Stupid Answers for Stupid Questions

In his Wall Street Journal column from Saturday, Jason Zweig asks Does Stock-Market Data Really Go Back 200 Years? My head immediately fills with responses.

Of course not.NYC_1848

Why would you think it did?

Who could possibly care?

The title of the column isn’t a trick or a pun. It is really a serious examination of the quality of the stock market data prior to 1845. That was a period when the the “stock” in New York Stock Exchange mostly meant what we today call Treasury bonds. Corporations were rare, each was specifically chartered by a state legislature, and they were widely considered to be a sinister product of financial engineering gone amuck.

Be that as it may, apparently the data that Prof. Jeremy Siegel has used to construct stock market returns for the years 1802 to 1820 included only seven companies, all banks. And the data he used for 1820 to 1845 isn’t much better. Shocking.

This is important, Zweig tells us, because “brokers and financial planners keep reminding us, there’s almost never been a 30-year period since 1802 when stocks have underperformed bonds” and they base this on Siegel’s research. Best I can tell, that reassuring “almost never” becomes “hardly ever” if you use data without Siegel’s distorted and rosy view of the returns from American equities in the early 19th Century.

This is amusing, but it illustrates a serious and widespread failing, the unwillingness, even of experts, to think critically and subjectively about investing.

Suppose it were true that in the 207 years since 1802 there have been no 30 year periods in which equities failed to beat government bonds. Then what? Are we to believe that it is some law of nature that such a thing could never happen? There are several 25 year periods in which bonds did beat stocks, for example the one ending just now. But some powerful force will kick in around year 26 and keep a 30 year period from occurring? Never has happened means never can happen?

I’ve written before on The Black Box Theory of The Stock Market, the idea that what drives the market is unknowable, so all we can do is make simple extrapolations from what it has done in the past. This is another example of this thinking, and a rather extreme one at that. Rather than make reasonable suppositions based on thoughtful analysis of the stock market, we prefer to carry out commercial archaeology.

Yes, the institution now known as the New York Stock Exchange did exist in 1802. It met in a coffee house. New York harbor was then filled with sailboats. The docks were worked by slaves. Business leaders sometimes settled disputes with duels. And yet Zweig, Siegel, and “brokers and financial planners” think that the price movements of the few stocks traded on this proto-market are a legitimate indication of what might happen in the 21st Century?

No Comments

  • By Rob Bennett, July 15, 2009 @ 11:53 am

    I couldn’t possibly disagree with you more, Frank.

    The supposedly data-based claims of people like Siegel were the primary cause of the out-of-control bull, which was the cause of the economic crisis we are all trying to survive today. Pointing out that the conventional investing wisdom of the past 30 years is to a large extent pure nonsense is The Way Out.

    Your words suggest that you think that you have not been taken in by the nonsense. I don’t think that is even a little bit so. You see through some of the junk. And you have been entirely taken in by some of the other junk (in my opinion, to be sure — but that is my strongly held opinion).

    I don’t fault you for having been taken in by a lot of junk. But I question how you think we are going to get out of this mess except by having people like Zweig begin doing the job that they should have been doing all along — holding the claims of The Stock-Selling Industry up to critical scrutiny.

    Here’s a link from the Elvis Costello song “New Lace Sleeves”:

    You say that the teacher never taught you anything but white lies.
    But you’ve never even seen the lies that you believe.


  • By gpr, July 15, 2009 @ 12:09 pm

    Business leaders sometimes settled disputes with duels.

    I apologize for this being off topic, but we must bring back this tradition of dueling. I think it would make us all a bit more careful in our actions.

    It would be rough on Bernie Madoff, but he could get one of those “now serving” deli-counter things.

  • By Ron, July 15, 2009 @ 12:23 pm

    Great post.

    Linear thinking usually leads to circular reasoning. Just because something has happened with regularity in the past doesn’t guarantee it will happen in the future, does it?

  • By ObliviousInvestor, July 15, 2009 @ 12:43 pm

    Data from the last 80 years gives me just as much confidence as 200 years of data would that the stock market will outperform the bond market over 20 year periods.

    That is, I’m “somewhat confident.” :)

  • By Rick Francis, July 15, 2009 @ 7:28 pm

    Even for a simple system like flipping a coin where the probability can be calculated exactly. You can’t know what the actual outcome will be for your next attempt… for instance the next 20 flips I could get 20 heads in a row but I REALLY shouldn’t count that as the chances are only 1 in 1,048,576.

    Even if we knew that 99.9% of the time stocks beat bonds over a 30 year period there would still be that 0.1% change that the next 30 years could be one of the rare times that bonds would win. Knowing the odds will never guarantee that you make the best choice.

    The value of the statistics is that it gives you some idea what is LIKELY to happen. With that information you can make a reasonable plan. Your plan should include a fallback position in case you are unlucky… For example if the market return is 8% CAGR over the next 25 years retire at 65, if it is 7% retire at 68.

    -Rick Francis

  • By Frank Curmudgeon, July 15, 2009 @ 8:59 pm

    gpr: I’m not sure that dueling would have stopped Madoff, but it sure would raise the ratings at CNBC. Also, b-schools could teach courses in handling small arms and swords. That would have been more useful than several courses I actually took.

  • By gpr, July 16, 2009 @ 3:07 pm

    I couldn’t possibly agree with you more, Frank.

    A Jon Stewart vs Jim Cramer duel would probably pull higher ratings than the SuperBowl. Well, maybe higher than the Stanley Cup.

    Curmudgeon vs Dave Ramsey might not be as popular, but I’d buy a ticket.

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