Devil Take the Hindmost - history repeats

We have been here and seen this bubble cycle many times before. In his 1999 book, Devil Take the Hindmost, Edward Chancellor documents the long history of financial speculation. Early in the book he quotes John Stuart Mill. Writing in the 1800's, Mill wrote:

"Some accident which excites expectations of rising prices... sets speculation at work...In certain states of the public mind, such examples of rapid increase of fortune call forth numerous imitators, and speculation not only goes much beyond what is justified by the original grounds for expecting a rise in price, but extends itself to articles in which there never was any such ground; these however, rise like the rest as soon as speculation sets in. At periods of this kind, a great extension of credit takes place."

Chancellor goes on to write this short description of the behaviors of bubble cycles, many of which which are playing out today:

"The governments failure to regulate or supervise the new stock market and its stimulation of a lottery "fever" were key factors in the genesis and development of the 1690's boom. This was supplemented by the venality of members of Parliament who were more interested in profiting personally from the stock market than in opposing its excesses. As we shall see, a combination of laissez-fair and political corruption is a common feature of later manias - the most notable example being the Japanese "bubble economy" of the 1980's. When the boom ended and was followed by an economic crisis, the political situation changed. The selfish and shortsighted behavior of stockjobbers and promoters suggested a limit to the economic role of self-interest, and laissez-faire was replaced by regulation of both trade and the stock market.. Other manias have also been followed by a wave of popular, if rather hypocritical, revulsion against "greed."

After the crisis of 1696, stockjobbers became a symbol for the avarice of society at large, just as the "moneylenders" (President Franklin D. Roosevelt's phrase) were castigated in the 1930's"

For the long term investor it is important to understand that the history of capital markets is filled with incidents that are similar to the one we are living through. It is not different this time. Rather, it appears to be consistent with the historical record.

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Bogle - On Long Term Investing

Bogle starts Common sense on Mutual Funds with a lesson on the long term nature of capital markets. He quotes from the book/movie Being There - about a reclusive gardener for a wealthy man. when the wealthy man dies the gardener, named Chance, is mistaken for the rich man by an advisor for the president. Chance is asked for advice on the troubled financial markets by the presidential advisor. Chance can only answer with what he knows. He says that "growth has its season. There are spring and summer, but there is also fall and winter. And then spring and summer again. As long as the roots are not severed, all is well and all will be well."

This is a great allegory of our capital markets. there will be ups and downs and periods of stagnation, but as long as the roots of our governments and financial systems stay intact, we will be rewarded as long term investors.

Bogle demonstrates that since 1800 our nation has been through many recessions, depressions, a civil war, 2 world wars and many other difficult times. But over that period we have seen the following:

* Stock Market returns of 8% (6.9% real - adjusted for inflation). The volatility of this return has shown returns as low as -48.4% and as high as 61.4% .

*Long Term US Treasury Bonds have had returns of 5.1% (3.6% real) with a volatility that ranges from -21.9% to a high of 35.1%.

Then Bogle goes on to demonstrate that over long periods of time, the swings in a market portfolio of stocks is dramatically reduced. In any given year an investor can and WILL experience the dramatic swing in returns (winter, spring, summer, fall).

holding stocks for the last 15 years would have resulted in a 6.9% real return (4% standard deviation). Holding stocks for the last 25 years would have netted a real return of 6.9% and a 1.4% standard deviation.

Standard deviation is a measure of volatility. A standard deviation of 4% means that 66% of the the fall within 4 of the 6.9% 15 year return. So, 66% of the time the returns were between 10.9% and 2.9%. It also means that 95% of the returns were within 2 standard deviations of the average.

The lesson is that for young people investing for retirement, for trusts and foundations, who all have a long term horizon, one can expect a historical return of 6.5% and long term standard deviation of 1% if they stay in the market.

"Ignore Jim Crammer. Pay attention to Jack Bogle!"

The title quote was authored by David F. Swensen, the Chief Investment Officer, Yale University.

I could not agree more. As we will learn in the coming weeks, Jack Bogle is the founder of The Vanguard Mutual Fund Group and one of the financial industries most respected advocates of index funds and low mutual fund fees. Jim Crammer is the host of Mad Money on CNBC, a brilliant man, but in my opinion, a man who perpetuates the idea among the average citizen that he can outperform the stock market. Where as Bogle advocates for a carefully diversified portfolio of index funds and owning stocks only for the long run. Crammer makes one think that through superior insight and/or information one can pick the right stocks, time the market and quickly get rich. Who is correct is a debate that rages on Wall St.

I fall on the side of Jack Bogle. Twenty years of study and observation have strengthened this position. These ideas will be explored as I Blog ideas from Bogles 10th anniversary edition of "Common Sense on Mutual Funds"