"In Investing, Extrapolation of Recent Experience Leads to Agnosticism - At Best"

Sydney M. Williams

Thought of the Day

“In Investing, Extrapolation of Recent Experiences Leads to Agnosticism – at Best”

July 1, 2010

A good friend who is managing his own wealth recently relayed the concerns of his son. The young man, in his early thirties, works as a policeman in another city; his entire experience with the market over the past dozen years has been unsatisfactory – in fact worse than that; he concludes that those of us in the business (and his father has been on Wall Street for over forty years) are either morons or crooks. My friend’s brother, an architect, agrees with his nephew and contrasted the 1950s NYSE advertisement about buying a piece of America to the eleven second average holding period for Tradeworx, a high frequency trading fund in Red Bank, New Jersey.

The Press is filled with stories of strikes in Greece, a slowdown in China, synthetic CDOs – problems that seem alien to the average investor. This has created, as my friend Craig Drill wrote yesterday, “an amorphous sense of fear and a loss of faith in the equity culture with which we all grew up.”

While these concerns do reflect a changing culture, they are also a function of a market that is lower today than it was a dozen years ago. At the end of February 1998 the S&P closed 1049.34. As this is written, the S&P 500 stands at 1030.69, an unpleasant experience for a young person just beginning his investment career and equally disheartening for one nearing the end of his career.

What makes the experience even worse and affects behavior has been the volatility of markets, the corruption and scandals and the enormous sums of money a few people have made while the indices went nowhere. In the past dozen years, the S&P 500 has twice been above 1500 (March 2000 and October 2007) and twice below 800 (October 2002 and March 2009). The scandals, in the first part of the last decade, at Enron and WorldCom, etc. made investors skittish, and the failure, in 2008, of household names like Lehman, Countrywide Credit, AIG, Fannie Mae and Freddie Mac added to investors nervousness. High frequency traders, operating in recesses of the market unavailable to the average investor, were largely responsible for the “flash crash” of May 6 of this year. And, despite a market that produced no gains over the past dozen years and scandals which racked the market, a small number of hedge fund managers pocketed a billion dollars for a year’s work.

Is it any wonder that this young cop feels that he is playing against a stacked deck? We all extrapolate our most recent experiences. It is human nature. The investment experience, over the past twelve years, has been disappointing. Millions of young people feel as does my friend’s son – that Wall Street is a fixed game, that investing is, at best, a no-win concept.

While it may not be comforting to a young person suffering from today’s market, we have been stuck in these ruts before. It took just over twenty-five years for the Dow Jones to reach a new high following the Great Depression – August 30, 1929 until November 23, 1954. On February 6, 1966 the Dow Jones closed at 995.14; it would take until December 17, 1982 before it consistently traded above that level. Those periods – twenty five and sixteen years respectively – are long, but keep in mind we have been in the current rut for a dozen years.

There is a sense that events are controlling Washington, that no one in charge fully appreciates this loss of faith by the millions of smaller investors in our capital markets and the importance of those markets to their future well-being. However, government can act. The tax code can be used to encourage long term investing. Profits on day trades, for example, could be taxed at 90%, while investments held more than five years might incur no tax. Regulatory bodies can ensure that high standards for listing on the various exchanges are maintained and that brokers comply with all regulations. A healthy investment environment is critical to the well-being of our nation. It is not Main Street against Wall Street. Theirs is a symbiotic relationship. Wall Street cannot function without Main Street anymore than Main Street can operate in isolation from Wall Street. We need a renewed sense that man, once again, controls events.

It is easy for me, an aged Wall Street warrior, to quote King Solomon, “this too shall pass.” And it will. But that does not help one whose investment experience, as of today, has been so discouraging.

The consequences of doing nothing are daunting. The tax code needs to be used to encourage savings and long term investments, discourage consumption and encourage exports. The economy, even as growth resumes, will be hindered by a deleveraging consumer. We have a government that has stretched its borrowing beyond reasonableness. We have consumers who have not saved for a retirement age that is fast approaching. We have interest rates that pay very little for the prudence of saving. We have a social security system well on the road toward insolvency, public pension funds that are dramatically underfunded and there is too little money in millions of 401K plans. We have a government that seems oblivious to this problem of inadequate private financial resources that threaten the future welfare of our people – a government that seems intent on gaining political advantage by condemning private enterprise and bad mouthing Wall Street; in exchange they offeri the welcoming arms of a [bankrupt] state.

We all extrapolate our experiences. Those experiences govern our behavior, but they also bring wisdom – wisdom from which we can learn. Nobody can foresee the future, yet history suggests, despite the last dozen years and no matter how bleak the future appears, that long term investors will be rewarded.