August 25, 1997
After the Fall: Some Lessons Are Not So Obvious
By Roger Lowenstein
|
Robert Shiller, an economist at Yale University, heard the news when a student interrupted his Monday-morning lecture: The stock market was crashing.
As it happened, Prof. Shiller had been waiting for just such a moment. For some time, he had been developing a theory about sudden market moves and bad been surveying investors about bow they responded -- and, in particular, why they sold -- when markets plunged. Now, with stocks in free-fall, Prof. Shiller knew he had a chance to test his theory.
By the next day, the wider world also had a theory -- or at least, an explanation. Pundits proclaimed that the gods of finance were punishing investors for the excessive speculations of the 1980s. The crash, apparently, bad drawn the curtain on an era of optimism run rampant arid greed triumphant, just as, six decades earlier, the crash of October 1929 had been a coda to the Roaring Twenties. The latter crash, too, was a cautionary tale, a Sunday school sermon for arbitragers.
In both years, stocks fell from late summer through autumn by more than one-third. Yet the historical analogy was in a sense misleading. At the end of 1929, the country was still on its feet.
The Great Crash would be seen as a watershed only in retrospect when it was known that the Depression and a brutal bear market would follow. After the initial fall, when the worst was thought to be over, stocks would go on to lose a further 80% of their value. The bottom would still be three years off; a recovery to old highs 25 years away. That was why 1929 would seem so freighted with portent -- so terrible a warning. An entire generation would never return to the market again.
The crash of 1957 would also be framed by the events that followed it -- framed and then invested with a portent of its own. And the singular fact of Black Monday was this: The market recovered quickly.
Stocks fell the next morning but gained ground later that day. They would never make new lows. No depression ensued, and far from being swept aside. Wall Street's deal makers resumed their duties with a vengeance.
By January 1989 15 months after the crash, the market had fully recovered. When a recession finally came, three years after the crash, it was excessive financial borrowing not the stock market -- that seemed to have caused it.
For market professionals, this was a different kind of watershed. The idea grew of a disconnect -- of a market at least temporarily disassociated from the underlying, real economy. Michael Steinhardt, then a fast-moving money manager and now retired, says. "The stock market is supposed to be an indicator of things to come, a discounting mechanism that is telling you of what the world is to be. All that context was shattered. In 1987, the stock-market crash was telling you nothing.
Small investors drew a similar but more significant moral. If the crash was an exclamation without the point if it had foretold nothing -- then, in retrospect, it had merely been an opportunity for buying. Then the pros who had done the selling on Oct. 19 had been foolish.
Alex Miselson, a stockbroker in New York now with Paragon Capital, began to tell people in the late '80s that the little guy wasn’t so dumb -- indeed, not as dumb as the money managers on Wall Street’s hyperactive, short-term treadmill. Little people, he noticed, weren’t panicking when prices fell -- they were laying in for the long haul and buying more.
Having witnessed the rapid recovery from Black Monday, people were inferring a moral that was to be the information credo of the 1990s: Buy on the dips.
"If you see things in different time frames, even the worst of headlines can be an Opportunity," says Steve Spence, a broker in Portland with PaineWebber. "That's the foundation of the conviction people have today."
It has occurred to Mr. Spence that a "dip" to 8000 now is not necessarily as attractive an entry point as a dip 1700 then. "What is interesting," he adds, "is that the crash was a sobering experience," but the conclusion drawn from it was intoxicating and bullish. Even a sound lesson, if mechanically and unthinkingly applied, can lead to peril.
We may deal briefly with other lessons. Before the market peaked in 1987, it was said that liquidity would keep it aloft. But when everybody wants to sell, there is never liquidity at yesterday’s price. Not then, not now.
It was said that fundamentals no longer mattered. But the bedrock of valuation is interest rates, and in 1987, when rates began to rise the bulls’ days were numbered. They do matter.
The Tuesday after the crash, Alan Greenspan issued a one-sentence assurance that the Federal Reserve would provide the system with necessary credit. John D. Rockefeller made a somewhat similar declaration in 1929 -- but failed to buoy the market. His day was over. Mr. Greenspan succeeded. The crash marked the hour of his arrival, the beginning of his status as near-deity on Wall Street.
A further lesson might be that whenever the market crashes, Donald Trump will claim to have sold his stocks just prior. Of course, nobody -- not even Mr. Trump could say for certain why stocks had fallen so precipitously that month, that week, that day.
Prof. Shiller's theory was that markets are sometimes irrational. Like Mr. Steinhardt, the pro, and like Mr. Miselson, the little man’s broker, Prof. Shiller saw 1987 as a page from the 19th century classic, "Extraordinary Popular Delusions and the Madness of Crowds."
Stocks might have been fairly valued on the afternoon of the previous Tuesday, when the Dow reached a high of 2528. Or, perhaps they were closer to the mark at Friday’s finish, 2246. Then again, maybe the price was right Monday afternoon, at 1738. Or at Tuesday’s low of 1616 -- or at its high, hours later, of 2067.
But not all those prices could have been correct. Even allowing for the fact that value is subjective -- that "true value" is really a range of reasonable values -- some of those prices must have been wildly wining. Calmly appraised, the intrinsic value of American industry didn't fall 23% in a day.
Business schools teach that financial markets are ever and always efficient -- that prices are ever rational. Indeed, Merton Miller, an economist-defender of the theory that markets are efficient, argued after the crash that "many investors simultaneously" reappraised the economic fundamentals on Oct. 19 and calmly, rationally, decided to sell.
Prof. Shiller, who unlike Prof. Miller hasn't won a Nobel Prize, actually asked investor's why they had sold. Questionnaires went out within days; about 1,000 investors, both individuals and pros, responded. No news story affected them on Oct. 19; no new data had changed their appraisal. Rather, investors, particularly the pros, reported that they had been fixated on news of the crash itself.