Only Yesterday and the Wall Street Dream Machine


Only Yesterday, by F. L. Allen, is a history of the 1920s.  My father and I discussed this book twenty years ago when he was in his late 70’s.  He said, “Yes, the late 1920s were only yesterday.”  And I wondered how events that happened 75 years before could seem so recent in his mind.

Now, I understand.  As the years add up, even decades seem to compress.  And fourteen years ago does seem like “only yesterday.”  In early March 2000, I was watching CNBC each day and wondering just how much longer the stocks would make CornerCap look like fools.  That memory is still vivid.  And five years ago, we spent a Sunday afternoon on the phone reviewing the CornerCap budget and a disastrous income statement for the year if the market didn’t get better.  That really seems like “only yesterday.”

For those who don’t remember, March 10, 2000 was the peak of the bubble, and after that we began to look much less stupid.  March 9, 2009 was the bottom of the great bear market .  Of course, we did not know that these were historic turning points.  This has been one of the greatest five years ever for the market, yet most people missed the ride. (The S&P 500 returned 208.9% from 3/9/09 to 3/7/14 for an annualized return of 25.3%.)

What have we learned from the past fourteen years – a time that has been called the “lost decade” – really almost a decade and a half?  As I look at some of our writings from those years, it is surprising how often we were right.  Not that CornerCap ever made a forecast – rather, we consistently said, stick with basic principles, don’t listen to experts who claim to have all the answers, and above all, don’t buy into the latest fad that promises to solve your investment worries.  And that really proved to be good advice.

Here are some of the things we wrote during the “lost years.”

2006 - Hedge fund investing increased because the traditional ways of making money in stocks has not worked for seven years.  People always look for a way to avoid their last mistake.  Investors’ last big mistake was investing in the stock market.   And hedge funds offer the promise that it will not happen again. Investors are hungry for an alternative that will give them a decent return AND a hedge against the downside. They say that they don’t expect miracles - just a good solid 9% a year will be enough to keep them happy – but 9% a year with no down years would be a miracle.

June 29, 2008 -   We always say that the terrible predictions during the bad times will not likely come true and the economy and market will muddle through and go up again at some point.  This isn't a very "catchy" story, but it has worked.  The problem is that deep in our gut we worry and ask ourselves, "But what if this time REALLY is different and the market goes off the edge and into freefall?"  The best we can say is that the probabilities don't favor that happening, and we go on investing as though the worst won't occur.

March 9-10, 2009 - Last evening on CNBC, Jim Cramer talked about how NONE of the things that worked in bear markets had worked this time.  And that there is no end in sight, so everyone should just forget about stocks.  We are building a generation just like the 1930s who will never touch stocks in their life.  With two serious market crashes in a single decade, both in the -50% range, investors want low risk and high return.  You cannot have both; you must make a choice.

March 27, 2009 - Everyone says, “The future isn’t clear, so let’s sit on our cash.  It’s a very scary time.”   Emotions force investors to do nothing because they are “uncertain.”  In fact, now is no more uncertain than any other time.  People are unsure because of what they’ve been through in the last few months. They believe that what has recently happened is going to continue forever.

February 2012 - In setting an appropriate asset mix for funds, it is now popular to allocate a significant portion to “alternative investments.”  This is especially troubling since alternatives have not produced significantly better returns over the last decade that a traditional mix of stocks and bonds.  They are even less appealing when you take into account their high costs, lack of liquidity, and lack of transparency. 

This walk down memory lane does have a point - human nature never changes.  Greed and fear continue to be the enemies of all investors.  This is where the Wall Street Dream Machine comes in.  The people who create products for investors understand very well their emotions, and they know that there is money to be made by playing to those emotions – in effect giving the customers what they want even if it isn’t what they need, promising to fulfill their dreams.

CornerCap’s consistent message has been - beware of this Dream Machine.  It always comes with a promise to save you from the last big problem you faced.  If you have lost money, as most people did from 1999 to now, then “Boy does Wall Street have a product for you.  An absolute return investment.  It won’t make you much money, but it will make you a little every year, with no down years.  You can sleep well.”

We warned that these products were expensive and not likely to deliver on their promise.   And how have they worked out?  Well, on average they declined about 20% in 2008 – so much for “no down years.” These alternatives began to gain popularity after the three year market decline 2000-02.  For good reason – in the three down years following the bubble, stocks declined 15.7% a year, and the alternative investments as a group went up 3.1%.  For those people who moved into alternatives in 2003, the results have not been bad, a return of 6.9% a year, only slightly below the S&P return of 7.6%.  However these returns represent averages.  There are examples of far worse results.  We have just reviewed a portfolio managed in a strategy including alternatives that produced a 12 year return of 2.9% after fees.  The advisors’ fees were almost half as large as the client’s return.

But the real pitch for alternatives came after the terrible bear market that ended early in 2009.  At this point a generation of investors declared that they would never again buy stocks.  Some simply moved to cash and others again bought into the Dream Machine, and this time in a big way.  Money poured into the alternatives.  And in the five years just ended, they returned 8.6% a year, slightly better than half the market return of 16.9%.  But again there are extreme examples of failed strategies.  One such fund was down -7.7% in 2013 and -21% for the five years 2008-13.

There is never a guarantee about the future.  The market has been choppy this year, making a lot of people nervous, even though the volatility has been within a normal range.  We suspect that the market will not have a serious drop until more people begin to feel “comfortable” with the market and want to invest in it again, most of them buying just ahead of a major downturn.  We have no idea when this will happen, but judging from the fearful comments we hear, we don’t think we are there yet.

Yielding to emotions and not sticking with a strategy has been, and probably always will be, costly.   Many people have been victims of their emotions over the last 14 years.  Decisions to do nothing, or to do something extreme, usually stack up a day at a time and we barely notice them.  And suddenly a decade or two seems like ‘only yesterday.”  Most of us get perhaps four decades in our life to save and invest, and this last fourteen years represents a third of our lifetime opportunity to build a portfolio and a secure financial life.  And many have squandered it with bad choices.  It is important to get on the right track, or stay on it, because March 2014 will seem like “only yesterday” quicker than you can imagine.