Supermoney E-Book

Adam Smith

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Investment Classic Series
• Sprache: Englisch
• Veröffentlichungsjahr: 2010

Seitenzahl: 476

Beschreibung

"Adam Smith continues to dazzle and sparkle! With the passage of time, Supermoney has, if anything, added to its power to inspire, arouse, provoke, motivate, inform, illuminate, entertain, and guide a whole new generation of readers, while marvelously reprising the global money show for earlier fans." -David M. Darst, author of The Art of Asset Allocation Managing Director and Chief Investment Strategist, Morgan Stanley Individual Investor Group "Nobody has written about the craft of money management with more insight, humor, and understanding than Adam Smith. Over the years, he has consistently separated wisdom from whimsy, brilliance from bluster, and character from chicanery." -Byron R. Wien, coauthor of Soros on Soros Chief Investment Strategist, Pequot Capital Management Supermoney may be even more relevant today than when it was first published nearly twenty-five years ago. Written in the bright and funny style that became Adam Smith's trademark, this book gives a view inside institutions, professionals, and the nature of markets that has rarely been shown before or since. "Adam Smith" was the first to introduce an obscure fund manager in Omaha, Nebraska, named Warren Buffett. In this new edition, Smith provides a fresh perspective in an updated Preface that contextualizes the applicability of the markets of the 1960s and 1970s to today's markets. Things change, but sometimes the more they change, the more they stay the same.

Leseprobe

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.

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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 expectations) over the ultimate fundamentals of balance sheets and discounted cash flows. It was an era in which investors considered “concepts” and “trends” as the touchstones of investing, easily able to rationalize them, since they were backed by numbers, however dubious their provenance. As Goodman writes in his introduction to this new edition: “. . . people viewed financial matters as rational, because the game was measured in numbers, and numbers are finite and definitive.”

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:

SubsequentHighLowNational Student Marketing361½Four Seasons Nursing Homes910Parvin Dohrmann14214Commonwealth United251Susquehanna807Management Assistance462

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.

The ending of the Go-Go era in 1968 was followed by a 5 percent decline in the stock market during 1969 and 1970. Even larger losses (averaging 30 percent) were incurred by the new breed of aggressive investors. But that decline was quickly offset by a 14 percent market recovery in 1971 (just as Jerry Goodman was writing Supermoney). In 1972, with another 19 percent gain, the market’s snapback continued. For the two years combined, the market and the MCG funds produced a total return of about 35 percent.

Those final two years of the bubble reflected a subtle shift from the Go-Go era to the “Favorite Fifty” era. But that metamorphosis didn’t help the other, more conservative, equity funds. Why? Because as the bubble mutated from generally smaller concept stocks to large, established companies—“the great companies” epitomized in the Rochester portfolio, sometimes called the “Favorite Fifty,” sometimes the “Vestal Virgins”—the stock prices of these companies, too, lost touch with the underlying economic reality, trading at price-earnings multiples that, as it was said, “discounted not only the future, but the hereafter.”

But as 1973 began, the game ended. During the next two calendar years, the aggressive funds tumbled by almost 50 percent on average, with Fidelity Trend off 47 percent and Enterprise Fund off 44 percent. (Winfield Fund, off 50 percent in 1969-1970, was no longer around for the final carnage.) Tsai’s Manhattan Fund, remarkably, did even worse, tumbling by 55 percent. By December 31, 1974, Manhattan Fund had provided the worst—the worst—eight-year record in the entire mutual fund industry: a cumulative loss of 70 percent of its shareholders’ capital. In the meantime, Tsai, the failed investor but still the brilliant entrepreneur, had sold his company to CNA Insurance in 1968. By 1974, Manhattan Fund’s assets had dwindled by a mere 90 percent, to $54 million, becoming a shell of its former self and a name that virtually vanished into the dustbin of market history.

And at Rochester University, the value of the endowment fund—for all the noble intentions of its managers—also plummeted. The coming of the Go-Go bubble followed by the Favorite Fifty bubble had carried its unit value from $3.17 in 1964 to $7.20 in 1972, but their going had carried it right back to $3.13 in 1974—even below where it had begun a decade earlier. Après moi le déluge indeed! (Reflecting the embarrassment of the Rochester managers, the cover of the endowment fund’s annual report for 1974 was red, “the deepest shade we could find.”)

My face was red, too. I can hardly find words to describe first my regret and then my anger at myself for having made so many bad choices. Associating myself—and the firm with whose leadership I had been entrusted—with a group of go-go managers. The stupid belief that outsized rewards could be achieved without assuming outsized risks. The naive conviction that I was smart enough to defy the clear lessons of history and select money managers who could consistently provide superior returns. Putting on an ill-fitting marketing hat to expand Wellington’s “product line” (a phrase I have come to detest when applied to the field of money management, accurate today only because the fund field is now one of money marketing, and, ugh!, product development). I, too, had become one of the mad crowd that harbored the extraordinary popular delusions of the day.

Ultimately, alas, the merger that I had sought and accomplished not only failed to solve Wellington’s problems, it exacerbated them. Despite the early glitter of success for the firm during the Go-Go years, the substance proved illusory. As a business matter, the merger worked beautifully for the first five years, but both I and the aggressive investment managers whom I had too opportunistically sought as my new partners let our fund shareholders down badly. In the great bear market of 1973-1974, stock prices declined by a devastating 50 percent from high to low. Even for the full two-year period, the S&P 500 Index provided a total return (including dividends) of minus 37 percent.

Most of our equity funds did even worse. During the same period, for example, Ivest lost a shocking 55 percent of its value. In my annual chairman’s letter to shareholders for 1974, I bluntly reported that “the fund’s net asset value declined by 44 percent for the August 31 fiscal year.... Comparing this with a decline of 31 percent for the S&P 500 . . . we regard the fund’s performance as unsatisfactory.” (One of the fund’s directors was appalled by my recognition of this seemingly self-evident fact. He soon resigned from the board.) We had also started other aggressive funds during this ebullient era. When the day of reckoning came, they, too, plummeted far more than the S&P 500: Explorer, -52 percent; Morgan Growth Fund, - 47 percent; and Trustees’ (!) Equity Fund, - 47 percent. The latter fund folded in 1978, and a speculative fund—Technivest—that we designed to “take advantage of technical market analysis” (I’m not kidding!) folded even earlier.

Even our crown jewel, Wellington Fund, with that earlier increase in its equity ratio and a portfolio laden with “the great growth companies of our society,” suffered a 26 percent loss in 1973-1974. Its record since the 1966 merger was near the bottom of the balanced fund barrel. With the average balanced fund up 23 percent for the decade, Wellington’s cumulative total return for the entire period (including dividends) was close to zero—a mere 2 percent. (In 1975, portfolio manager Cabot left the firm to become manager of the Harvard Endowment Fund.)

In a business environment that was falling apart almost week by week, this terrible performance put enormous strains on the once-cooperative partnership, strains that were soon exacerbated by personal differences, conflicting ambitions and egos, and the desire to hold the reins of power. Not surprisingly, my new partners and I had a falling-out. But they had more votes on the board, and it was they who fired me from what I had considered “my” company.

I had failed our shareholders and I had failed in my career—not in getting fired, but in jumping on the speculative bandwagon of aggressive investing in the first place. Life was fair, however: I had made a big error and I paid a high price.1 I was heartbroken, my career in shambles. But I wasn’t defeated. I had always been told that when a door closed (this one had slammed!), a window would open. I decided that I would open that window myself, resume my career, and change the very structure under which mutual funds operated, which was, importantly, responsible for the industry’s abject failure during the Go-Go era. I would make the mutual fund industry a better place to invest.

But how could that goal be accomplished? With the essence of simplicity. Why should mutual funds retain an outside company to manage their affairs—then, and now, the modus operandi of our industry—when, once they reach a critical asset mass, funds are perfectly capable of managing themselves and saving a small fortune in fees? Why not create a structure in which mutual funds would, uniquely, be truly mutual? They would be run, not in the interest of an external adviser—a business whose goal is to earn the highest possible profit for its own separate set of owners—but in the interest of their own shareholder/owners, at the lowest possible cost. The firm would not be run on the basis of product marketing. The funds would focus, not on hot sectors of the market, but on the total market itself. The core investment philosophy would eschew the fallacy of short-term speculation and trumpet the wisdom of long-term investing. And so, on September 24, 1974, out of all the hyperbole and madness of the Go-Go era and the Favorite Fifty era, and the travail of the great crash that followed, came the creation of the Vanguard Group of Investment Companies.

Part Three: Another Bubble

One of the most engaging anecdotes in Supermoney is the tale of an annual investment conference in New York City that attracted some 1,500 trust officers and mutual fund managers (presumably the 1970 Conference held by Institutional Investor magazine). Jerry Goodman was the moderator, and as he writes, he “thought it would be a nice psychological purge after the (then) worst year of the Big Bear, if some of the previous winners could get up and confess their big sins.” However good for the soul that might have been, few confessions were forthcoming. But the crowd was reminded of its sins by crusty New Englander David Babson, who described the stock market of the day as “a national craps game.” His philosophy as an investment manager revolved around hard work and common sense, “virtues that would triumph in the long run.”

He lashed into the assembled crowd, describing how professional investors had “gotten sucked into speculation,” reading off a list, name by name, of once-vaunted stocks that had plummeted in price (from 80 to 7, 68 to 4, 46 to 2, 68 to 3, and so on), and suggesting that some of the assembled managers should leave the business. Despite Goodman’s warning (“David, you have passed the pain threshold of the audience”), Babson singled out “the new breed of investment managers who bought and churned the worst collection of new issues and other junk in history, and the underwriters who made a fortune in bringing them out . . . and elements of the financial press which promoted into new investment geniuses a group of neophytes who had . . . no sense of responsibility for managing other people’s money.” Babson concluded that “no greater period of skullduggery in American financial history exists than 1967 to 1969. It has burned this generation like 1929 did another one, and it will be a long, long time before it happens again.”

As one might imagine, Mr. Babson’s remarks were not well received by the audience of money managers. But while he failed to foresee a second leg of the bubble (the Favorite Fifty era) that would quickly follow, he was right. Just as some 35 years had elapsed from 1929 until the start of the Go-Go era in 1965, so some 33 years would elapse before the next bubble emerged. Once again, a new generation would forget the lessons learned by its predecessors.

Some of the causes of the new bubble were the same. (They may be eternal.) David Babson had listed them: “Accountants who played footsie with stock-promoting managements by classifying earnings that weren’t earnings at all. ‘Modern’ corporate treasurers who looked upon their company pension funds as new-found profit centers . . . mutual fund managers who tried to become millionaires overnight by using every gimmick imaginable to manufacture their own paper performance . . . security analysts who forgot about their professional ethics to become storytellers and let their institutions be taken in by a whole parade of confidence men.” Charles Ellis’s 1968 insight that “portfolio managers buy stocks, they do not ‘invest’ in corporations” also came back to haunt us. (With a twist, of course. Managers didn’t merely buy stocks; they traded them with unprecedented ferocity.)

If you conclude that the more things change, the more they remain the same, you get my point. But each bubble has its own characteristics, too, and the bubble of the late 1990s added a host of new elements to the eternal equation. Part of the bullish thesis underlying that bubble (as it was described by WIRED magazine) was based on a heavy dose of rose-colored vision: “the triumph of the United States, the end of major wars, waves of new technology, soaring productivity, a truly global market, and corporate restructuring—a virtuous circle . . . driven by an open society in an integrated world.” And there was more: the excitement accompanying the turn of the millennium that would begin in 2001 (even though most people celebrated it on January 1, 2000); the “information age” and the technology revolution; the (once-capitalized) “new economy.” Together, these powerful changes seemed to hold the prospects of extraordinary opportunity. And so, once again, investors lost their perspective.

Why should that surprise us? After all, way back in the second century B.C.E. the Roman orator Cato warned us:

There must certainly be a vast Fund of Stupidity in Human Nature, else Men would not be caught as they are, a thousand times over, by the same Snare, and while they yet remember their past Misfortunes, go on to court and encourage the Causes to which they were owing, and which will again produce them.

After my experience in the earlier bubble, I hardly needed Cato’s warning. Late in March of 2000—within days of the stock market’s hyperinflated peak—I was writing a speech that would soon warn a gathering of institutional investors in Boston that we could well be “caught in one of those periodic snares set by the limitless supply of stupidity in human nature.... Professional investors who ignore today’s rife signs of market madness—of a bubble, if you will—are abrogating their fiduciary duty, and dishonoring their responsibility for the stewardship of their clients’ assets.”

“How should that responsibility be honored?” I asked. “By recognizing that, for all of the projections and assumptions we make (and almost take for granted) . . . stock market returns are completely unpredictable in the short run and—unless we know more about the world 25 years from now than we do about the world today—may prove even less predictable over the long-run. The problem is that future expectations often lose touch with future reality. Sometimes hope rides in the saddle, sometimes greed, sometimes fear. No, there is no ‘new paradigm.’ Hope, greed, and fear make up the market’s eternal paradigm.”

In the speech, I also noted that, “by almost any conventional measure of stock valuation, stocks have never been riskier than they are today,” pointing out that major market highs were almost invariably signaled when the dividend yield on stocks fell below 3 percent, when the price-earnings ratio rose much above 20 times earnings, and when the aggregate market value of U.S. equities reached 80 percent of our nation’s gross domestic product (GDP). “Yet today,” I warned, “dividend yields have fallen to just over 1 percent . . . stocks are now selling at something like 32 times last year’s earnings . . . and the equity market value has almost reached 200 percent of GDP. (Just be patient!) Clearly, if past data mean anything, risk is the forgotten man of this Great Bull Market.”

The disquieting similarities between the Go-Go era and the recent technology-driven market also caught my attention. In the course of my remarks, I presented the exhibit below to show the striking parallels between the huge upside returns of the aggressive funds of each era and the enormous capital inflows that they enjoyed when investors—as always, late to the game—chased those returns.

Déjà vu?Comparison of Go-Go Era to Tech-Boom Era

My conclusion:

So, let me be clear: You can place me firmly in the camp of those who are deeply concerned that the stock market is all too likely to be riding for a painful fall—indeed a fall that may well have begun as I began to write this speech ten days ago. From Milton Friedman to Robert Shiller (author of the newly published Irrational Exuberance), to John Cassidy of The New Yorker, and Steven Leuthold, Jeremy Grantham, Jeremy Siegel, Julian Robertson (who just threw in the towel), Gary Brinson (whose convictions may have cost him his job), and Alan Greenspan (whose convictions haven’t). Viewed a decade hence, today’s stock market may just be one more chapter in Extraordinary Popular Delusions and the Madness of Crowds.

As it turned out, the painful fall had begun, on March 10, 2000, just as I began to write that speech. (There’s luck in that; while we often know what will happen in the stock market, we never know when.) But what about those three question marks about future returns that I posted in the lower right corner of the exhibit? Again, the similarities to the earlier bubble were to prove stunning. While the S&P 500 was off just 7 percent in 2000-2005, the total return of the average large technology fund was a staggering minus 58 percent. “History may not repeat itself,” in Mark Twain’s wise formulation, “but it rhymes.”

So, dear reader, learn from the wonderful history you are about to read. Enjoy a fast-moving page-turner about a wild and crazy era, the kind of era that, as Cato warned us, repeats itself over and over again. Profit from the lessons of the past that “Adam Smith” so vividly brings to life in Supermoney. Profit too, if you will, from my own personal and professional failures, and learn from them the easy way rather than the hard way that was my lot. (Not that, after a long and character-building struggle, it didn’t have a wonderful outcome!) Above all, heed the idealistic goal set by John Maynard Keynes 70 years ago, quoted at length in Supermoney:

(While) the actual private object of most skilled investors today . . . is a battle of wits to anticipate the basis of conventional valuation a few months hence . . . the social object of investment should be to defeat the dark forces of time and ignorance which envelop our future.

John C. Bogle Valley Forge, Pennsylvania January 11, 2006

Preface to the 2006 Edition

Who’s Warren Buffett? What Is Supermoney?

The handwritten letter appeared in 1970; it was from “La Champouse,” 42 Avenue de Marseille, Aix-en-Provence. Benjamin Graham was living in the South of France, retired, with his lady friend, and translating Greek and Latin classics. That was a favorite avocation. The prescript of Security Analysis, the forbidding black bible of security analysts, is from Horace: “Many shall be restored that are now fallen and many shall fall that are now in honor.”

I hadn’t known him, but I had written some sentences about him in The Money Game. Graham, I had written, was “the dean of our profession, if security analysis can be said to be a profession. The reason that Graham is the undisputed dean is that before him there was no profession and after him they began to call it that.”

Graham liked being called “the dean.” He corrected, in Greek, a sentence in my book that no one had checked, and one or two other references. He said he had something in mind to discuss when he came to New York.

Shortly thereafter, he did appear in New York, to see a publisher about his translation of Aeschuylus and to see his grandchildren. I asked him what he thought of the market. Hoc etiam transibit, he said, “This too shall pass.”

Graham said he wanted me to work on the next edition of The Intelligent Investor, the popular version of his textbook. “There are only two people I would ask to do this,” he said. “You are one, and Warren Buffett is the other.”

“Who’s Warren Buffett?” I asked. A natural question. In 1970 Warren Buffett wasn’t known outside of Omaha, Nebraska, or Ben Graham’s circle of friends.

Today, Warren is so well known that when newspapers mention him they sometimes need no phrase in apposition to identify him, or if they do, they say simply, “the investor.” There are full-length biographies on the shelves. He is indeed “the investor,” one of the best in history. Investing has made him the second-richest person in the country, behind his bridge buddy Bill Gates.

Even in 1970, Warren had an outstanding investment record, and with an unfashionable technique. He had started an investment partnership in 1956 with $105,000 from friends and relatives. When he terminated the partnership in 1969, it had $105 million and had compounded at 31 percent. Warren’s performance fee meant he was worth about $25 million. He ended the partnership because he said he couldn’t understand the stock market anymore.

I was not the right author to work on the next edition of The Intelligent Investor. I was an acolyte of Sam Stedman (not the mutual funds or the bridge conventions) by way of Phil Fisher. Stedman’s investment philosophy, loosely called “growth,” said you should find a couple of rapidly growing companies whose growth rates were secure. The companies would have a competitive advantage because of their patent protection or impregnable market positions; they would have three years of earning visibility; and you would buy them at less than their growth rates, because their prices would seem high compared to the average stock and they paid no dividends.

The machine that addicted us to growth investing was the Xerox 914. It was the first machine to copy plain paper, and I can remember writing that some day people would use the word Xerox as a verb. That seemed radical at the time. Xerox was a ten-bagger, and once you have a ten-bagger, everything else seems tame. The Xerox crowd even got to play the game again, with Rank Xerox in the United Kingdom and Fuji Xerox in Japan.

We all went to Dunhill on 57th Street and had suits tailored where the four buttons on the sleeves had real buttonholes. We did not think much about Ben Graham. Charming as he was, he had written, in 1949, that he could not buy IBM because its price precluded the “margin of safety which we consider essential to a true investment.”

At Graham’s urging, I had several conversations with Warren, and then I flew to Omaha to meet him, even though I still didn’t think I was right for the job. We had a steak dinner. We had a bacon, eggs, and potatoes breakfast. We got along famously. Warren was, and is, cheerful and funny. He has a gift of metaphor that is irresistible. And, as everybody now knows, he is very smart.

Warren didn’t look like the Xerox crowd. While he wore a suit and a tie, his wrists emerged from the sleeves, revealing an indifference to tailoring. (Today, as our senior financial statesman, he is dressed impeccably, but without, I suspect, intense interest in the process.) To a member of the Xerox crowd then, he looked like he had fallen off the turnip truck.

I went to Warren’s house on Farnam Street, which he had bought for $31,500 in 1958. It was a rambling, comfortable house. He had added a racquetball court to it.

How, I wanted to know, could he operate from Omaha? In New York, the portfolio managers were all trading stories at breakfast, lunch, and dinner.

“Omaha gives me perspective,” Warren said. He showed me a write-up from a Wall Street firm that said, “Securities must be studied on a minute-by-minute program.”

“Wow!” Warren said. “This sort of stuff makes me feel guilty when I go out for a Pepsi.”

I couldn’t interest Warren in the truffle hunt for the next Xerox. Our growth crowd was sniffing everywhere, talking to vendors, customers, competitors, the Phil Fisher geometry. Not that Warren didn’t do research his own way.

For example, Warren noticed that the bonds of the Indiana Turnpike were selling in the 70s, while the nearly identical bonds of the Illinois Turnpike sold in the 90s. The casual word among the bond crowd was that the maintenance allowance wasn’t high enough behind the Indiana bonds.

Warren got into his car and drove the length of the Indiana Turnpike. Then he went to Indianapolis and turned the pages of the maintenance reports of the highway department. He thought the Indiana Turnpike didn’t need that much work, and bought the bonds. They closed the gap with the bonds of the Illinois Turnpike. Not exactly the next Xerox.

Warren showed me the principles he had written out on a lined, yellow legal pad and framed:

a. Our investments will be chosen on the basis of value, not popularity.

b. Our investments will attempt to reduce the risk of permanent capital loss (not short-term quotation loss) to a minimum.

c. My wife, children and I will have virtually our entire net worth in the partnership.

Warren had ended his partnership, so I couldn’t have bought into it anyway. The partnership had bought shares in an old New England textile company, Berkshire Hathaway, and that stock was traded in the “pink sheets.” I looked up Berkshire. It seemed to be a failing New England textile company.

“Berkshire is hardly going to be as profitable as Xerox in a hypertense market,” Warren wrote to his investors, “but it is a very comfortable thing to own. We will not go into a business where technology which is way over my head is crucial to the decision.” Berkshire’s attraction was that it had $18 in net working capital, and Buffett’s investors had paid $13.

I didn’t buy Berkshire Hathaway. At the end of my stay, I said I didn’t want to work on Ben Graham’s book. Warren said he didn’t either. We wrote a note to Ben saying his book didn’t really need any improvements.

The little story about Ben and Warren went into this book. The original publisher, Random House, gave a party for the book. Warren came to the party, and had a good time. We have the pictures. My hair is embarrassingly long, and Warren’s haircut looks, well, mid-America. We kept in touch.

“Who’s Warren Buffett?” the people at The Washington Post Company asked when Warren bought a stake. They ordered 50 copies of Supermoney.

I tried the Washington Post idea on my Wall Street friends. They couldn’t see it.

“Big city newspapers are dead,” they said. “The trucks can’t get through the streets. Labor problems are terrible. People get their news from television.” And anyway, it wasn’t the next Xerox.

In 1976, Rupert Murdoch’s News Corp launched an unfriendly takeover of The New York Magazine Company. I had been one of its founders, with 5-cent stock. We had spent eight years building a unique property. We not only had New York Magazine, but also the Village Voice and a California magazine called New West. Now Murdoch had bought 50.1 percent of the stock.

I called up Warren and whined.

“You want it back?” he asked.

I got very attentive. He sent me News Corp’s annual report. It was full of British or Australian accounting terminology. I didn’t get it.

“News Corp has a market cap of only $50 million,” Warren said. “For $27 million, you could have two big newspapers in Australia, 73 weekly newspapers in Britain, two television stations, 20 percent of Ansett Airlines, and you’d have your magazine back.”

“How do we do it?” I asked.

“What is this we, kemosabe?” Warren said, using a term from our radio days with The Lone Ranger. “You want your magazine back, I’m telling you how to do it.”

“But Murdoch controls News Corp,” I said.

“You didn’t read carefully,” Warren said. “Look at footnote 14. Clarendon has 40 percent. The rest is Australian institutions. Clarendon is Murdoch and his four sisters. I figure it would take one sister and the float and a year in Australia, and guess which one of us is going to spend the year in Australia?”

I didn’t go, and we didn’t get the property back, either. I should have bought News Corp. Murdoch sold our magazines for many times what he had paid in the raid.

When we launched the weekly Adam Smith television show, we took it to Omaha right away. It was the first TV Warren had done, and for a long time, the only TV. It didn’t take much to get Warren to use his baseball metaphors.

“When I look at the managers who run my companies, I feel like Miller Huggins looking at his lineup of the 1927 Yankees.” (Those were the Yankees, of course, with Babe Ruth and Lou Gehrig.)

Or this one: “In the stock market, it’s as if you are the batter and the market is the pitcher. The market has to keep pitching, but in this game there are no called strikes. The market can throw you a hundred different pitches every day, but you don’t have to swing until you get a fat pitch.”

“So, you might not swing for six months?”

“You might not swing for two years. That’s the beauty of Berkshire not being on Wall Street—nobody’s at the fence behind me calling out: ‘Swing, you bum!’”

Warren continued this theme in subsequent television interviews with me.

“You have said: ‘They could close the New York Stock Exchange for two years, and I wouldn’t care.’ But you are considered an investment guru. So how do you reconcile this?”

“Whether the New York Stock Exchange is open or not has nothing to do with whether The Washington Post is getting more valuable. The New York Stock Exchange is closed on weekends, and I don’t break out in hives. When I look at a company, the last thing I look at is the price. You don’t ask what your house is worth three times a day, do you? Every stock is a business. You have to ask, what is its value as a business?”

Warren once sent me the collected annual reports of National Mutual Life Assurance, when Lord Keynes was the chairman of that company in Britain. “This guy knows how to write a chairman’s report,” Warren scribbled.

Warren’s own chairman’s letters for Berkshire Hathaway became even more famous than those of Keynes. They were teaching instruments. They carefully spelled out not only the businesses, but also the accounting procedures, and a very plain vanilla evaluation of the scene.

The annual meeting of Berkshire in Omaha draws more than 10,000 people, and Buffett and his vice chairman Charlie Munger answer questions for hours, questions on all sorts of subjects. It is a unique seminar with attendance hitting new records every year. No matter whether Berkshire has had a really good year or not, when you leave Omaha after this Woodstock of capitalism, you feel more lighthearted.

During the dot-com bubble, Buffett kept his cool. He said that if he were teaching an investment course he would ask: “How do you value a dot-com?” If the student answered anything at all, Buffett said: “He would get an F.”

Warren has never wavered either from the warm and folksy persona or from his sound, shirtsleeves wisdom. He is a powerful intellect, but he is also bien dans sa peau—“comfortable in his skin ”—which mobilizes him and helps to keep him from second-guessing his perceptions.

Corporate and institutional icons have fallen, and others are under suspicion. “Growth” companies that once were accorded reverence are now said to “smooth” their earnings. A prominent accounting firm whose name was an imprimatur has lost its credibility. Many have fallen that had been in honor, as Horace wrote.

But Buffett is still Buffett: still in the same house on Farnam, still in the same office in Kiewit Plaza as when I first went to discuss the Ben Graham project. Warren was counted on by the government to right the wrongs at Salomon. He takes to print in the op-ed pages of the Washington Post on important issues. Recently, his chairman’s letter found him in high moral dudgeon. “Charlie and I,” he wrote referring to his vice chairman, Charles Munger, “are disgusted by the situation, so common in the last few years, in which shareholders have suffered billions in losses while the CEOs, promoters, and other higher-ups who fathered these disasters have walked away with extraordinary wealth . . . to their shame, these business leaders view shareholders as patsies, not partners.”

Warren Buffett was entitled to be in high moral dudgeon in the age of Enron and Worldcom and Adelphi. His comments met a receptive audience. The same moral dudgeon exists in this book. The financial world has always invited the sleight-of-hand artist; money is choreographed in numbers, and numbers are so easy to push around. Richard Whitney, president of The New York Stock Exchange at the time of the Great Crash, was photographed on the steps of Sing Sing, the prison that was to become his home. He was the Martha Stewart of his day, but society today is more forgiving; Richard Whitney did not emerge to host a radio show or star in a movie. This book, originally published in 1972, also has a distinguished character in high moral dudgeon: David Babson, founder of the firm that bears his name. He was the “avenging angel” described in the chapter, “An Unsuccessful Group Therapy Session for Fifteen Hundred Investment Professionals Starring the Avenging Angel.” I sponsored, I moderated that historic session, when the crusty New Englander said to the representatives of big banks and mutual funds still familiar today, “Some of you should leave this business.” He then read a list of stocks that had gone from lofty levels to 1, some even to 0, and cataloged his own Cotton Mather list of sins: the conglomerate shell game, accountants who certified earnings that weren’t there, CEOs and CFOs who treated the pension fund as a cookie jar, mutual fund managers who manufactured paper performance, and so on. Virtually nothing on his list is out-of-date, decades later. What fun David Babson could have had with the hedge funds. I’m sorry he is no longer with us.

Supermoney is the successor to The Money Game. Both books used some of the techniques of what was then called New Journalism, the first-person narrator, the dramatization of points with the actions of various characters. The Great Winfield, for example, appears handsomely in The Money Game, coming to work in jeans and cowboy boots, chasing stocks that went from 5 to 50. In Supermoney, his accounts have gone down 90 percent in the credit contraction and stock implosion of the early 1970s. But he was not perturbed. He still owned the side of the mountain in Aspen he had bought with his winnings, and he was studying art history at Columbia. He had bought some regulated utilities. “The Great Winfield in utilities?” I asked. “Things change, m’boy, things change. We have to recognize them when they do,” he said. The figure called Seymour the Head, sockless and tieless in this book, made the New York Times even in 2005. He was a figure in class-action lawsuits, and there was some problem about whether, as the aggrieved investor, he was kicking back to the law firms that brought the suits.

Things change, said The Great Winfield, but sometimes the more they change, the more they seem the same. For example, as this edition of Supermoney appears, we are engaged in an expensive and unpopular war, we are running big budget deficits, and the country is feeling divided and ill-tempered. Plus ca change. The scenario could be back in the early 1970s: Vietnam and its deficits, and the feeling that something unpleasant lurked around the next corner. In the financial world, structural changes are about to occur, just as they did at the time of the original edition. Those changes, in the 1970s, took out three quarters of the firms on Wall Street. We don’t know what will happen in this decade, but we can sense the tremors.

Beneath the anecdotal approach and the names of some of the characters, there are serious themes in these books. For example, The Money Game suggested that people viewed financial matters as rational, because the game was measured in numbers, and numbers are finite and definitive. But, said The Money Game, the truth was elsewhere. Any intelligent observer could see that behavior—psychology—had a lot to do with the outcome. Further, people did not behave as economists postulated, always assuming that people maximized their actions for rational gain. The Money Game, it said, right off, “is about image and reality and identity and anxiety and money.” Some of the aphorisms in it were “the stock doesn’t know you own it,” “prices have no memory,” and “yesterday has nothing to do with tomorrow.” The founder of Fidelity, Mr. Johnson, tested the thesis, “a crowd of men behaves like a single woman,” and a psychiatrist postulated that some people actually want to lose. Mr. Johnson also said, somewhat prophetically, “The dominant note of our time is unreality.” This idea was startling enough that when The Wall Street Journal ran a front-page story about the book, its headline was “New Book That Views Market as Irrational Is a Hit on Wall Street.”

Several decades later, Amos Tversky and Daniel Kahneman did their pioneering work in what has now become the fashionable field of behavioral economics, and what did they find? That people can behave irrationally. They don’t maximize their odds, they fear loss. Tversky and Kahneman were psychologists, not economists. Their work in psychology had breathtaking ingenuity; they constructed games, puzzles, and situations that revealed how people actually behave, as opposed to the postulations of classical economics. They called this “prospect theory,” and published it in Econometrica, the economic journal, rather than Psychological Review, because Econometrica had published notable papers in decision making. Had the paper been published in a psychology journal, it might never have had the impact it did. My colleagues and I pored over Tversky and Kahneman looking for some edge in the market, and their follower Richard Thaler (without, I should say, particular financial results). Kahneman received the Nobel Prize in economics in 2002. (Tversky had died a few years before.)

Supermoney also attempts to take on some serious ideas; it expands from a visit to a new greenfield General Motors Plant to a discussion of whether the Protestant ethic, that engine of productivity, has been evaporating. Supermoney itself is a term I coined to describe the difference between the green bills in your wallet and the real wealth in the country, which is earnings, or profits, capitalized, when they are run through markets, that is, stocks. You might work very hard on your algorithms in your job at Google, but your weekly paycheck will be dwarfed by your Google options, which have the opinion of the market place applied to multiples of the stock. Cash your paycheck at Google, and you have money; cash your options and you have supermoney. So we have a wide gap in this country—indeed, all over the world—between those who have no currency, those who have currency, and those who have supercurrency. And Supermoney also mulls about how we account for the unquantifiable in our economic system. A 500-year-old sequoia redwood, chopped down, appears as a plus in the accounts of the gross domestic product; there is no minus for the lack of a redwood. And even large quantities of supermoney don’t guarantee a community in harmony. This book asks, Will General Motors Believe in Harmony? Will General Electric Believe in Beauty and Truth? The phrasing of the questions is done in an offhand, angular, journalistic tone, but the underlying questions bear some discussion and could still be asked today.

I would like to acknowledge the help of Craig Drill and Warren E. Buffett in the preface to this new edition. - AS

© Adam Smith 2006