HISTORICAL LESSONS ABOUT WEALTH
Years ago, I participated in a historical and analytical study of wealth (how it has been generated, grown, and lost). This study and the experiences of the years since then yielded valuable insights.
OBSERVATIONS
• Wealth creation has often been associated with waves of particular opportunity which favored ownership of certain asset classes or businesses over others. Sources of wealth for the “Forbes 400” wealthiest Americans vary considerably over time. Oil and real estate were dominant sources of wealth in the 1970’s but gave way to entertainment, computers, and communications in the 1990’s.
• Timing is everything! Assets and businesses have cycles during which their values and prospects vary tremendously – from low to high, or high to low, and then often back again. Fortunes made during upswings often decline substantially, or are even lost, during ensuing downswings. Separate industry, business, and asset cycles, moving from periods of excess capacity and low prices to periods of tight capacity and high prices (with the “invisible hand” of economics acting to reverse each extreme), can differ greatly from the overall economic cycle.
• New businesses and industries usually follow a typical “S-curve” pattern of market acceptance and development over the life cycle from introduction through adoption (at varying rates) to maturity and eventual decline. The investor often makes much better returns by investing just before the rapid growth phase (and after the initial enthusiasm declines somewhat), rather than at the beginning.
• Even older businesses, though, frequently experience periods of large prospective improvement – due to favorable swings in product/market specifics or in the economic environment. For example, leveraged buyouts of older, established, slow-growth firms have been highly favored investments since 1982 due to the long-cycle decline in interest rates. This decline from historical highs dramatically lowered interest costs of leveraging these businesses while also increasing valuation multiples – resulting in spectacular wealth generation opportunities even though a business was growing little or even not at all. We experienced more than 40% pre-tax annual returns on investment, even in no-growth businesses, during this period.
• Thus, there are certain times when it is better to own one asset class or business than another. The oil price boom periods of 1973-74 and 1979-80 were great times to be in the oil business, but the oil bust of 1985-86 was not. Hawaii real estate was a great investment from 1960 to 1990, but has declined significantly since then. Japanese stocks appreciated greatly during the 1980’s, but have declined substantially since 1990. U.S. stocks were generally weak investments in the 1970’s but have been generally outstanding since 1992.
• There are identifiable indicators of overvaluation and undervaluation which can be analyzed and used to “buy low and sell high”.
• The emotional and price patterns of public speculative manias through history, from tulips to South Seas real estate to the Internet, have been basically the same.
• More wealth has typically been generated by contrarian action than by following the crowd. The best buys occur when most people are selling.
• Investors who can flexibly move from one industry or asset class to another can have a greater prospect of generating, maintaining, and increasing wealth.
POINTERS FOR THE FUTURE
Cycles of business and asset valuation display patterns which continually recur because of the basic nature of human emotion. Indications are that cyclical patterns of the past are likely to repeat in the future.
Strategic analysis is essential to help one take advantage of cyclical swings. Contrarian action can result in higher returns.
Undervaluation situations and periods can be identified and used to build positions with greater chances of value increases and wealth creation.
Overvaluation situations and periods can be identified and used to exit positions while value is high and while others perceive chances of further gains ahead.
Careful consideration of public speculative manias, and their emotional overvaluation extremes, can prevent ill-timed commitments and avoid the staggeringly rapid losses which can occur when bubbles burst. Most of those who bought gold at $800 per ounce in 1980, or the Nikkei near 39,000 in 1989, or Hawaii real estate in 1990 wish they had known more about financial history and had acted more thoughtfully, analytically, and carefully.
Richard Bird
June 1998
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