still to come.

If you really need to re-live 1979 then bounce on a space hopper, listen to a Boomtown Rats CD or wear a orange jumper, but maybe think about living shares alone and don't short gold!

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