How the 1973-74 Bear Market Changed How People Judge Investment Performance

Jonathan Clements wrote my favorite personal finance book of 2016 — How to Think About MoneyPeople have an odd relationship with money because we spend most of our time stressed out about it. This book does a great job of trying to get people into the right frame of mind about their financial decisions and using money to make them happier, not miserable.

While discussing the need to embrace humility when investing, Clements brought up a fascinating story about an interview he did with the late-great Peter Bernstein in the mid-1990s. With a little help from the author himself I tracked down that original interview. Here’s the part that jumped out at me (taken from the original piece in the WSJ):

The bear market of 1973-74 nearly halved the Dow Jones Industrial Average, sending it spiraling down from a January 1973 peak of 1051.70 to 577.60 in December 1974. It was a slide that permanently changed the way people judged investment performance.

Before the fall, institutional and individual investors often didn’t bother to measure the returns their money managers produced against a benchmark index. Instead, they innocently turned over their money to bank trust departments and insurance companies, never doubting that they would get results that handily outpaced the Dow Jones Industrial Average.

What’s more, when performance comparisons were made in the 1950s and 1960s, they weren’t very meaningful. Money managers often looked just at the price change for the industrial average, says Peter Bernstein, an economic consultant and former money manager in New York. What about dividends, which historically have accounted for almost half of the market’s total return? They were ignored.

 ”Any sort of performance measurement, as we think of it today, was extremely primitive,” Mr. Bernstein recalls. ”We had portfolios in which everybody owned bonds, and we compared them to the Dow Jones average, which was ridiculous. But nobody told us it was ridiculous.”

The 1973-74 bear market changed all that. Investors, burned by the plunge, vowed to keep closer tabs on their portfolio managers by comparing each manager’s performance with a benchmark. For many managers, the comparison didn’t prove flattering. That, in turn, prompted some investors to use investments that removed the manager from the decision making: index funds.

Before the bear market, ”managers were expected to regularly beat the market by 20%,” recalls Stephen Rogers, chairman of pension consultants Rogers, Casey & Associates in Darien, Conn. ”Most investors just relied on what their managers told them [about performance]. It was only with the 1973-74 [plunge] that things got torn apart.”

To recap, before the mid-1970s, investors:

  • didn’t really know how to benchmark their investment performance correctly.
  • ignored dividends when calculating performance comparisons.
  • compared everything — even bonds — to the Dow Jones.
  • really had no idea whether or not their money managers were any good or not.

Investment professionals spend a ton of time digging through historical market data to tease out the best strategies, trades or allocations (I’m no different). Yet very few ever try to place context around the state of the investment industry when performing backtests or scenario analysis.

There are so many facets to money management that are completely different now than they were in the past — trading costs, fund expenses, data availability, competition for outperformance, knowledge, the make-up of the investor base, investment offerings, research capabilities, technology, asset allocation preferences, demographics, geopolitical events, economic policies, access to advice and information and much more.

These things will be different in the future too.

Before the 1990s it was basically impossible for most investors to invest in small caps, emerging markets, commodities, many foreign markets or smart beta/factor-based funds.

There’s also a huge list of interest rate sensitive asset classes that didn’t really exist the last time we had a sustained rising rate environment — high yield bonds, private equity, unconstrained bond funds and REITs to name a few.

Some things in the the markets are never different (i.e., human nature) but many things are always different.

My point here is that it’s really difficult to understand historical market data without first considering a whole host of outside variables.

The entire Clements interview with Bernstein is worth a read:
Compare and Contrast (WSJ)

Further Reading:
How Things Have Changed on Wall Street in the Last 50 Years


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    Reminds me of Trump during one of the debates…

  • When I was starting out (1989), I used to hear war stories about 1973. The horror was not so much the magnitude of the decline (which was bad enough), but that the decline went on and on and on for many months without significant respite. In contrast, 1987 was over in a flash.

    Nick de Peyster

  • Jim Clark

    One thing that I remember when I first about the stock market in the late 1960s was the NYSE introduced their own index to fix shortcomings in the DJIA. Not the lack of dividends but the fact the DJIA was almost four digits. It was felt this confused the general public, a 30 point drop in one day might seem like a 30%. So the idea was the NYSE index would start at 50 and if it ever reached 100, it would reset to 50. I’m not sure if this was ever implemented; nobody much used it (newspapers and tv used Dow or S&P 500) and in 2004 it was reset to 5,000 and does use reinvested dividends.
    The 1973-74 drop came in an era of rising inflation (people thought stocks were a good hedge against inflation) and also with the winding down of the Vietnam War, people thought there would be a “peace dividend”.
    But I don’t remember reinvested dividends being discussed in the book “How to buy common stocks” by Louis Engel that my bemused stock broker at Merrill Lynch gave me. A decent book over in teaching about how a company grows, how it uses bonds, preferred stocks, splits. I always wanted my details at the end about the soda jerk who came to this country n 1914, never made more than $1.0 an hour and died in 1940 leaving $150,000 to his heirs (lived in a sparsely furnished apartment and had two years back issues of the “Wall Street Journal”).

  • James A McIntyre

    I find the “historical” markets fascinating. Dow earnings data prior to the 1950s is deeply erratic. The S&P earnings data used in Professer Shiller’s work is a late 1950s attempt to construct an earnings stream to match their reconstructed index; the starting point of 1927 for the SPX was determined in the 1950s. Prior to the 50s the only reliable pricing mechanism for the market was the dividend yield spread over the long bond. Bad data = bad “knowledge”.

  • Stef

    As a premise, I would like to say that I’m very simple minded about investing; I have never given much thought to it and only got interested in it as I have to. I am trying to find the best strategy for me and then just implement it spending as little time on these matters as possible, but there’s something I don’t really understand. Jonathan Clements book, which you say is your favourite 2016 book on personal finance, says that the smart thing to do is not to try to beat the market and just use a B&H strategy (‘there are those who try to beat the market….and then there are the smart ones who get it’). In contrast, in a previous post you wrote favouraby of Gary Antonacci’s book and said you were a fan of momentum investing. The basic idea in Antonacci’s book is precisely that the market can be beaten (by a lot) using a simple strategy available to anyone, which takes a couple of minutes a month to implement. It’s not just a matter of limiting DD, but of highly improving the CAGR over long times periods. So, both books give advice on how to effciently manage one’s finances for the very long term. The goal is the same. So, in my simple vision, since they recommend constrasting strategies to achieve the same goal, if one is right is would seem that other is wrong. How can both strategies and books be recommended? Thaks