That helps explain why we fixate on the raw magnitude of a market decline and forget to put the loss in proportion. So, if a TV reporter hollers, “The market is plunging-the Dow is down 100 points! ” most people instinctively shudder. But, at the Dow’s recent level of 8,000, that’s a drop of just 1.2%. Now think how ridiculous it would sound if, on a day when it’s 81 degrees outside, the TV weatherman shrieked, “The temperature is plunging-it’s dropped from 81 degrees to degrees! ” That, too, is a 1.2% drop. When you forget to view changing market prices in percentage terms, it’s all too easy to panic over minor vibrations. (If you have decades of investing ahead of you, there’s a better way to visualize the financial news broadcasts; see the sidebar on p. 222.) In the late 1990s, many people came to feel that they were in the dark unless they checked the prices of their stocks several times a day. But, as Graham puts it, the typical investor “would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgCommentary on Chapter 8
The neuroscience of investing is explored in Jason Zweig, “Are You Wired for Wealth?” Money, October, 2002, pp. 74
September 4th, 2009 — Investment Strategies
3s, due 2047-originally a 150 year maturity!-long a typical Baarated bond.) Because of their inverse relationship the low yields correspond to the high prices and vice versa. The decline in the Northern The Investor and Market Fluctuations
- Graham has much more to say on what is now known as “corporate governance.” See the commentary on Chapter 19.Pacific 3s in 1940 represented mainly doubts as to the safety of the
issue. It is extraordinary that the price recovered to an all time high in the next few years, and then lost two thirds of its price chiefly because of the rise in general interest rates. There have been startling variations, as well, in the price of even the highest grade bonds in the past forty years.
Note that bond prices do not fluctuate in the same (inverse) proportion as the calculated yields, because their fixed maturity value of 100% exerts a moderating influence. However, for very long maturities, as in our Northern Pacific example, prices and yields change at close to the same rate.
Since 1964 record movements in both directions have taken place in the high grade bond market. Taking “prime municipals” (taxfree) as an example, their yield more than doubled, from 3.2% in January 1965 to 7% in June 1970. Their price index declined, correspondingly, from 110.8 to 67.5. In mid 1970 the yields on highgrade long term bonds were higher than at any time in the nearly 200 years of this country’s economic history.* Twenty five years earlier, just before our protracted bull market began, bond yields were at their lowest point in history; long term municipals returned as little as 1%, and industrials gave 2.40% compared with the ?2 to 5% formerly considered “normal.” Those of us with a long experience on Wall Street had seen Newton’s law of “action and reaction, equal and opposite” work itself out repeatedly in the stock market-the most noteworthy example being the rise in the DJIA from 64 in 1921 to 381 in 1929, followed by a record collapse to 41 in 1932. But this time the widest pendulum swings took place in the usually staid and slow moving array of high grade bond prices and yields.
September 4th, 2009 — Investment Strategies
Aside from forecasting the movements of the general market, much effort and ability are directed on Wall Street toward selecting stocks or industrial groups that in matter of price will “do better” than the rest over a fairly short period in the future. Logical as this endeavor may seem, we do not believe it is suited to the needs or temperament of the true investor-particularly since he would be competing with a large number of stock market traders and firstclass financial analysts who are trying to do the same thing. As in all other activities that emphasize price movements first and underlying values second, the work of many intelligent minds constantly engaged in this field tends to be self neutralizing and selfdefeating over the years.
The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored. He should never buy a stock because it has gone up or sell one because it has gone down. He would not be far wrong if this motto read more simply: “Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop.”
An Added Consideration
Something should be said about the significance of average market prices as a measure of managerial competence. The shareholder 206 The Intelligent Investorjudges whether his own investment has been successful in terms both of dividends received and of the long range trend of the average market value. The same criteria should logically be applied in testing the effectiveness of a company’s management and the soundness of its attitude toward the owners of the business.
September 3rd, 2009 — Investment Strategies
This period saw a complete debacle in a host of newly launched common stocks of small enterprises-the so called hot issues- which had been offered to the public at ridiculously high prices and then had been further pushed up by needless speculation to levels little short of insane. Many of these lost 90% and more of the quotations in just a few months.
The collapse in the first half of 1962 was disconcerting, if not disastrous, to many self acknowledged speculators and perhaps A Century of Stock Market History 73to many more imprudent people who called themselves “investors.” But the turnabout that came later that year was equally unsuspected by the financial community. The stock market averages resumed their upward course, producing the following sequence:
Standard & Poor’s DJIA 500 Stock Composite
December 1961 735 72. June 1962 536 52. November 1964 892 86. The recovery and new ascent of common stock prices was indeed remarkable and created a corresponding revision of Wall Street sentiment. At the low level of June 1962 predictions had appeared predominantly bearish, and after the partial recovery to the end of that year they were mixed, leaning to the skeptical side.
September 3rd, 2009 — Investment Strategies
At the beginning of 1959 we found the DJIA at an all time high of 584. Our lengthy analysis made from all points of view may be summarized in the following (from page 59 of the 1959 edition): “In sum, we feel compelled to express the conclusion that the present level of stock prices is a dangerous one. It may well be perilous because prices are already far too high. But even if this is not the case the market’s momentum is such as inevitably to carry it to unjustifiable heights. Frankly, we cannot imagine a market of the future in which there will never be any serious losses, and in which, every tyro will be guaranteed a large profit on his stock purchases.” The caution we expressed in 1959 was somewhat better justified by the sequel than was our corresponding attitude in 1954. Yet it was far from fully vindicated. The DJIAadvanced to 685 in 1961; then fell a little below our 584 level (to 566) later in the year; advanced again to 735 in late 1961; and then declined in near panic to 536 in May 1962, showing a loss of 27% within the brief period of six months. At the same time there was a far more serious shrinkage in the most popular “growth stocks”-as evidenced by the striking fall of the indisputable leader, International Business Machines, from a high of 607 in December 1961 to a low of 300 in June 1962.
September 3rd, 2009 — Investment Strategies
Let us comment on them as follows: The full decade figures smooth out the year to year fluctuations and leave a general picture of persistent growth. Only two of the nine decades after the first show a decrease in earnings and average prices (in 1891
September 3rd, 2009 — Investment Strategies
Either directly or through a fund, TIPS are the ideal substitute for the proportion of your retirement funds you would otherwise keep in cash. Do not trade them: TIPS can be volatile in the short run, so they work best as a permanent, lifelong holding. For most investors, allocating at least 10% of your retirement assets to TIPS is an intelligent way to keep a portion of your money absolutely safe-and entirely beyond the reach of the long, invisible claws of inflation.
64 Commentary on Chapter
For details on these funds, see www.vanguard.com or www.fidelity.com.CHAPTER A Century of Stock Market History: The Level of Stock Prices in Early The investor’s portfolio of common stocks will represent a small cross section of that immense and formidable institution known as the stock market. Prudence suggests that he have an adequate idea of stock market history, in terms particularly of the major fluctuations in its price level and of the varying relationships between stock prices as a whole and their earnings and dividends. With this background he may be in a position to form some worthwhile judgment of the attractiveness or dangers of the level of the market as it presents itself at different times. By a coincidence, useful statistical data on prices, earnings, and dividends go back just years, to 1871. (The material is not nearly as full or dependable in the first half period as in the second, but it will serve.) In this chapter we shall present the figures, in highly condensed form, with two objects in view. The first is to show the general manner in which stocks have made their underlying advance through the many cycles of the past century. The second is to view the picture in terms of successive ten year averages, not only of stock prices but of earnings and dividends as well, to bring out the varying relationship between the three important factors. With this wealth of material as a background we shall pass to a consideration of the level of stock prices at the beginning of 1972.
September 3rd, 2009 — Investment Strategies
On this point we can be categorical. There is no close time connection between inflationary (or deflationary) conditions and the movement of common stock earnings and prices. The obvious example is the recent period, 1966