A Market History Lesson From Peter Bernstein

Earlier this week I wrote about the attributes successful investors share but I forgot one — a deep understanding of financial market history. This history proves to be more of a guide to human psychology than a road map for beating the market. No two market environments are ever exactly the same but fear, greed, panic and euphoria are always involved when investors take things to the extreme.

Studying market history is incomplete by just looking at the numbers, though. You also have to look back at how things were structured to get a better understanding of how markets worked at the time. I’ve written on this in the past (see here, here, here and here) but I’m always fascinated when I learn something new about how things worked for investors of the past.

I recently went down a Peter Bernstein rabbit hole and came across an interview he did with PBS in the late-1990s. Berstein weaves into his story tales from the roaring 1920s bull market to the Great Depression through the WWII-era which led to the 1950s-1960s bull market which eventually resulted in the 1970s bear market and finally the 1980s-1990s bull. Maybe the craziest thing about the interview is the fact that 10-Year Treasuries yielded 7% at the time but his description of each period was illuminating.

Here he is talking about the start of his career when no one wanted anything to do with stocks following the aftermath of the Great Depression:

When I came into this in 1951 nobody of my generation was interested. Everybody in the market was older…and they knew a great deal because they’d all survived this terrible experience (1929). And they were all terribly conservative in the way that money was to be managed. And there were laws, too. I mean, you couldn’t put a personal trust more than 35 percent in common stocks in New York. And in some states you couldn’t own any common stocks in any kind of a legal fiduciary. There’s some state that’s just now is changing. The state pension fund is mandated zero in equities.

No more than 35% in stocks for personal trusts?! Zero percent in stocks for pensions?! That would be madness today but that’s how things were back then. The wounds from the Great Depression were still fresh. Can you imagine investing at a time when you look back at prices 20 years prior that fell almost 90% for the overall stock market? It’s no wonder people didn’t have any interest in stocks.

Now here’s Bernstein talking about the technology, or lack thereof, in his early years:

So, the ticker tape every ten minutes would print what the Dow Jones Average was. And you got the prices, then you had to do this arithmetic without computers, maybe an adding machine. So every ten minutes you’d get the market. The S&P — Standard & Poors started their indexes I guess in the 1950s, but ’cause they had an index with 500 stocks in it, you couldn’t figure that every ten minutes. So it was published, I think maybe only monthly, but certainly the most frequently weekly. You didn’t get it every minute. Like now you push a button and there it is because the computer can do it. So this is the reason that the Dow was always kind of the benchmark, was because it was easy to do the arithmetic and figure out what it was doing. Also it was “the” blue chips in the market.

It sounds like the Dow became the benchmark everyone used simply because it was much harder to calculate how the S&P 500 was doing. Today, we can instantaneously pull up the price of almost any security in the world on a piece of glass we carry in our pockets. Back then they had to calculate things out by hand. I wonder if seeing the market on a weekly or monthly basis would be better for investors today?

Finally, check out this story about how long it took for one of the most famous papers in academic finance history to catch on with investors:

1952, year after I started the stock market, “The Journal of Finance”, the primary academic journal of people in the world of finance, carried no articles about the stock market. It was all about banks and insurance companies, nothing about the stock market. Carried a 14-page article called “Portfolio Selection” by a graduate student at Chicago named Harry Markowitz. In 1991, Harry Markowitz won the Nobel Prize in Economics for those articles. Well, he did things later built on it, but it was that article. He later wrote a book. Nobody paid any attention to that article for 15 years. It was in the backwaters. You look in the other academic journals, there are no citations to portfolio selection for ten years and then it begins to make its appearance. The stock market was not a serious place for research until it was at — instead of being at 160, where it was in 1949, until it was around 400 or 500, three or four times where it had been at that — at that point, that it began to be a respectable place to go to work and then a respectable place to do economic research. Now “The Journal of Finance” may have one or two articles on banking, a couple of articles on insurance. It’s all about investing.

It took 15 years for people to pay attention to the seminal piece of academic research on portfolio construction and diversification. Now think about how fast news, research, opinions, and analysis gets disseminated today.

Creating backtests for use in scenario analysis can be helpful because it provides investors with a range of outcomes to consider. But you have to take every historical performance or risk statistic with a huge grain of salt. You also have to understand what it was like for investor at that time.

Many investors take for granted how lucky we are to have access to so much information, research, market data and low-cost investment options. I can’t imagine what it would have been like to be an investor back then. But Peter Bernstein does a great job at helping me understand.

This entire interview is worth a read:
Interview with Peter Bernstein (PBS)

Further Reading:
Unlearning From Peter Bernstein


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