Bull! Page 6

  A graduate of the Harvard Business School, Awad arrived on Wall Street in the sixties, part of the youth revolution that swept downtown Manhattan. The “hotshot” fund managers of the go-go market should be distinguished from the better-known youth brigade that protested the Vietnam War. The protesters made only a guest appearance at the NYSE in 1967 when Abbie Hoffman and his Yippie friends stood in the visitor’s gallery, throwing dollar bills onto the Stock Exchange floor. (The Exchange responded by installing bulletproof glass around the visitor’s gallery, “thereby seeming to indicate that it considered thrown-away dollar bills to be lethal weapons,” noted New Yorker writer John Brooks in his history of the era, The Go-Go Years.)4

  Youthful money managers like Awad belonged to a slightly older, more buttoned-down generation. Most attended college in the early or mid-sixties—just before the campus rebellions began. And those few years made all the difference. This, after all, was the cohort that, in the early sixties, voted against coeducation at Yale. In the late sixties, many adopted the mod fashion of the times, growing sideburns and wearing flowered ties, but Wall Street’s new stars were not bucking the establishment. They were the establishment.

  The newcomers were filling a power vacuum. Following the crash of 1929, few young men wished to launch a career on scorched earth. As a result, when the old guard from the twenties retired, they had few middle-aged heirs. Into the breach sauntered the wunderkinds who would lead the bull market of the sixties. By the end of the decade half of Wall Street’s salesmen and analysts had been in the market for less than seven years.5 Like their counterparts in the nineties, they had never seen a bear.

  With the youth revolution, a wave of shiny new IPOs came to market early in the decade. Brooks described the issues as “tiny scientific companies put together by little clutches of glittery-eyed young Ph.D.’s, their company names ending in ‘___onics.’” Thirty years later “.com” would replace “onics” and the IPOs would be launched by little clutches of no-less-bright-eyed business-school dropouts. But Brooks could just as easily have been describing the nineties when he wrote: “It was coming to be believed, in the absence of evidence to the contrary, that almost any man under forty could intuitively understand and foresee the growth of young, fast-moving unconventional companies better than almost anyone over forty.”6

  Financial euphoria achieved a summit in February of 1966 when the Dow reached out and touched 1000—hitting an interday high of 1001.11 to be exact—and staying there almost as long as you could hold your breath. As it turned out, this would be the bull market’s high watermark. Nevertheless, the go-go market continued. Now it was a momentum market, driven by “hotshots” like Awad.

  WARREN BUFFETT STEPS TO THE SIDELINES

  Back in Nebraska, Warren Buffett did not join in the celebration of youth. By 1966, Buffett realized that a bull this brazen was just asking to be replaced by a bear. Stock prices were simply too rich. Worried that he would not be able to find a safe home for fresh money, Buffett closed his partnership to new accounts. Still, the Buffett Partnership flourished, thanks in large part to the bargains Buffett had found earlier in the decade. In 1967 his fund rose 36 percent—more than twice the Dow’s advance—and in 1968 the Partnership returned 59 percent. Meanwhile, the market reeled from one rally to the next, “like a drunk intent on finishing the last bottle,” said Roger Lowenstein, Buffett’s biographer.7

  “The game is being played by the gullible, the self-hypnotized, and the cynical,” Buffet wrote in a letter to his investors in 1969.8 And in May of that year, he stunned them by announcing that he was liquidating the Buffett Partnership. At the height of a bull market, with his own portfolio soaring, Warren Buffett was cashing in his chips.

  Buffett spent the rest of the year selling stocks so that he could return his investors’ money—plus the handsome profits their investments had accumulated over a period of years. He advised them that he was putting most of his own money into municipal bonds, while holding on to just two stocks: Diversified Retailing, a small holding company for a dress chain, and a textile company called Berkshire Hathaway. “On the one hand, he didn’t think much of textiles; on the other hand, he liked the guy in charge,” Lowenstein reported.

  Buffett gave his investors a choice between keeping their Berkshire shares or taking cash—making it clear he planned to hold on to his own Berkshire shares. “That’s all anybody had to hear if they had any brains,” recalled a local doctor who was one of his most devoted partners.9 Even while liquidating the partnership, Buffett managed a 7 percent gain for ’69, then closed his books.

  Warren Buffett was not the only professional investor who saw trouble ahead. At Merrill Lynch, Bob Farrell oversaw the firm’s market strategists, and in 1969 he, too, turned bearish, causing some consternation at his firm. “Don Regan, who was our CEO back then, had the marketing people poll the brokers in our retail offices to see if my bearishness was hurting business,” Farrell recalled more than 40 years later. “But it was okay—they left me alone.”10

  Farrell would continue calling the market as he saw it for the next 31 years. From 1976 to 1992, Institutional Investor named Farrell the Street’s number one market timer every year save one, and on Wall Street, he became known as an independent, honest voice. Farrell did not claim special courage: “I joined Merrill in 1957, and I grew up with the guys who ran the firm,” he explained in a 2001 interview. “They were brokers back when I was an analyst. From that, I had the implicit power to be independent. I was close to the people in charge, so the bureaucrats steered clear of me.” It was not until March of 2000 that Farrell, who had been bearish on technology stocks for some time, felt constrained. That spring he got a call from a research director at Merrill: “Bob,” he said, “we’d prefer you didn’t talk about individual stocks—just stick to general themes.”11 Farrell, of course, had good reason to be skeptical in March of 2000—just as he did in 1969.

  In 1969 the market was already set on a crash course that would end, four years later, in the sell-off of 1973–74—a disaster that would rival the Great Crash of 1929.

  But first, the bear toyed with investors, taking them on a toboggan ride that they would never forget. After grazing 1000 in February of 1966, the Dow slid headfirst, hitting 744 in October, then turned around and headed back uphill, flirting with 1000 a second time at the very end of 1968—before plummeting once again.

  By the fall of 1969, investors who had bought the hottest stocks of the go-go market—companies like Litton Industries, Transitron and National General—were decimated. Nevertheless, many a conservative investor still sat on a nice stack of paper gains. The mood in New York remained complacent: “Tables were scarce at expensive restaurants,” Brooks reported. “In some areas, a Mercedes was almost as common a sight on the road as a Pontiac; and all that summer and fall, packed airliners departing for or returning from Europe were so numerous at New York City’s Kennedy International that they sometimes had to wait hours for clearance to take off or land.”12

  In 1970, the first major crash of the early seventies began: by May the Dow had fallen from roughly 800 to 630, and insouciance quickly gave way to fear. When it was all over, a portfolio made up of one share of every stock traded on the New York Stock Exchange was worth half of what it had been at the beginning of 1969. Small investors took a beating: a 1970 New York Stock Exchange survey showed that fully one-third of all individual investors had bought their first share sometime between 1965–when the Dow stood just under 1000—and mid-1970, when it had fallen to 650. “Exactly how much of the $300 billion overall paper loss in the 1969–1970 crash was suffered by those 11 million new investors is incalculable,” Brooks observed. But “it is entirely possible that as of July 1970, [what was then called] ‘the people’s capitalism’ had left at least 10 million Americans, or one-third of all investors, poorer than it had found them.”13

  Financial pundits saw the sell-off of 1970 as a bear market bottom. Loyal investors held on; recovery, they
assumed, must be just around the corner. And late in 1970, it seemed that they were rewarded for their faith. Now, the Dow began climbing. It would not be a smooth ride, but over the next two years the index rallied.

  THE NIFTY FIFTY

  During this period, mutual fund managers looking for safe havens gravitated toward a select group of high-growth blue chips, companies like IBM, Kodak, Polaroid, Avon, Merck, and Texas Instruments. Dubbed the “Nifty Fifty,” these were the Microsofts, GEs, and Ciscos of their day.

  Growth was king. “People clung to the belief that if you bought the premier growth companies, they would hold up well, even in a market decline,” said Steve Leuthold, a Minnesota-based money manager who in 1969 had already begun to establish a national reputation for his market research. “These were the ‘One Decision’ stocks of the time. In theory, all you had to do was just buy them and hold them. Everyone knew that the rise of companies like Xerox, Avon, Polaroid, and Digital Equipment marked the beginning of a New Era.”14 Demand sent prices soaring, and when the Nifty Fifty hit its high in 1972, the “One Decision” stocks were trading at 80 times earnings.

  Meanwhile, the Dow continued to rise, and in January of 1973, the benchmark index finally smashed through the 1000 barrier, setting a new high at 1071. A new bull market had begun—or so it seemed.

  Now, the bear moved in for the kill. What followed was the crash of 1973–74, the most savage mauling investors had endured since 1930. There was no place to hide. The Nifty Fifty sank along with everything else: by 1974, the glamour growth stocks had shed 54 percent of their value.15 The very stocks that were supposed to sustain investors for the long run betrayed them.

  Finally, investors had had enough. In 1970, they had said that it was too late to sell—they would wait for the market to recover. In the rout of 1974, shell-shocked investors raffled off shares for whatever they could fetch.

  Jim Awad was one of those trampled in the rush for the exits. Just two years earlier, in 1972, the long-haired 26-year-old Harvard Business School graduate was a celebrity: his small-cap fund was ranked number three in its category by Lipper, a firm that rated mutual funds. “There was a big New York Times article—with a picture of me,” Awad recalled. There he was, making money to the tune of the Rolling Stones’ “Satisfaction.” Could life get any better?

  One of Awad’s favorite stocks was Polaroid. He bet not only his fund’s money but his own nest egg on Polaroid, investing $100,000—a fair-sized fortune in 1972. “I ran the $100,000 down to $20,000,” said Awad, paling at the memory, more than 35 years later. He could still recall the feeling: “complete humiliation.” Investors who bought Polaroid in 1972 still would be waiting to get their money back—without interest—in 1999.

  “That was when I grew up as an investor,” said Awad. “That’s when I learned that managing money isn’t just about picking stocks and holding them. It takes a lot of blocking and tackling—disciplined, consistent effort.”16

  Polaroid was not the only disaster. As a group, Minneapolis money manager Steve Leuthold calculated, a portfolio made up of the 25 most popular stocks gained a paltry 2 percent over the next decade—and then, only if the portfolio included Merck, which climbed an extraordinary 382 percent. (Without Merck, a portfolio would have shrunk by 12 percent.)17

  Leuthold’s research contradicted Jeremy Siegel’s Stocks for the Long Run, a book that many saw as the bible of buy-and-hold investing in the nineties. Siegel, a professor of finance at the Wharton School, used the Nifty Fifty to make the argument that if an investor holds on, over the long haul, stocks outperform all other investments. “Did the Nifty Fifty become overvalued during the buying spree of 1972? Yes—but only by a very small margin,” Siegel declared. If an investor bought the Nifty Fifty at their peak in December of 1972, he pointed out, and stood pat until November of 2001, his returns would have averaged 11.76 percent a year.

  But Siegel’s hypothetical example bore only a tangential relationship to the real world. He assumed that an individual who invested in the Nifty Fifty in 1972 had divided his portfolio evenly among the 50 stocks, putting 2 percent of his savings into each company—and that, as the group plunged, he rebalanced his portfolio each month, for 19 years, taking profits on his winners and putting the profits into his losers, so that each position remained at 2 percent.18

  As Leuthold pointed out, it was “wholly unrealistic” to imagine that anyone would plow the gains from, say, Merck back into a loser like Polaroid, Burroughs, or Xerox, year after year. After all, from 1972 to 1982 the 10 worst performers in the group lost between 37 and 75 percent. With losses that steep, who would continue to send good money after bad? Indeed, most investors who bought the Nifty Fifty in 1972 became discouraged long before 1993 and dumped their fallen angels, probably at a low point, losing even more than Leuthold’s numbers suggested.

  BUFFETT TAP-DANCES (1973–74)

  Warren Buffett had not been seduced by the rallies that followed his exit in May of 1969. From 1969 through 1973, while the bear played with investors’ hopes, Buffett hibernated. Nor was he tempted by the Nifty Fifty. As a value investor, committed to “buying low and selling high,” Buffett understood that everything depends on the price you pay when you get in. In that sense, any value investor is a market timer: at the end of a cycle, when prices are highest, he stops buying. And in Buffett’s view, in the early seventies prices still were exorbitant.

  It was not until 1973, when the Dow went into free-fall, that the market once again commanded Buffett’s attention. As he told Forbes late in 1974: “All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it.”19

  Buffett’s timing was all but perfect. Of course, one could say that when Buffett abandoned the market in 1969, he was “early.” After all, if he had hung on, he could have ridden the Dow to the very top: 1071 in January of 1973. But Warren Buffett was not concerned about catching the top of the wave. He was far more interested in not wiping out. While most investors are motivated by a desire to make money, Buffett focused first on not losing money. In that way, Buffett behaved like Old Money. The majority of investors agonize over the prospect of getting out too early and missing out on the profits that would have made them rich. But the very rich don’t fret so much about making money. They have money. Their greatest fear is losing it. This explains why, when the bidding escalates—whether in a stock market, a “hot” real estate market, or at a Sotheby’s auction—Old Money tends to step aside, letting New Money carry the day.

  When virtually no one else wanted to buy stocks, Buffett went on a buying binge. Corporate America was on sale, and Buffett snapped up one company after another: “National Presto Industries…Detroit International Bridge…Sperry & Hutchinson…U.S. Truck Lines…J. Walter Thompson…Dean Witter…Ford Motor…Grand Union,…” One day during this period, Buffett’s bridge partner, Judge John Grant, mentioned that he had been “having fun trying an interesting case.” According to Lowenstein, Buffett’s eyes twinkled. “‘You know,’ he said, ‘some days I get up and I want to tap dance.’”20

  Because Buffett had sold his positions in 1969, he had plenty of cash when the market began its final nosedive. Like 1949, 1974 was a very good year to begin buying stocks. Most investors were not so lucky. By 1974 they were tapped out, both financially and psychologically. And it would be a long time before they made their money back. Although the market hit rock bottom that year, the Dow would not again cross 1000, and stay there, until 1982—eight long years after the crash. Only then would a new bull run begin.

  Buffett made money because he bought at the very bottom. But the majority of investors who remained in the market in the mid-seventies had established their positions in the late sixties or early seventies, when prices were much higher. Following the crash of 1973–74, relatively few investors had the cash or the courage to put new money into the market.21

  Maureen Allyn was an exception. In 2002, Allyn, who had just retired as chief economist at Zuric
h Scudder Investments, recalled how she avoided the go-go market of the sixties, not because she was too shrewd to buy into a bubble, but because she was too young.22

  “I just got lucky generationally—I didn’t have any money to invest until the seventies,” Allyn explained. “But in November of 1974, I was newly married, and my husband and I decided that we should start saving. So we went to a broker and told him we wanted to buy some shares. I still remember what he said:

  “‘I really don’t think this is a good idea, a nice young couple like you—you really shouldn’t be putting your money into something as risky as stocks.’

  “That’s how you can tell it’s a bottom,” added Allyn. “They don’t even want to sell you the stuff.”

  Nevertheless, Allyn insisted. At 29, she had just started a new job as chief economist at Sea-Land, one of the largest shipping companies in the United States, and she was primed to invest. “We bought 200 shares of Rite Aid at $3.50 a share. It was down from $30,” Allyn remembered, “and it paid a good dividend. Still, I was terrified. It was $700.”

  In 2001, Allyn still had a few Rite-Aid shares left. “Today, I may be the only person alive with a capital gain on Rite-Aid,” she added dryly, referring to the company’s 1999 plunge from $50 to $5 following charges of accounting fraud.

  But most investors were not lucky enough to get in on the ground floor of the next bull market. Instead, they bought when stocks were hot, in the late sixties, then watched the market move sideways for a dozen years—or more. Indeed, if a buy-and-hold investor committed his savings to the S&P 500 in 1968, his capital gains, over the next 14 years, would add up to exactly zero.23

  For the majority of investors, however, this was a moot point. In reality, very few were able to hold on to either the S&P or the Nifty Fifty for 14 years. Many needed their money before then. Others simply needed a good night’s sleep.