Graham & Dodd on today’s market

For perspective amid the market turmoil, I’ve been reading the classic Security Analysis by Benjamin Graham and David Dodd. The first edition, from our local library, takes us back 75 years to the market of 1934.

In the midst of the Great Depression, the value mavens write:

img_28511Economic events between 1927 and 1933 involved something more than a mere repetition of the familiar phenomena of business and stock-market cycles. A glance at the appended chart covering the movements of the Dow-Jones averages of industrial common stocks since 1897 will show how entirely unprecedented was the extent of both the recent advance and the ensuing collapse. They seem to differ from the series of preceding fluctuations as a tidal wave differs from ordinary billows …

Sounds a little like the rise and fall we’ve experienced recently. Graham and Dodd, while expounding quantitative approaches for hundreds of pages, also comment on the role of human nature:

One of the striking features of the past five years has been the domination of the financial scene by purely psychological elements. In previous bull markets the rise in stock prices remained in fairly close relationship with the improvement in business during the greater part of the cycle; it was only in its invariably short-lived culminating phase that quotations were forced to disproportionate heights by the unbridled optimism of the speculative contingent. But in the 1921-1933 cycle this ‘culminating phase’ lasted for years instead of months, and it drew its support not from a group of speculators but from the entire financial community.

This, too, sounds a bit like the bull-to-bear cycle from the 1990s to present. Back to Graham and Dodd, in 1934:

We suggest that this psychological phenomenon is closely related to the dominant importance assumed in recent years by intangible factors, viz., good-will, management, expected earning power, etc. Such value factors, while undoubtedly real, are not susceptible to mathematical calculation; hence the standards by which they are measured are to a great extent arbitrary and can suffer the widest variations in accordance with the prevalent psychology.

The authors say “the investing class” is more likely to be carried away with speculative values and intangibles when investors have “surplus wealth” to deploy. In hard times like the 1930s, investors will apply “the old-established acid test that the principal value be justified by the income.”

That, to me, is an application of market history to investor relations. We can expect investors in 2009 and beyond, battered by the bear market, to be much more focused on the acid test – the visibility of real earnings. And more skeptical of excitement and potential. We should communicate to investors where they are.


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