The holidays are giving me a chance to catch up on some reading, I’m making it through the December edition of The Atlantic, and they have a second article on investment bubbles worth noting. I previously posted on the article describing academic research showing humans always create investment bubbles, even when it appears completely irrational to do so. In “Why Wall Street Always Blows It” Henry Blodget provides a similar discussion but from a real-world observational perspective.
A quick sidebar: Blodget is one of the bad guys from the Tech Bubble. He gives a superficial review of his roll as a star stock analyst who helped pump tech stocks of questionable value, but ultimately claims he was just a cog in a much larger wheel. As someone who was more than a casual observer of the workings of Wall Street during that time, I can say that Blodget was a very large cog, if not a wheel himself. There is a reason he was subsequently barred from the securities industry. That being said, he has reinvented himself as an insightful commentator on Wall Street and his article is a worthwhile read in its entirety. Below are just a few snippets and comments.
I wholeheartedly agree with Blodget’s claim that our current economic crisis is much more than a housing bubble bursting. As I have also been telling clients,
Boom-and-bust cycles like the one we just went through take a long time to complete. The really big busts, in fact, the ones that affect the whole market and economy, are usually separated by more than 30 years—think 1929, 1966, and 2000. (Why did the housing bubble follow the tech bubble so closely? Because both were really just parts of a larger credit bubble, which had been building since the late 1980s. That bubble didn’t deflate after the 2000 crash, in part thanks to Greenspan’s attempts to save the economy.)
Blodget spends a lot of time talking about the psychology of investors, investment professionals, and quotes one of the best commentators on the subject that I have read, Jeremy Grantham. (Grantham’s quarterly letters are not to be missed; they were the earliest words of caution that I read on the impending housing bubble and the massive havoc it would cause.) As Blodget quotes from one of Grantham’s recent letters:
“We will learn an enormous amount in a very short time, quite a bit in the medium term, and absolutely nothing in the long term.”
Most interesting to me is the discussion of “this time it’s different”. Often used as an excuse to invest into a obvious bubble, it is also used later to explain the foolishness of investing in that bubble (you didn’t actually believe that it would be different this time, did you?). If, in fact, it is not different this time, then what should we expect going forward? One answer is that we recover quickly, the ever-resilient economy gets back on its feet in a relatively short period of time, and the stock market resumes its inexorable march up and to the right. Another answer is implied, although not explicitly stated, by Blodget.
If we are in the midst of one of the “really big busts” that have happened only a few times, “think 1929, 1966, and 2000”, what does that imply? We know what happened in the Great Depression. What about 1966? In January 1966 the S&P 500 hit a high of 92.88. Over 12 years later, in March of 1978 the S&P 500 was trading lower, at 89.21. In fact, if you invested in the S&P in January of 1966 and held on until July 1982 – that’s 16.5 years – you would have seen your investment rise from 92.88 to 107.09 a paltry 14.21 or 15.3%. We’re more in the mindset of expecting 15.3% annual returns, not that much in 16.5 years! A simple savings account would have done better.
If it is not different this time, then we will have a hang-over from this bubble bursting for a while longer than many hope.