Supermoney, p.1
Supermoney, page 1
Table of Contents
INTRODUCING WILEY INVESTMENT CLASSICS
Title Page
Copyright Page
Dedication
Foreword
Part One: The Supermoney Era
Part Two: Retribution Comes
Part Three: Another Bubble
Preface to the 2006 Edition
I: - Supermoney
1: - METAPHYSICAL DOUBTS, VERY SHORT
2: - LIQUIDITY: MR. ODD-LOT ROBERT IS ASKED HOW HE FEELS
3: - SUPERMONEY, WHERE IT IS: THE SUPERCURRENCY
II: - The Day the Music Almost Died
1: - THE DAY THE MUSIC ALMOST DIED THE BANKS JUNE 1970
2: - THE DAY THE MUSIC ALMOST DIED THE BROKERS SEPTEMBER 1970
III: - The Pros
1: - NOSTALGIA TIME: THE GREAT BUYING PANIC
2: - AN UNSUCCESSFUL GROUP THERAPY SESSION FOR FIFTEEN HUNDRED INVESTMENT ...
3: - CAUTIONARY TALES REMEMBER THESE, O BROTHER, IN YOUR NEW HOURS OF TRIUMPH
4: - HOW MY SWISS BANK BLEW $40 MILLION AND WENT BROKE
5: - SOMEBODY MUST HAVE DONE SOMETHING RIGHT: THE LESSONS OF THE MASTER
IV: - Is the System Blown?
1: - THE DEBASED LANGUAGE OF SUPERCURRENCY
2: - CO-OPTING SOME OF THE SUPERCURRENCY
3: - BETA, OR SPEAK TO ME SOFTLY IN ALGEBRA
Some Notes
About the Author
INTRODUCING WILEY INVESTMENT CLASSICS
There are certain books that have redefined the way we see the worlds of finance and investing—books that deserve a place on every investor’s shelf. Wiley Investment Classics will introduce you to these memorable books, which are just as relevant and vital today as when they were first published. Open a Wiley Investment Classic and rediscover the proven strategies, market philosophies, and definitive techniques that continue to stand the test of time.
Copyright © 1972 by ‘Adam Smith’. All rights reserved
Foreword copyright © 2006 by John Wiley & Sons, Inc. All rights reserved
Preface copyright © 2006 by ‘Adam Smith’. All rights reserved
Published by John Wiley & Sons, Inc., Hoboken, New Jersey
Published simultaneously in Canada
Originally published in 1972 by Random House.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4470, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.
Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com.
ISBN-13 978-0-471-78631-3
ISBN-10 0-471-78631-4
For Mark O. Park
and
Susannah B. Fish
FOREWORD
Supermoney, along with its predecessor, The Money Game, told the story of what came to be known as the “Go-Go” years in the U.S. stock market. It is the book that introduced Warren Buffett, now the world’s most noted investor, long before he became the paradigm of investment success and homespun financial wisdom. In Supermoney , author “Adam Smith” travels to Omaha to meet this Will Rogers character, and later brings him on his television show, Adam Smith’s Money World. Buffett’s distinction in the Go-Go era was that he was one of the few who divined it correctly, quietly dropping out and closing the investment fund he managed. His remaining interest, in a thinly traded New England textile company, Berkshire Hathaway, would later become the vehicle for what may well be the most successful investment program of all time.
The era of speculation described in The Money Game—and in Supermoney—began in the early 1960s and was pretty much over by 1968, only to be succeeded by yet another wave of speculation—albeit one that was starkly different in its derivation—that drove the stock market ever higher through early 1973. Then the bubble of that era burst. By the autumn of 1974 the market had fallen by 50 percent from its high, taking it back below the level it reached in 1959, 15 years earlier.
Both books reached large, eager, and well-informed audiences, deservedly earning best-seller status. In them, the author “Adam Smith” recounted perceptive, bouncing, often hilarious anecdotes about the dramatis personae of the stage show that investing had become. While The Money Game was essentially a study in the behavior of individual investors, Supermoney, as its book jacket reminded us, was about the social behavior of institutional investors, focusing on the use of “supercurrency”—income garnered through market appreciation and stock options—that became the coin of the realm during the Go-Go years.
These two books quickly became part of the lore of investing in that wild and crazy era. In retrospect, however, they provided Cassandra-like warnings about the next wild and crazy era, which would come, as it happens, some three decades later. The New Economy bubble of the late 1990s, followed by, yes, another 50 percent collapse in stock prices, had truly remarkable parallels with its earlier counterpart. Surely Santayana was right when he warned that “those who cannot remember the past are condemned to repeat it.”
In the aftermath of that second great crash, as investors again struggle to find their bearings, the timing of this new edition of Supermoney is inspired. It is a thoroughly enchanting history, laced with wit and wisdom that provides useful lessons for those investors who didn’t live through the Go-Go years. It also provides poignant reminiscences for those who did live through them. Using the insightful (but probably apocryphal) words attributed to Yogi Berra, it is “déjà vu all over again.”
I consider myself fortunate to have learned the lessons of the Supermoney bubble, albeit the hard way. While I was among those who lived and lost, both personally and professionally, in that era, I summoned the strength to return and fight again. Hardened in the crucible of that experience, I reshaped my ideas about sound investing. So as the New Economy bubble inflated to the bursting point in the years before the recent turn of the century, I was one of a handful of Cassandras, urging investors to avoid concentration in the high-tech stocks of the day, to diversify to the nth degree, and to allocate significant assets to, yes, bonds.
I also consider myself fortunate to have known and worked with Jerry Goodman (the present-day Adam Smith) during this long span, having been periodically interviewed for Institutional Investor magazine (of which he was founding editor) and for his popular Public Broadcasting Network television show, Adam Smith’s Money World. We served together on the Advisory Council of the Economics Department of Princeton University during the 1970s, where his strong and well-founded opinions were a highlight of our annual roundtable discussions. While I have no hesitation in acknowledging Jerry’s superior mind and writing skill—a nice combination!—I console myself with our parity on the fields of combat. (Exact parity: Years ago, on a Princeton squash court, we were tied at 2-2 in the match and at 7-7 in the deciding game when the lights went out and the match ended.)
As one of a very few participants who has been part of the march of the financial markets during a period that has now reached 55 years—including both the Go-Go bubble of yore and the New Economy bubble of recent memory—I’m honored and delighted to contribute the foreword to this 2006 reissue of a remarkable book. I’ll first discuss the excesses of the Supermoney era; next, the relentless retribution that came in its aftermath; and finally, the coming and going of yet the most recent example of the “extraordinarily popular delusions and the madness of crowds” that have punctuated the financial markets all through history. Of course, if tomorrow’s investors actually learn from the hard-won experience of their elders and the lessons of history chronicled in this wonderful volume, there will never be another bubble. But I wouldn’t count on it!
Part One: The Supermoney Era
The Goodman books chronicled an era that verged on—and sometimes even crossed the line into—financial insanity: the triumph of perception over reality, of the transitory illusion of earnings (to say nothing of earnings calculations and earnings expectat
During the Money Game/Supermoney era, perception was able to overwhelm reality in large measure because of financial trickery that made reality appear much better than it was. “Adam Smith” described how easy it was to inflate corporate earnings: “Decrease depreciation charges by changing from accelerated to straight line . . . change the valuation of your inventories . . . adjust the charges made for your pension fund . . . capitalize research instead of expensing it . . . defer the costs of a project until it brings in revenues . . . play with pooling and purchase (accounting) . . . all done with an eye on the stock, not on what might be considered economic reality.” And the public accountants, sitting by in silence, let the game go on. The most respected accountant of the generation, Leonard Spacek, chairman emeritus of Arthur Andersen, was almost alone in speaking out against the financial engineering that had become commonplace: “How my profession can tolerate such fiction and look the public in the eye is beyond my understanding . . . financial statements are a roulette wheel.” His warning was not heeded.
The acceptance of this foolishness by the investment community was broad and deep. Writing in Institutional Investor in January 1968, no less an industry guru than Charles D. Ellis, then an analyst at institutional research broker Donaldson, Lufkin and Jenrette, concluded that “short-term investing may actually be safer than long-term investing sometimes, and the price action of the stocks may be more important than the ‘fundamentals’ on which most research is based . . . portfolio managers buy stocks, they do not ‘invest’ in corporations.”
Yet reality, finally, took over. When it did, the stocks that were in the forefront of the bubble collapsed, fallen idols that proved to have feet of clay. Consider this table from Supermoney:
Subsequent
High Low
National Student Marketing 36 1½
Four Seasons Nursing Homes 91 0
Parvin Dohrmann 142 14
Commonwealth United 25 1
Susquehanna 80 7
Management Assistance 46 2
Stocks like these were among the favorites of mutual fund managers, and those that played the money game the hardest had the greatest near-term success. In its 1966 edition, the Investment Companies manual, published annually by Arthur Wiesenberger & Co. since the early 1940s, even created a special category for such funds. “Maximum Capital Gain” (MCG) funds were separated from the traditional “Long-Term Growth, Income Secondary” (LTG) funds, with remaining equity funds in the staid “Growth and Current Income” (GCI) funds category. During the Go-Go era (1963-1968 inclusive), the disparities in returns were stunning: GCI funds, +116 percent; LTG funds, +151 percent; MCG funds, a remarkable +285 percent.
At the beginning of the Go-Go era, there were 22 MCG funds; at the peak, 143. Amazingly, after its initial offering in 1966, Gerald Tsai’s Manhattan Fund—a hot IPO in an industry that had never before had even a warm IPO—was placed in the LTG category. The offering attracted $250 million, nearly 15 percent of the total cash flow into equity funds for the year, and its assets would soar to $560 million within two years. Tsai was the inscrutable manager who had turned in a remarkable record in running Fidelity Capital Fund—+296 percent in 1958-1965 compared to a gain of 166 percent for the average conservative equity fund. An article in Newsweek epitomized Tsai’s lionization: “radiates total cool . . . dazzling rewards . . . no man wields greater influence . . . king of the mutual funds.” Tsai, no mean marketer, described himself as “really very conservative,” and even denied that there was “such a thing as a go-go [fund].”
During the bubble of 1963-1968, equally remarkable gains were achieved by other Go-Go funds. With the S&P 500 up some 99 percent, Fidelity Trend Fund rose 245 percent, Winfield Fund leaped 285 percent, and Enterprise Fund a remarkable 643 percent. But after the 1968 peak, these funds earned unexceptional—indeed subpar—returns during the period from 1969 to 1971. Nonetheless, with their extraordinary performance during the boom years (however achieved), their lifetime records through 1971 continued to appear extraordinary.
It was not only mutual funds that joined in the market madness. While the cupidity of fund managers could at least be understood, it was not obvious why major not-for-profit institutions also succumbed. Even the Ford Foundation added fuel to the fire, warning that, “over the long run, caution has cost our universities more than imprudence or excessive risk-taking.” The poster child for imprudence was the University of Rochester’s endowment fund. Supermoney describes its approach: “to buy the so-called great companies and not sell them,” a portfolio dominated by holdings in IBM, Xerox, and Eastman Kodak. The unit value of its portfolio (presented as an appendix in Supermoney) soared from $2.26 in 1962 to $4.95 in 1967, and to $5.60 in 1971—an aggregate gain of 150 percent. Could it really be that easy?
Alas, if only I knew then what I know now. Lured by the siren song of the Go-Go years, I too mindlessly jumped on the bandwagon. In 1965, I was directed by Wellington Management Company chairman and founder Walter L. Morgan to “do whatever is necessary” to bring the firm that I had joined in 1951, right out of college, into the new era. I quickly engineered a merger with Boston money manager Thorndike, Doran, Paine, and Lewis, whose Ivest Fund was one of the top-performing Go-Go funds of the era. The merger was completed in 1966. In 1967 I callowly announced to our staff, “We’re #1”—for during the five years ended December 31, 1966, the fund had delivered the highest total return of any mutual fund in the entire industry. So far, so good.
The story of that merger was chronicled in the lead article in the January 1968 issue of Institutional Investor, whose editor was none other than George J.W. Goodman. “The Whiz Kids Take Over at Wellington” described how the new partners had moved Wellington off the traditional “balanced” investment course to a new “contemporary” course. In Wellington Fund’s 1967 annual report, it was described as “dynamic conservatism” by the fund’s new portfolio manager, Walter M. Cabot:Times change. We decided we too should change to bring the portfolio more into line with modern concepts and opportunities. We have chosen “dynamic conservatism” as our philosophy, with emphasis on companies that demonstrate the ability to meet, shape and profit from change. [We have] increased our common stock position from 64 percent of resources to 72 percent, with a definite emphasis on growth stocks and a reduction in traditional basic industries. A conservative investment fund is one that aggressively seeks rewards, and therefore has a substantial exposure to capital growth, potential profits and rising dividends . . . [one that] demands imagination, creativity, and flexibility. We will be invested in many of the great growth companies of our society. Dynamic and conservative investing is not, then, a contradiction in terms. A strong offense is the best defense.
When one of the most conservative funds in the entire mutual fund industry begins to “aggressively seek rewards,” it should have been obvious that the Go-Go era was over. And it was over. Sadly, in the market carnage that would soon follow, the fund’s strong offense, however unsurprisingly, turned out to be the worst defense.
Part Two: Retribution Comes
When there is a gap between perception and reality, it is only a matter of time until the gap is reconciled. But since reality is so stubborn and tolerates no gamesmanship, it is impossible for reality to rise to meet perception. So it follows that perception must decline to meet reality. Après moi le déluge.
