Closer To The Ideal

It’s a little known fact, but Warren Buffet is rich because of my great-grandmother, Nanny. She had a simple, two-step process for making him rich:

1.) She told my grandparents, and my dad, “Don’t ever invest in the stock market. Only crazy people invest in the stock market.”

2.) She, and everyone else in her generation, eventually passed away.

She herself got rich in Florida, during the land boom of 1925-1927, and then she lost most of it when the crash came in 1929. If you told her that real estate always appreciates in value she would have laughed in your face.

Warren Buffet is a transitional figure, and he has been well rewarded for correctly sensing the transition of sentiment that he lived through. For 50 years after the crash, the public was well aware of the dangers of investing. My great-grandmother died in 1974. By the time the stock market boom started in the 1980s, there were few people around who’d actually lost money during the crash of 1929-1932.

The stock market has had an incredible run since 1982. Though (according to Kevin Phillips)  it lost 75% of its value from 1966 to 1982 (adjusting the nominal value for inflation – remember the 70s saw the Great Inflation) it has since risen with few interruptions. 26 years is a very long boom. This chart suggests that the market returned to the long-term trend line and then rose unsustainably above it.

There were millions of citizens, like my great-grandmother, who avoided the stock market after 1929. They helped create the low valuations that made the stocks on the stock market a good value, using traditional metrics like P/E ratios. Once upon a time, in a land now far, far away, a P/E ratio of 15 was considered frighteningly high. This month, the Dow Jones is suddenly back under 15, having spent most of the last decade above it. Will this level again come to be seen as normal, or will this eventually be seen as an aberration?

I recall sitting at a coffeeshop with a friend of mine in 1994. She had just gotten her masters degree and, with her first real job, she had received a long sales pitch from the investment advisor who played some role with the retirement plans that her new company offered. She’d been given two options, a low risk fund that would return 12% a year, and a high risk fund that would return 16% a year. Inflation, she was told, averaged 4% a year, so real returns would be 8% or 12% a year. That kind of nonsense was common back then. At 16% a year, then a $1,000 invested in 1994 would now be worth $9,265, yet no one has made that kind of money on the stock market. (Note that the chart I just linked to says that the real rate of growth for the Dow since 1915 has been 2%. And recall that most investors and fund managers do worse than the market averages.) Impossibly attractive rates of return were made to sound normal. And yet while my friend and I were both wary of the numbers, that kind of rhetoric seemed to have some kind of legitimacy, just because it was coming from so many sources: the TV, business magazines, advisors, friends, co-workers. My great grandmother was no longer around, and could no longer laugh in people’s faces.

This entry was posted on Wednesday, December 31st, 2008 at 7:18 pm and is filed under business. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.