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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Money was pouring into stocks and mutual funds as everyone became an investorINTRODUCTION The future can be annoying. In 1997, when we actually started putting words on paper that would become this book, there was really no reason why anyone should ever want to read them. Investors had dodged a bullet. In 1994 nearly every investment guru who was being quoted in the media said that the U.S. stock market was over. It was supposed to be going into at least a decade-long decline. Gold, international stocks, and treasury bills were supposed to have been the only places any sane person would put his or her money. What actually transpired made those dire prognostications look cartoonishly foolish. A new era of prosperity for the American economy began in 1995, and every sector of the stock market posted stellar returns. By 1997 there was universal confidence in U.S. equities, and the advance was in full swing. But although this turn of events delighted us as investors, it troubled us deeply as investment consultants. For the investment community to have been so wrong about the direction of the financial markets in 1994 meant that the traditional methods used to assess them must be fundamentally flawed. Our concern was that if this flaw were not uncovered, we would not be prepared for other significant inevitabilities affecting our clients and our own personal wealth. So we started the research project that grew into this book. We were astounded by what we found. We knew from the beginning that we would have to do more than revisit the customary lines of reasoning if we were to spot weaknesses in the existing order. It would be necessary to amass copious amounts of cultural, economic, and social information, as well as financial data, and then organize it in a kind of mapping the investment genome fashion. We picked the prosperous twelfth century as a starting point. This was when the great cathedrals of Canterbury (1175) and Chartres (1194) were built and the Universities of Paris, Oxford, and Bologna were founded. How the thriving economy fueled European expansion is an exciting story unto itself. We moved forward century by century and picked up a thread in the 1800s that appeared to be tied to the present. Cultural parallels materialized, and then economic ones. The action of the financial markets felt uncannily familiar. The more facts we pulled out, the more the conventional explanations for todays market behavior unraveled. When the facts reassembled themselves, they had carved out a pattern that leaves the investment culture ahead of us looking very different from the one we just left behind. That is why the future can be so annoying. Investors had become absorbed in a process that had worked for a long time. There were reliable formulations, sacrosanct arrangements, and taboos that defined the investment system. Now everything is forced to mean something different. But even though moving into a new investment culture is annoying, it is annoying like moving into a newly constructed home a lot of trouble and a lot of new things to figure out, but well worth the effort. The new investment culture is more efficient, is user-friendly, and, yes, has more wealth-creating potential than anything that has come before it. With the help of our clients and a combined 40 years in the investment industry, we have attempted to explain its evolution in a way that everyone can understand. Compacting all of the information we had accumulated into something readable was a fairly arduous and time-consuming process. As a result, the first chapters, set down in 2000 and 2001, have more age on them than do the last chapters. We decided to update them only slightly prior to submitting the final manuscript at the end of July 2002. We retained sentences such as the following from Chapter 2, written in August 2001, which discusses potential difficulties arising out of the weakening of the old investment culture: This economic contraction will further stress an already deteriorating old dominant investment system, making it likely that we will see a major disruption of at least one or two companies like what occurred with U.S. Steel a century earlier. That was written prior to the bankruptcy of K-Mart, the Enron scandal, and the collapse of Worldcom; it is not meant to show that the authors have any powers of prediction, but rather to illustrate that in studying the process by which another investment culture deteriorated, we can be guided through our own transition process today. This project was not about organizing the future. That is, of course, impossible and unnecessary. The important work is of a more significant nature. It is to create an understanding of, and an appreciation for, the new investment culture. The mission is to open everyones eyes to what many have felt but few have seen and to create a language for what is often sensed but not defined. This is a very real and important thing that is happening. We hope we have done it some small justice. The attitude . . . beginning in the high places, among men and women of prestige and authority, trickles down, trickles down, with its formulations, to the masses. Now this, now that individual is deflected in their direction. Soon a group has formed definable by the attitude. Then the attitude generates habits. The habits . . . integrate into a common way of life which is now the custom of the group. A tradition grows up centering on the custom and accounting for it. Both become sacrosanct and are hedged about with reverence and taboos; opposition becomes criminal and variation blasphemous. It is the established order now. . . . Yet with alternatives pressing always on the verge. Horace M. Kallen, The Philosophy of William James HOW THE TIMES THAT WERE A-CHANGIN FINALLY CHANGED BREAKING UP IS HARD TO DO How the Stock Market Outgrew the Dow and Will Change Your Future Transformation is a marvelous thing. . . . I am thinking especially of butterflies. Though wonderful to watch . . . it is not a particularly pleasant process. Vladimir Nabokov At a New Year s Eve party in 1998, an attorney friend of ours asked if we would meet with a client of his who was on his way to Florida to spend the high social season. The man was the owner of eight private corporations. He was also a sophisticated investor who had practiced classic stock analysis for over 40 years. We were told he was nervous about the stock market. This intrigued us because unlike most people at the end of 1998, we were, too. This was not a time when many people outside of the financial services industry had qualms about their investments. The Dow had averaged over 27% per year for the last four years. Money was pouring into stocks and mutual funds as everyone became an investor. The only fear most people had was that they would miss out by not getting in fast enough. So we were eager to hear why one nonprofessional, like our prospective new client, apparently saw things differently. Two weeks later we were standing on the terrace of Mr. R.Q.s winter residence watching the sun set over the Gulf of Mexico. What would have normally been a serene moment was disrupted by Mr. R.Q.s hand shaking so badly that we could hear the ice cubes tinkling in his glass. Ive lost millions of dollars over the last few months because I bought blue-chip stocks, he said. How can that have happened when the environment for investing has been so perfect? Im 70 years old, and Ive been doing this for over half my life. Now suddenly its not the same anymore. I have no idea what to do. The market had changed, and saying things werent the same anymore was an understatement. As the market was considered to be soaring in 1998, 488 stocks of the Standard & Poor s (S&P) 500 averaged a return of less than 5%. Mr. R.Q. was stunned by his losses in Coca-Cola and Dupont as these companies, along with a third of the stocks of the Dow Jones Industrial Average, were losing half of their value. These were big losses for what was pitched as the hottest bull market ever. Dow stocks like Merck were falling apart while companies that few recognized, like Pharmaceutical Product Development Inc. (PPDI), were making the bull market happen. This contradiction was sending those inside the financial industry into a tailspin. With the exception of a handful of investors like Mr. R.Q., most people outside the financial industry did not realize then nor do they now how seriously many stocks of the Dow and that ilk have failed them. The reason is that the machinery that markets investing to the masses was able to manipulate investors into ignoring the obvious signals of change. It was a triumph of mass marketing that the shakeout that was taking place, during what was perceived as a roaring bull market, has still not been acknowledged, much less addressed, by most people who have money in stocks or mutual funds. The last half of the 1990s provided the most fertile environment for the growth of stocks in decades. Interest rates were low; productivity was higher than it had been for 24 years; the economy was booming; demographics were perfect because baby boomers were investing for retirement; and everyone was putting money into 401(k) plans. It was by selling the idea of averages that the attention of the general public could be steered away from the curious fact that so many Dow stocks, and so many blue-chip companies of the S&P 500, were falling in value when the conditions for stocks were so spectacular. In 1998 the Dow averaged 18.16%. The S&P 500 averaged 28.58%. Regarding the term average, the peculiar way by which these numbers are reached namely, by giving the largest companies, whose shares have gone up the most, a weighting that is many times out of proportion to the other companies in the indexes produces a number that is not an average at all. The numbers can, and in 1998 and 1999 effectively did, disguise the deterioration of many stocks. By 1999, even the stocks of the 12 companies of the S&P 500 that had increased in value more than 5% the previous year began to falter. As 1999 ended, the list of S&P 500 stocks participating in the bull market dropped to only seven. Still, the S&P 500 index was promoted as averaging 21.04%. This attracted more and more money into mutual funds that duplicated the indexes. As they poured money in, most investors had no idea what companies their hard earned dollars were helping to shore up. We learned that Mr. R.Q. had figured all of this out for himself. We learned that Mr. R.Q.s biggest concern was not that he had already lost money, but that if the old reliable companies that made up the Dow Jones Industrial Average could do so poorly in the best environment for stocks in 30 years, what would they do when conditions were less than perfect? His question was perceptive and his timing uncanny. What had occurred in 1998 was the death of an old investment culture and the birth of a new one. Beginning on that January evening in 1999 and lasting until he returned to New York two months later, we laid out for Mr. R.Q. the collapse of the infrastructure that had made the Dow Jones Industrial Average and the biggest companies in the United States the best place to invest for dependable growth for most of the twentieth century. We detailed for him how a new kind of stock market, with more growth potential than anything we had witnessed before, came into existence. We explained why this would require new investment techniques and how to use them. We illustrated for him in person what we document for you in this book. |
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