21 Sep 2001 Capitulation
Have they won? Not if you listened to our President last night and believed his resolve to win this war. They have not won if you believe in the resolve of the American people. They have not won if you believe the world leaders will be “with us” and not “with the terrorists.” Indeed because of strong leadership by President Bush, his able cabinet, and a united Congress, as well as strong support from our allies, we hold the hope that the grip of terrorism on the civilized world will be broken and eventually eradicated.
Our markets as marked by the DOW, the S&P 500, and the NASDAQ indexes have fallen short of the patriotic answer to the terrorists that many were hoping for. Our first week of trading after the attacks looks like it will go into the books as one of the worst in history. Markets and the investors who drive them are not ruled by patriotism, but by judgments of value. The larger truth is that, in the short run, markets are ruled by emotion and not the logic of value calculations. This week big investors and small alike ran for cover. Fear that our economy is headed into recession in light of terrorist activities and continuing threats has convinced many market participants that recovery is now too far away to own stocks, and cash is the place to be. That is a short-term view.
Long-term investors believe that market movements over one or two-year periods are random. They believe that effort to predict markets over the short cycle is wasted. Rather, long-term investors spend their time and energy finding companies they think will earn substantially more in three to five years than they do now. As their earnings grow, so will their stock value. Indeed, longer periods of time favor stocks over all other forms of investing. The chart below from Forbes.com illustrates the volatility that is introduced into markets by unforeseen events.
Historical perspective can be useful in such
situations. Financial markets tend to be manic-depressive, overeating bad news
only to snap back relatively quickly. The table below, gleaned from a document
making the rounds on Wall Street, shows the reaction of the Dow to various
crisis events since the fall of France in 1940. Our sources seem to verify the
numbers’ accuracy.
The chart demonstrates that markets generally recover relatively quickly after shocks to confidence. It should be noted that the larger breaks such as the oil embargo of ‘73 and the crash of ‘87 occurred during much more difficult economic conditions with high interest rates, inflation and unemployment. As Greenspan pointed out yesterday, our economy had positive momentum developing before the shock of the terrorist attacks. Interest rates and inflation are low while unemployment is still well below levels reached in earlier recessions. The logarithmic chart below of the Dow over the past 30 years puts some of the events above in a longer perspective.
There is no crystal ball to consult for answers. The experts on CNBC speak with great confidence as they recommend what you should do now. They suggest that stocks are not the place to be. What were they saying at the peak of the bubble in 2000? They were saying that stocks were the place to be. I do not know what our future holds. I don’t know where the markets will be this year or next, but I have confidence that the companies we own will grow and that the American economy will grow and innovate. As they grow, stock prices will once again reflect their value. The trap, into which we all fall victim occasionally, is the futile attempt at analysis of the mass-psychological hysteria we call “the market.” Benjamin Graham called “the market” a voting machine in the short run and a weighing machine in the long. Do we really want to compete and ‘vote’ with all the palmists, astrologists, psychics, Indian chiefs, and ‘experts’ out there? Our job is to find, buy and hold good companies in the knowledge that their competitive advantage will translate into higher stock prices in the future.
My best to you and your family as we weather this global storm.
