The Death of Equities

“Men resist randomness, markets resist prophecy.”

– MAGGIE MAHAR

AMAZON WENT PUBLIC in the spring of 1997.

That first year the stock was up more than 150%. The following year it gained close to 1,000%, and then another 40% and change in 1999 as the dot-com bubble really took off. The stock was down 80% in 2000 after the dot-com bubble burst. It would drop nearly 95% before all was said and done.

Amazon is now a trillion-dollar corporation and it seems so obvious it would become one of the most important companies in almost all of our lives. I break down more Amazon boxes in my garage every year than a UPS store. But it wasn’t quite so obvious at the time when Amazon was still finding its way.

A few months before Amazon’s IPO, Jeff Bezos flew to Boston to give a presentation at Harvard Business School. After giving a talk to a class, Bezos stood off to the side as the graduate students pretended he wasn’t there to dissect the prospects of the online retailer. The consensus from the future Harvard MBAs was that Amazon probably wouldn’t survive when other retailers made the move online. One student flatly told Bezos, “You seem like a really nice guy, so don’t take this the wrong way, but you really need to sell to Barnes & Noble and get out now.”*

Whoops. Yogi Berra said it best when it comes to forecasting: “It’s tough to make predictions, especially about the future.”

Of course it is. The future is unknowable! The past is littered with terrible

predictions about what will happen next.

In the early 1900s, a banker advised Henry Ford’s lawyer to avoid investing in Ford Motor because “The horse is here to stay but the automobile is only a novelty – a fad.”

In 1946 a Hollywood producer was positive the television would also become a fad when he said, “Television won’t be able to hold on to any market it captures after the first six months. People will soon get tired of staring at a plywood box every night.”

When Microsoft CEO Steve Ballmer was asked what his first reaction was when the iPhone was introduced in 2007, he laughed heartily and told a reporter it was too expensive and wouldn’t appeal to business customers because it didn’t have a keyboard.

Before their 1984 title fight in Russia, Ivan Drago told Rocky Balboa, “I will crush you” in the boxing ring. Rocky knocked out the Russian in the 15th round in a major upset. OK, that one is from Rocky IV, but you get the picture.

People aren’t very good at making predictions about the stock market either.

How many people own stocks?

The boom-bust nature of stock market cycles along with changes in household ownership in the market can help provide some context behind investor behavior in stocks.

Recall that just 2–3% of U.S. households owned stocks heading into the gigantic 1929 to 1932 market crash during the Great Depression. Most people still weren’t all that interested in the market mainly because most households didn’t have much in the way of disposable income to invest. In 1929, nearly 60% of American families had incomes that placed them below the poverty line.

The lost decades and economic stagnation that followed didn’t do much to engender confidence in stocks as an asset class. That would all change in the post-Second World War era. The economic malaise following the Great Depression didn’t really end until the Second World War kicked off a post-war recovery unlike anything the world had ever seen. The boom times following the war changed the trajectory of the United States and the rest of

the world in terms of growth, jobs, income, demographics and wealth for decades to come.

The average pay for manufacturing workers was up almost 90% between 1939 and 1945. Disposable income for all Americans rose nearly 75% between 1929 and 1950. By 1945, GDP was 2.4 times the size of the economy in 1939. Frederick Lewis Allen called it “the most extraordinary increase in production that had ever been accomplished in five years in all economic history.”

The middle class in America was more or less born of that post-Second World War era through a combination of a federal housing bill, a baby boom, and the large number of soldiers coming home from war looking to settle down and start a family. The number of new single-family homes built in America grew from 114,000 in 1944 to 1.7 million by 1950.

Once people owned homes and had some disposable income, they could finally consider investing some of their capital. It was still pretty slow going, though. In 1953 only 4% of the country owned stocks. Even after the 1950s bull market, which saw the U.S. stock market rise by nearly 500% – 19.5% per year for a decade – there were only 12.5 million stockholders out of a population of 177 million. Scars from the Great Depression cut deep.

By the 1960s, there were finally enough new investors who didn’t wear the scars so stock ownership finally took off. Equity ownership reached 30% heading into the 1970s. It would fall to 15% by the end of that atrocious decade. You not only had stocks and bonds perform poorly in the 1970s, but savers could get double-digit yields on their cash in money markets, CDs and savings accounts. Why would you want to invest in stocks when you could earn 15% with no market risk?

That mentality led to the most infamous magazine cover in stock market history. In the summer of 1979 BusinessWeek published a cover story titled “The Death of Equities.” Frankly, the timing could have been a little better. The stock market was about to embark on one of the greatest bull markets ever, as it rose 2,500%, or nearly 18% per year, from 1980 to 1999.

Sir John Templeton once opined, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” It was fertile ground for a bull market heading into the 1980s because pessimism broke out to new all-time highs after the 1970s debacle. Barton Biggs once said, “A bull market is like sex. It feels best just before it ends.” The opposite is true of a bear market – it feels the worst just before it ends.

Inflation was still out of control. Stocks had gone nowhere for well over a decade. To combat seemingly never-ending inflation, the Fed raised interest rates to heights we’ve never seen before or since.

It made sense investors wanted nothing to do with the stock market. Here’s an excerpt from the BusinessWeek article:

Further, this ‘death of equity’ can no longer be seen as something a stock market rally – however strong – will check. It has persisted for more than 10 years through market rallies, business cycles, recession, recoveries, and booms. The public was first drawn to equities in big numbers in the 1950s by a massive promotion campaign by Wall Street that worked because the economic climate was right: fairly steady growth with little inflation. To bring equities back to life now, secular inflation would have to be wrung out of the economy, and then accounting policies would have to be made more realistic and tax laws rewritten. But these steps may not be enough.

The coming decades would see an explosion of equity ownership in America like never before. But investors weren’t positioned for the coming bull market just yet.

Fidelity burst onto the fund scene in the 1960s as mutual funds became the new preferred way to invest in stocks during the Go-Go Years. The fund firm had $5 billion in assets in 1968 with 90% of the money invested in stocks. By 1982, it was managing $17 billion, but just 12% of assets were now in stocks. In the 20 years prior to the 1970s, pension plans kept more than half of their assets in the stock market. By 1982, they were putting just 24% into equities. “The Death of Equities” cover story was based on the reality at the time. Investors were abandoning stocks. But it wouldn’t last.

Not only did interest rates and inflation peak in the early 1980s, but a tax bill in 1981 contained a provision that allowed workers to lower their taxable income by $2,000 a year if they put it into a new tax-deferred retirement account. The Individual Retirement Account (IRA) was born, and all that cash on the sidelines had a new home that allowed people to invest in stocks for the long run in a tax-deferred investment vehicle. Game on.

Fidelity was opening up 10,000 new accounts a day in the lead-up to the

1983 tax deadline. T. Rowe Price said 70% of incoming IRA money went into stock funds in 1983 versus just 28% in 1982. Merrill Lynch customers who opened accounts to invest in stocks doubled once IRAs became available. IRAs not only gave people an incentive to save for retirement but also forced them to realize they were on their own when it came to saving for their post-work years.

By 1987, 55 million people had opened a mutual fund account, and most of those funds were invested in stocks. The 1980s bull market was the first in history to include younger investors and the middle class. It helped that the eldest baby boomers were entering their prime earning years. The addition of low-cost brokerages and 401k accounts played a role here too. The stars were aligned. Then came a massive bubble.

The dot-com bubble wrecked a lot of portfolios once it deflated, but it got people interested and invested in the stock market in a big way. By the early 1980s, the share of households with a stake in the stock market was just 19%. The number of people who were invested in the stock market shot up to an estimated 60% of households by 2000. Almost two-thirds of those who owned stocks had purchased their first share after 1990. One-third of equity owners had made their first purchase after 1995.*

No one thought that scenario was possible coming out of the 1970s, save for one group of investors. Here’s one more passage from “The Death of Equities” story:

The problem is not merely that there are seven million fewer shareholders than there were in 1970. Younger investors, in particular, are avoiding stocks. Between 1970 and 1975, the number of investors declined in every age group but one: individuals 65 and older. While the number of investors under 65 dropped by about 25%, the number of investors over 65 jumped by more than 30%. Only the elderly who have not understood the changes in the nation’s financial markets, or who are unable to adjust to them, are sticking with stocks.

Older investors holding onto or adding to their equity holdings were being openly mocked. Those silly long-term investors. Surely, the young and inexperienced investors throwing in the towel knew what they were doing. . . right?

Those 65 and over investors had lived through some cycles in their day. They knew lost decades were part of the bargain when it comes to investing in stocks. It was the young investors who broke the number one rule of compounding by interrupting it unnecessarily.

Here are some takeaways from this history lesson: The best time to buy stocks is when they’re out of favor. In the fall of 2008, a colleague confided in me that he was changing his 401k contributions from stocks to a stable value fund. He urged me to do the same as the entire financial system seemingly crumbled around us. This made no sense then or now. I was in my 20s at the time.*

Why would I run from the stock market when prices were lower than at any point in my working life? If the financial system ever implodes, does it matter what you invest in? At that point, canned food and ammo are better hedges than stocks and bonds.

As long as you have a long time horizon and money to invest, you should become more excited about the stock market the more others hate it.

There is a lifecycle of wealth. The problem with looking at the markets from the vantage point of static start and end points is that it’s simply not realistic for the vast majority of investors. How many investors put their money in at one point in time and just leave it be? And how many investors do so at the precise top or bottom of the market?

Unless you’re the heir to a wealthy fortune, you don’t invest a single lump sum and let it ride. You invest your money periodically out of a regular paycheck, thus diversifying across time and market environment. If you’re done saving, you’re taking withdrawals, reinvesting income and dividends, rebalancing your portfolio or changing your asset allocation.

And the best part about investing on a set interval – quarterly, monthly, weekly, etc. – is that you diversify your entry points. You don’t have to worry as much about tops and bottoms. Some purchases will be better than others, but so it goes. Dollar-cost averaging is far from the perfect investment strategy. The good news is you don’t need to be perfect to find investment success. You just have to be consistent. That consistency matters most during down markets.

Risk is for the young. Your biggest assets as a young investor are time and human capital (your future earning potential). It’s nearly impossible for young people to invest their money too aggressively in stocks. If stocks

rise, the value of your portfolio increases. If stocks fall, you can invest your future savings at lower prices. Win-win.

Any investor who dutifully purchased stocks throughout the horrific 1970s market would not have felt great by the end of that decade, but they had set themselves up wonderfully for the years ahead. Let’s say you put $100/month into the U.S. stock market throughout the 1970s. By the end of the decade, you would have contributed $12,000 in total, which would have grown to a little more than $15,000. That probably wouldn’t feel great after a decade of investing. It was even worse after inflation.

But let’s say you kept making those same contributions in the 1980s. Now we’re up to $24,000 at cost, but the market value of your shares as of year-end 1989 would have been more than $90,000. All of those consistent purchases during the ups and downs of the 1970s paid off big time.

Bad returns are not always bad as long as you take advantage of them when they lead to good returns later. Your older self will thank you if you stay in the game when you’re young.

The next chapter looks at why it’s so important to think and act for the long term when it comes to compounding your capital.