The world as we know it

I have a brother who is a history teacher, and a son who is on his way to becoming one. For me, history was one of my least favorite subjects in school, but now it represents a major portion of my reading. Studying financial history early in my career may have been the turning point.

When I was in my 20s and just starting my investment career, I familiarized myself with the financial markets by looking at decades of history. What amazed me was that prevailing opinions about how stocks, bonds, and money market accounts behaved often did not account for some of the extremes — or even some of the norms — seen in past decades.

History does not repeat itself in an orderly manner, but it is valuable to tell you what financial markets are capable of doing. The more you appreciate just how broad a range of returns and risk the past has seen, the less you are surprised by new twists and turns.

The reality, though, is that people are most influenced by their recent experiences — especially when those experiences have fallen into a pattern over several years. The following are some of the major eras that the economy and markets have seen in recent decades, with a discussion of the popular mindset that resulted from each.

  1. The cynical era (1973 to 1981). Between Watergate and Vietnam, there was plenty to be cynical about in this period. Economically, this was the era of “stagflation, ” a poisonous combination of a stagnant economy and soaring inflation. For investors, it was a time when S&P 500 stock prices climbed a total of 3.8 percent in nine years — and that’s a cumulative return, not an annualized number. Bond prices sank as long-term yields soared from 5.96 percent to 13.73 percent. Consumer prices, meanwhile, more than doubled during this period. The natural reaction was that investing was a loser’s game, because inflation would exceed the return you got on your money. And yet, the truth is that by the end of this period, stocks and bonds were poised for long-term bull markets.
  2. The “greed is good” era (1981 – 1990). Investment returns didn’t just get better in this period, but investing became sexy. Modern robber barons like Michael Milken and Ivan Boesky made magazine covers — as Wall Street heroes at first, before they made headlines again for crooked investment schemes. There were some huge gains on stocks during this period, but also sharp downturns in 1987 and 1990 that taught bandwagon investors a painful lesson.
  3. The spoiled rotten era (1991 – 1999). This was an era when stock prices soared and the unemployment rate steadily dropped, reaching just 4 percent by the end of 1999. Those are good things, but they encouraged some bad habits. Retirement investors — from individuals first learning their way around a 401k plan to large institutions that should have known better — got so used to high returns that they slacked off on contributing to their plans. Meanwhile, a generation of college graduates got used to being wooed by employers plying them with signing bonuses, and never learned to deal with the harsh realities of searching meticulously for a job, being willing to work their way up, and focusing on adding value. The era that followed was to teach both investors and many employees that the world isn’t usually as giving as it was in the 1990s.
  4. The lost era (2000 – 2009). From the end of 1999 through the end of 2009, stock prices declined by more than 20 percent while the unemployment rate soared from 4 percent to around 10 percent. As a result, for many Americans this was a lost decade for both retirement saving and investment returns. Some compounded the problem by turning from the stock market to even riskier alternatives, such as real estate, oil futures, and gold, all of which would go through a boom-then-bust cycle.
  5. The low interest era (2010 – 2013). Recent years have been great for borrowers but terrible for savers, as interest rates have plunged to record lows. Longer term, though, people who learned to save despite minimal interest incentives will be better prepared for retirement, and if interest rates finally start to rise — signs of which began in 2013 — they might finally be rewarded for those savings. Stocks though, which recovered spectacularly during this period, might find it heavier going in competition with rising interest rates.

What each of these eras had in common was a set of economic and financial market conditions that came to dominate the public mindset, after which conditions changed drastically. This underscores the importance of basing your financial decisions on more than just the most recent few years of experience. Consider the range of different conditions represented by the above eras, and be sure to keep a watchful eye on the future in addition to being mindful of the past.

2 Responses to “The world as we know it”

  1. Anonymous

    Great post! It connect my two passions: history and finance. Cycles in market are so powerfull. Learning form the past is a great way to predict the future

  2. Anonymous

    Reading financial history has helped me make better decisions, its refreshing to see a Dow Jones chart for the last 100 years, it really puts things into perspective. I am a better and much calmer investor because I have the knowledge of Financial History. Thanks for sharing, great post.

Leave a Reply