Beating the Street (7 page)

In between worrying about the killer bear market and the worldwide depression, we worried about the trade deficit, unemployment, and the budget deficit. I rarely sleep well the night before I'm scheduled to meet with the
Barron's
panel, but after this one I had bad dreams for three months.

The 1989 panel was somewhat cheerier than 1988, although Mr. Zulauf brought up the fact that this was the Year of the Snake, a bad sign in Chinese cosmology. When we convened in 1990, the oft-predicted Depression was nowhere in evidence and the Dow had climbed back to 2500 points. Still, we found new reasons to stay out of stocks. There was the collapse in real estate, another calamity to add to the list. We were unsettled by the fact that after seven straight years of up markets (1987 ended with a slight gain over 1986, in spite of the Great Correction), a down market was inevitable. Here was a worry that things had been going too well! Friends of mine, sophisticated people and not easily frightened, were talking about taking the money out of banks and hiding it at home, because they thought the money-center banks might fail and collapse the banking system.

The pessimism of 1990 beat the pessimism of 1980–82, when investors were so depressed about stocks that whenever the subject came
up they changed it to earthquakes, funerals, or even the futile pennant hopes of the Boston Red Sox. In 1990, they weren't simply avoiding the subject, they were eager to tell you how they were betting
against
the market. I actually heard cabdrivers recommending bonds, and barbers bragging about how they'd bought “puts,” which increase in value as stocks decline.

Barbers are a segment of the population that I assumed had never heard of put options, but here they were making these complicated wagers with their own paychecks. If Bernard Baruch was right about selling all stocks when the shoeshine boys are buying, then surely the right time to be buying is when the barbers discover puts.

I collected a sample of some of the happier headlines to re-create the public mood in the fall of 1990:

“Layoffs This Time Hit Professional Ranks with Unusual Force,”
Wall Street Journal
, October 4.

“How Safe Is Your Job?,”
Newsweek
, November 5.

“Scraping By,”
New York Times
, November 25.

“The Real Estate Bust,”
Newsweek
, October 1.

“High Rents Could Be Keeping Young from Setting Up House,”
Business Week
, October 22.

“Housing Slump Hammering Home Remodelers,”
Business Week
, October 22.

“How the Real Estate Crash Threatens Financial Institutions,”
U.S. News
, November 12.

“Housing Recession That Began in Northeast Three Years Ago Now Engulfs Entire Nation,”
New York Times
, December 16.

“Deficit Plan Will Face Dicey Fate in Congress and Isn't a Cure-Ail,”
Wall Street Journal
, October 1.

“Uncertainty Rains for U.S. Economy,”
Wall Street Journal
, December 3.

“The Consumer Has Seen the Future, and Gotten Depressed,”
Business Week
, December 10.

“A Survival Guide for the Age of Anxiety,”
Newsweek
, December 31.

“Can America Still Compete?,”
Time
, October 29.

“Can Your Bank Stay Afloat?,”
U.S. News
, November 12.

“Can You Compete? The Americas Are Falling Behind and What Can Be Done to Pick Up the Pace,”
Business Week
, December 17.

To top it all off, there was a war in the desert to fight. Cameras were rolling in the Pentagon briefing rooms, where millions of viewers learned for the first time where Iraq and Kuwait were located. Military strategists debated how many body bags would be needed to ship home the casualties from the chemical and biological weapons soon to be loosed on our soldiers by the well-trained Iraqi army, fourth-largest in the world, hunkered down in reinforced bunkers hidden in the sand dunes.

This Mother of All Worries had a predictable effect on the fearful forecasters. By January 15, 1991, when we convened at the
Barron's
offices, the specter of body bags hung over our spirits. In our “wither the economy” discussion, Zulauf, though gloomy as usual, once again was outgloomed. He foresaw a fall in the Dow to somewhere between 2000 and the lows of the 1987 Big Correction, while Michael Price saw a 500-point downside, Marc Perkins an eventual fall to 1600–1700. Yours truly volunteered that in the worst case we could have a major recession, and if the war was as terrible as some had expected we'd see a 33 percent drop in the price of stocks.

Since you can't get onto the
Barron's
panel without being a successful investor, it's safe to assume that all of us have somehow managed to develop a disciplined approach to investing that enables us to block out our own distress signals. Along with the rest of the country, I knew there was a chance that Operation Desert Storm would turn into a long and bloody conflict, but meanwhile, the stockpicker in me couldn't help notice the amazing bargains that had resulted from the widespread selling by investors. I was no longer dealing in millions of shares as I had at Magellan, but I was adding to my holdings in my own account, and buying for the charitable trusts and public foundations whose portfolios I help manage. In October 1990,
The Wall Street Journal
noticed that I'd increased my personal stake in W. R. Grace and Morrison-Knudsen, two companies on whose boards I serve. I told the reporter, Georgette Jasen, that these were just “two of about ten stocks I added to… if they go lower, I'll buy more.” I also went on record as having purchased another 2,000 shares in Magellan to add to my holdings, just as I had after I retired.

This was the perfect scenario for the disciplined stockpicker to search his or her buy lists for likely prospects. The headlines were negative, the Dow Jones average had lost 600 points over the summer and the early fall, cabdrivers were recommending bonds, mutual-fund
managers had 12 percent of their fund assets in cash, and at least five of my fellow panelists were predicting a severe recession.

Of course, we now know that the war wasn't as terrible as some had expected (unless you were an Iraqi) and what we got from the stock market instead of a 33 percent drop was a 30 percent gain in the S&P 500 average, a 25 percent gain in the Dow, and a 60 percent gain in smaller stocks, which added up to making 1991 the best year in two decades. You would have missed it had you paid the slightest attention to our celebrated prognostications.

Moreover, if you had paid close attention to the negative tone of most of our “whither the economy” sessions over the past six years, you would have been scared out of your stocks during the strongest leg of the greatest market advance in modern history, when investors who maintained their blissful ignorance of the world coming to an end were merrily tripling or quadrupling their money. Remember this the next time you find you're being talked out of a good investment by somebody who convinces you that Japan is going bankrupt or that a rogue meteor is hurtling toward the New York Stock Exchange.

“Suspense and dread cast a heavy pall over the markets,” said
Barron's
the week of our gathering for the 1991 Roundtable and just prior to the great upward spurt in the market that would carry the Dow to a record high.

It's simple enough to tell yourself, “Gee, I guess I'll ignore the bad news the next time the stock market is going down and pick up some bargains.” But since each crisis seems worse than the last, ignoring bad news is getting harder and harder to do. The best way not to be scared out of stocks is to buy them on a regular schedule, month in and month out, which is what many people are doing in the 401 (k) retirement plans and in their investment clubs, as mentioned before. It's no surprise that they've done better with this money than the money they move in and out of the market as they feel more and less confident.

The trouble with the Dr. Feelgood method of stockpicking is that people invariably feel better after the market gains 600 points and stocks are overvalued and worse after it drops 600 points and the
bargains abound. If you don't buy stocks with the discipline of adding so much money a month to your holdings, you've got to find some way to keep the faith.

Keeping the faith and stockpicking are normally not discussed in the same paragraph, but success in the latter depends on the former. You can be the world's greatest expert on balance sheets or p/e ratios, but without faith, you'll tend to believe the negative headlines. You can put your assets in a good mutual fund, but without faith you'll sell when you fear the worst, which undoubtedly will be when the prices are their lowest.

What sort of faith am I talking about? Faith that America will survive, that people will continue to get up in the morning and put their pants on one leg at a time, and that the corporations that make the pants will turn a profit for the shareholders. Faith that as old enterprises lose momentum and disappear, exciting new ones such as Wal-Mart, Federal Express, and Apple Computer will emerge to take their place. Faith that America is a nation of hardworking and inventive people, and that even yuppies have gotten a bad rap for being lazy.

Whenever I am confronted with doubts and despair about the current Big Picture, I try to concentrate on the Even Bigger Picture. The Even Bigger Picture is the one that's worth knowing about, if you expect to be able to keep the faith in stocks.

The Even Bigger Picture tells us that over the last 70 years, stocks have provided their owners with gains of 11 percent a year, on average, whereas Treasury bills, bonds, and CDs have returned less than half that amount. In spite of all the great and minor calamities that have occurred in this century—all the thousands of reasons that the world might be coming to an end—owning stocks has continued to be twice as rewarding as owning bonds. Acting on this bit of information will be far more lucrative in the long run than acting on the opinion of 200 commentators and advisory services that are predicting the coming depression.

Moreover, in this same 70 years in which stocks have outperformed the other popular alternatives, there have been 40 scary declines of 10 percent or more in the market. Of these 40 scary declines, 13 have been for 33 percent, which puts them into the category of terrifying declines, including the Mother of All Terrifying Declines, the 1929–33 sell-off.

I'm convinced that it's the cultural memory of the 1929 Crash
more than any other single factor that continues to keep millions of investors away from stocks and attracts them to bonds and to money-market accounts. Sixty years later, the Crash is still scaring people out of stocks, including people in my generation who weren't even born in 1929.

If this is a post-Crash trauma syndrome we suffer from, it's been very costly. All the people who've kept their money in bonds, money-market accounts, savings accounts or CDs to avoid being involved in another Crash have missed out on 60 years of stock-market gains and have suffered the ravages of inflation, which over time has done more damage to their wealth than another crash would have done, had they experienced one.

Because the famous Crash was followed by the Depression, we've learned to associate stock-market collapses with economic collapses, and we continue to believe that the former will lead to the latter. This misguided conviction persists in the public mind, even though we had an underpublicized crash in 1972 that was almost as severe as the one in 1929 (stocks in wonderful companies such as Taco Bell declined from $15 to $1) and it didn't lead to an economic collapse, nor did the Great Correction of 1987.

Perhaps there will be another Big One, but since I'm not equipped to predict such matters—nor, obviously, are my learned colleagues on the
Barron's
panel—what's the sense of trying to protect myself in advance? In 39 out of the 40 stock-market corrections in modern history, I would have sold all my stocks and been sorry. Even from the Big One, stocks eventually came back.

A decline in stocks is not a surprising event, it's a recurring event—as normal as frigid air in Minnesota. If you live in a cold climate, you expect freezing temperatures, so when your outdoor thermometer drops below zero, you don't think of this as the beginning of the next Ice Age. You put on your parka, throw salt on the walk, and remind yourself that by summertime it will be warm outside.

A successful stockpicker has the same relationship with a drop in the market as a Minnesotan has with freezing weather. You know it's coming, and you're ready to ride it out, and when your favorite stocks go down with the rest, you jump at the chance to buy more.

After the Great Correction, when 508 points were shaved from the Dow Jones average in a single day, a symphony of experts predicted the worst, but as it turned out, the 1000-point decline in the
Dow (33 percent from the August high) did not bring on the apocalypse that so many were expecting. It was a normal, albeit severe, correction, the latest in a string of 13 such 33 percent drops in this century.

The next 10 percent decline, which may already have occurred since I've written this, will be the 41st in recent history, or, if it happens to be a 33 percent decline, the 14th. In Magellan's annual reports, I often reminded the shareholders that such setbacks were inevitable.

The story of the 40 declines continues to comfort me during gloomy periods when you and I have another chance in a long string of chances to buy great companies at bargain prices.

Mutual funds were supposed to take the confusion out of investing—no more worrying about which stock to pick. Not anymore. Now you have to worry about which mutual fund to pick. There are 3,565 of them at recent count: 1,266 equity funds, 1,457 bond and income funds, 566 taxable money-market funds, and 276 short-term municipal bond funds. This compares with 452 funds (278 of them equity) in existence in 1976.