I was watching an old video of Warren Buffett talking to University of Georgia students from 2001, just after the tech bubble burst. It’s a great video to watch (as are most videos when Buffett is giving a lecture). One of the highlights for me is listening to Buffett discuss his very basic philosophy on value investing and why it works. At around the 50 minute mark of this video, he gets asked this question (paraphrasing):
How is the recent market decline (referring to the 40%+ decline in the major averages from the 2000 high) similar to that of the 1929 stock market crash?
Buffett answers the question by describing the various secular bull and bear markets from the previous 100 years with some well known, but worth repeating facts:
- The GDP growth per capita in the United States was stunning in the 20th century, rising 610%
- The overall GDP growth per capita increased every single decade (including the 1930’s)
However, the stock market did not follow the economy hand in hand at all times. Stocks experienced periods of increases far greater than the GDP growth in the same given period (these are bull markets) as well as prolonged periods where the stock market lagged the economic growth (bear markets). For instance:
- From 1900-1921, the Dow went from 66 to 71, less than a 10% total rise in 21 years.
- From 1921-1929, the Dow went from 71 to 381, a 500% increase in 8 years, far faster than the economy.
- From 1929-1948, the Dow went from 381 to 180, over a 50% decrease in 18 years!
- From 1948-1965, the Dow went from 180 to about 1000, roughly a 600% rise.
- From 1965 to 1981, the Dow went down (was lower in ’81 than it was in ’65), again… the economy grew significantly more than stock prices during this time period.
- From 1981 to 2000, the Dow had about a 1200% total increase, far exceeding the economic growth.
The video is from 2001, and of course we could extend this analysis to the current time in 2012, where stock averages are around, or slightly lower than where they were in 2000. So for 12 years stocks have once again been flat. These flat periods are generally referred to as secular bear markets, with the opposite of course being labeled secular bull markets.
The most interesting comment from Buffett came after he laid out the above summary. He said the above analysis makes you ask yourself “How could this be?” How can there be a situation where an economy advances year after year after year, but stock prices have very long periods of no returns followed by very long periods of huge returns?
He answered his own question with this (paraphrasing):
The answer is that investors behave in very human ways… meaning they invest by looking in the rear view mirror… and when they look in the rear view mirror and they see a lot of money being made, they plow into stocks pushing them higher and higher…. Conversely, when they look in the mirror and they see no money being made, they don’t want to go anywhere near stocks.
He summed this behavior by saying this:
“(The behavior) is astounding. But it creates huge opportunity. Just huge opportunity.“
This last comment sums up why value investing works. Just about everyone has the ability to apply the concepts and principles needed to become a good investor. It’s just simple understanding of income and balance sheets, numbers, and elementary school math skills. But not everyone has the temperament needed to succeed. In fact, most do not have the temperament to succeed. And because of this, these people are the ones who decide to invest after stocks have already gone up, and they sell after stocks have already gone down. And this irrational behavior causes inefficiency (opportunity) in markets.
These opportunities continue to appear, they always have, and they always will. Human nature, thankfully, does not change.
P.S. I recommend reading these outstanding pieces that Buffett wrote regarding the topic of human nature and the folly of most investors (pros and public):