Tuesday, January 26, 2010

The Four Pillars of Investing Part 3

This is a multi part series dedicated to the review of  William Bernstein's book The Four Pillars of Investing.
The Four Pillars of Investing: Lessons for Building a Winning PortfolioNumbered Page references are from the hardcover edition.

Value = Bad Companies = higher risk = higher return
Small or Emerging Markets = higher risk = higher return

Pillar Two - The History of Investing
Chapter 5
George Santayana - "Progress, far from consisting in change, depends on retentiveness. Those who cannot remember the past are condemned to repeat it."
Larry Swedroe - "There is nothing new-only the history you have not read."

A chapter all about booms and busts.
Technological progress drives economic progress. Technological advancements come in spurts.
Stephen Ambrose, "Undaunted Courage", "A critical fact in the world of 1801 was that nothing moved faster than the speed of a horse. No human being, no manufactured item, no bushel of wheat, no side of beef, no letter, no information, no idea, order of instruction of an kind moved faster. Nothing had moved any faster, and, as far as Jefferson's contemporaries were able to tell, nothing ever would."

The revolution of communication was also dramatic. Important news could be instantaneous. Today just allows for more trivial information to be communicated instantly. :)
Four ingredients to produce a bubble.
•    A major techological revolution or shift in financial practice.
•    Liquidity - i.e. easy credit
•    Amnesia for the last bubble - or one per generation.
•    Abandonment of time-honored methods of security valuation, usually caused by the takeover of the makret by inexperienced investors.

1720-The South Sea Bubble and the Mississippi Company
Canal building - more often than not, the users of the technology prosper more than the inventors. Industry fared better from the advent of canals than the companies which built them.
England railroads bubble
Sonics and tronics and then the Nifty Fifty bubbles
The Dot Com tech sector bubble
and now the housing credit bubble

Chapter 6
The bottoms that follow the euphoria. The depressed, but great buying opportunity times.
1979 Business Week - Death of the Equities article
Best rewards come after a devastating bear market.
Busts follow the same four ingredients.
A generalized loss in the faith of the new technologies to cure the the system's ills is usually the triggering factor. Followed by a contraction of liquidity. Amnesia for the recoveries, and cheap stocks only excite the analytical minds.

What follows is a lot of political intervention and new regulations to string up a scapegoat. Luckily, most have been in favor of the shareholder.
How to handle the panic? Stand pat. Stay the course. Ideally, when prices fall - increase your position by maybe 5% after a drop of 25% so as to avoid running out of cash before the real bottom.

Alphonse Karr, Plus ca change, plus c'est la meme chose; The more things change the more they stay the same.

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