Section 1
WHATâS OLD IS NEW AGAIN
Back across the ages, bear markets follow bulls as famine follows feast, and 3,000 years ago Joseph proved that anticipation of the inflection point can make tremendous difference in your life-style.
âBarton Biggs, April 1, 1996
Reading through over two decades of Bartonâs chronicles, itâs hard to argue with one of his favorite adages, âhistory doesnât repeat itself, but it rhymes.â Biggs believed that a deep and thorough understanding of the past was importantânay, absolutely necessaryâto preparing for the future. Like a symphony orchestra, the music may change and evolve, but ultimately the players behind the instruments remain the same. âThe present always seems different from the past, but human nature doesnât change, and the patterns of fear and greed repeat.â
Biggs was fascinated with the mechanics of bubbles and panics and devoted numerous weekly missives to the topic. He read narrative accounts of past market crashes and assembled lists of dozens of âstock market breaks and deathsâ from around the worldâmost unknown to the U.S. investorâwhich convinced him that the boom-bust cycle was not a rare occurrence, but an integral aspect of the market. Manias and panics are simply a phenomenon to be expected, understood, and planned for like any naturally occurring and ultimately unstoppable event such as a hurricane. Or as Biggs would say more succinctly, âAs long as there are markets and people, there will be panics, manias, and crashes, and the more you know about them, the better your chances of not getting killed in one.â
He also believed strongly in the reversion to the mean. While extremes do exist in nature, conditions moderate back to the normal over time, just as sunshine follows rain. âThe course of events in markets really donât change much from century to century, because the two great constants in the stock market are human emotion and prices. Patterns tend to repeat themselves.â
If there was ever an investor living at the polar opposite of todayâs high-speed, black-box trader, it was Barton Biggs. Biggs didnât just study markets over weeks, months, and years. He launched himself into geosynchronous orbit to view economic cycles on the scale of decades and centuries. He concluded that despite the ups and downs, stocks were the place to be in the long run. âHistory supports the cult of the equity, providing you can hang on through the air pockets,â albeit with a tempering caveat: âThey really do generate the real returns, but not the double-digit ones some people now anticipate.â
Fundamentally, history is the study of past human actions. Whether the scene is the trading floor, battlefield, or political podium, Biggs saw commonalities. He studied the full gamut of history and came to his own startlingly prescient conclusions for our future.
For one, Biggs foresaw Islamic extremism as a long-term market risk years before 9/11 brought the concept front and center in the mindshare of America. He saw a future with ârandom acts of terrorismâ that would someday âdegenerate into a real shooting war.â
He was also a voice of reason among doomsayers amid skyrocketing oil prices during an existential standoff between Eastern Communism and Western Democracy. While heavyweight pundits decried the decline of the West, Biggs dismissed the catastrophization as nonsense, not because of wishful thinking or pathological denial, but because of the astute observation that events throughout history do not happen in a vacuum. Actions beget reactions, and human beings have a remarkable ability to adapt and copeâoften in unexpected ways. As Biggs noted, quoting Barbara Tuchman, âYou cannot extrapolate any series in which the human element intrudes; history, that is, the human narrative, never follows, and will always fool, the scientific curve.â
Some of his most captivating and unique work came in the form of diary entries, where Biggs provided readers a hypothetical inside glimpse of the innermost thoughts of world leaders and despots in the midst of historic events like Tiananmen Square and the fall of the Berlin Wall. The creative approach serves as a memorial to the Cold Warâera mind-set, along with the unknown consequences of our current involvement in Iraq and Afghanistan.
While Biggsâs occasional articles with a historical bent are hardly a comprehensive treatment of world events, an investor could do worse. Together, the pieces constitute a powerful foundation for understanding the long view of a true financial luminary through three decades of dramatic change and tectonic world shifts.
Section 1A:
Market History and the Long View
In Search of History and a Word Processor That Works
April 23, 1985
Last week, I said I would write this week about the crucial allocation between stocks and bonds that is on everybodyâs mind. After spending three hours or so writing on this subject on Sunday, the ultimate word processor nightmare occurred, and, on the print command, my entire text was erased. Itâs too late to attempt to rewrite this week what was lost so, instead, let me summarize some conclusions.
In making asset allocation decisions, I use both mathematical tools and subjective judgment. Nunzio Tartagliaâs Analytical Systems Group has developed a variety of quantitative models for comparing stocks, bonds, and short-term investments, and I use a Present Value Model and the Ford Dividend Discount Model. In addition, straight risk/reward analysis of stocks, bonds, and bills is helpful. Next week, I will report on the status of each of these systems, all of which, incidentally, say that bonds are more attractive than stocks right now.
However, I place more emphasis on judgment considerations, because valuation models are just snapshots of the presentâs relative value relationships. These models have no predictive powers. Yet, financial asset prices have a lot of the future in them; in other words, they incorporate discounting mechanisms. Valuation models are like X-rays; they do not in and of themselves evaluate a patientâs future health, but they help the doctor to do so.
It may sound corny, but I believe the investor should heed the lessons of history, because the past replays, and one ignores its lessons at oneâs peril. The present always seems different from the past, but human nature doesnât change, and the patterns of fear and greed repeat. The cycles of economic history, particularly the ebb and flow of inflation, and the pattern of the relative performance of asset categories recurs. I am convinced that the past really is the key to the future.
We have done a great deal of work in collecting and ordering statistics. We found that it is very difficult to determine the exact year (much less the quarter) in which a particular era began or ended, and it is often difficult to fairly represent the performance of different assets. Messing around in the yellowing, dry pages of old manuals trying to reconstruct the past into an orderly framework is a good way to learn that even economic history is extremely complicated.
I think our work indicates that you want to be in bonds and commercial paper in deflationary times and in stocks in periods of price stability, disinflation, and moderate inflation. In times of rapid or accelerating inflation, real estate, precious metals, and equities provide positive real returns. But generalizations must be viewed with caution because performance varies considerably relative to the initial valuation of the asset in question. In other words, if the asset entered the period overvalued, its relative performance suffered. A recent example is equities in the latest inflationary era. After a long bull market, stocks were overpriced by all historical and psychological benchmarks as inflation began to accelerate; thus they failed as an inflation hedge. Knowing the record of history is not enough. The investor must be able to determine the present valuation of each asset relative to other assets and to its own valuation cycle.
Kondratieff and the Long Cycle
June 25, 1985
I believe that although knowledge increases, the world progresses, and technology advances, human behavior unfortunately remains the same. This is certainly true in the cycles of emotion in the stock market, and it has always seemed to me that it also should be valid in economic patterns. Thus I have been intrigued with the idea of a long cycle in human events that in general terms recurs. History does not have to repeat itself, but because people donât change, it does.
Economics is really mostly about cycles. Economists like Wesley Mitchell, Simon Kuznets, and Joseph Schumpeter have written about both the conventional business cycle and longer, 10- or even 20-year Juglar cycles. I have been fascinated for years, however, with the supercycles described by a Russian government economist named Nikolai Kondratieff, who created the first five-year plan for Russian agriculture in 1920. In 1922, Kondratieff published âThe Long Waves in Economic Life,â which describes a recurring 50- to 60-year economic cycle driven by the ebb and flow of innovation and capital investment, and that had social implications. In many ways, Kondratieffâs writings are an explanation of history.
The commissars were not amused, however, when they realized that their agricultural economistâs theory argued that the downturns in capitalist economies were not attributable to inherent defects within the system but were self-correcting. He was put on trial and sentenced to Siberia, where he spent the rest of his life breaking big stones into little ones. It is believed he died in the 1930s. His papers were generally ignored until the last decade or so, when the work of Professor Jay Forrester of the Sloane School at MIT attracted attention.
The idea of long cycles in human economic history goes back to biblical times. The Old Testament tells of 50-year jubilees, in which slaves were freed and debts were forgiven. Gibbonâs Decline and Fall of the Roman Empire gives evidence of a 50-year cycle of war and inflation, and a 54-year cycle can be found in the history of agricultural prices going as far back as the Mayans in Central America in 1260. Even primitive economies seemed to become overextended in a regular, more or less half-century cycle. Wealth in terms of land, slaves, and debt would become concentrated, and a purge to revitalize was almost part of the order of nature.
Each cycle, as the accompanying chart shows, is characterized by four distinct phases. First there is a long growth era (27 years on average) culminating in an inflationary peak. Then comes a 1- or 2-year primary depression, which is followed by a plateau of 5 to 10 years. The last phase is a secondary depression and 15 or more years of stagnation. The precise timing of each cycle is different, but the broad outline is eerily similar.
Kondratieff identified three 54-year cycles: 1790 to 1843, 1843 to 1896, and 1896 to the early l940s. His charts and papers, which relate to England, the United States, and France, analyze commodity prices, interest rates, and wages. Actually, Kondratieff identified rather than analyzed. Professor Forrester and his Systems Dynamics Group believe the waves can be explained by capital investment. During growth phases, demand is imposed on the capital goods industries by both the consumer goods area and the capital goods sector itself. At the peak, a labor shortage drives wages up and encourages capital-intensive production, which puts even greater stress on the capital goods area. During the plateau phase, the capacity created during the growth period is not exploited, while a relative fall in labor costs encourages a shift back to greater use of labor, which further diminishes the need for new capital equipment. The stagnant phase is marked by a secondary depression and a rapid collapse of the capital goods sector. Accumulating physical depreciation then sets the stage for the next growth phase. In effect, as For...
