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

  I:

  Supermoney

  1:

  METAPHYSICAL DOUBTS, VERY SHORT

  NOT even a decade ago, everybody believed.

  Events did seem under control. Inflation would creep, not gallop; the New Economics would fine-tune the economy; productivity would increase; wars would be fought, but not by us—we were the mediators, understanding but tough; problems would be articulated, and that articulation was half the solution; we would begin upon the solutions. Kennedy rhetoric: let us begin; let the word go forth; let us never negotiate from fear, nor fear to negotiate; let anybody call upon us. Confident, ambitious, optimistic, even naïve—the very best of the American tradition. Hail Columbia, happy land.

  Then, one thing and another, the John Philip Sousa music faded a bit. Could rational men make events behave rationally? Maybe they couldn’t. (Nobody then asked for a definition of “rational.”) Maybe the falcons could not hear the falconers. They were still wheeling around up there; would they listen?

  2:

  LIQUIDITY: MR. ODD-LOT ROBERT IS ASKED HOW HE FEELS

  WE have a capital market that is a great national asset, like the wheat fields of Kansas and the Grand Canyon. Some of the Yankee monopoly in technology and management techniques has been broken, gone to Wolfsburg and Milan and Toyota City. But Tokyo and Amsterdam and Frankfurt and Buenos Aires do not have that great, deep capital market, ready to handle the world’s investable funds, so everybody still has to come to New York, and when they come, they bring money not only for what they buy but also for commissions, tips and shoeshines. Everybody came because the great capital market was so liquid and honest and continuous; today’s price related to yesterday’s price, and you could buy and sell in almost any size.

  But there were some nagging doubts. We had a market slide, the biggest since 1929, and some crises. Market slides frighten the Public, and 1969-1970 was no exception. What would the Public do?

  I think it was Gertrude Stein’s cousin, according to Miss Stein, who said that money is always there, but the pockets change; it is not in the same pockets after a change, and that is all there is to say about money. Well, maybe.

  From all accounts, we are now in a marvelous economy, moving forward to Normal—Normal being July 4, 1955, during the Eisenhower Regency: peace, prosperity and harmony. Did the Public get a little frightened there for a year or two? They are coming back; the brokers all sit like hunters in a blind, with the first honks already coming over the horizon. Did the Big Bear leave some scars? Welcome to the club: Justice Holmes said that a man has to be part of the actions and passions of the times.

  Only two years ago, you could fire off a cannon in a downtown restaurant like Oscar’s and not hit anybody, because the price of Beef Wellington had been moving up with the prime rate, and many citizens in the financial community had switched to tuna on white toast. Now the corks are popping again; wonderful, the cyclicality of life.

  What happened to the money community has some relevance to the larger drifts of our society, for that community is in charge of much of the liquid wealth of the country. The money community’s health affects our savings and investments, the assets of university endowments and foundations, the cost of government, and whether the pension money will be there when the employees are ready to retire.

  In turn, some of the changing attitudes about work and play and people and the uses of the present are going to affect the money community and what it shepherds.

  A while back, there were some metaphysical doubts and some specific doubts. The metaphysical doubts were perhaps common to the country as a whole, and concerned the assumption that rational men could make events behave rationally. Maybe the falcons could not hear the falconers.

  The jury has to be counted as still out on whether the falcons are within earshot. On the bread-and-butter level, the specific doubts concerned liquidity, which can mean a number of things but in this context meant the ability of buyers to buy and sellers to sell. We have that capital market that brings in the people from everywhere.

  Liquidity seemed to be disappearing. The Public was beginning to cash in its mutual funds, and the minus signs were getting fatter on line 30 of the Federal Reserve’s computer print-out labeled Flow of Funds, The Sector Statements of Saving and Investment: Households, Personal Trusts, and Nonprofit Organizations. William McChesney Martin, Jr., was upset. Mr. Martin—a former president of the New York Stock Exchange and a former chairman of the Board of Governors of the Federal Reserve—is to the money business what de Gaulle was to France, which is to say he was there when times were bad and he was the only man everybody could agree on when they got bad again. “I’m very concerned about the liquidity of the stock market,” Mr. Martin said, “and I’ve talked to corporation heads who are worried to death about it.” (When asked why individuals were leaving, Mr. Martin said he thought the lack of integrity in the marketplace was a reason, and when asked where the individuals were putting their money, Mr. Martin said some of those he talked to were putting the money into lotteries. But there is no line on the Fed’s Flow of Funds for lotteries.) Institutions—mutual funds, insurance companies, pension funds and so on—were coming to dominate the marketplace, and that was thought to be troubling for liquidity. Edgar Bunce runs the $3.5 billion of Prudential’s stock portfolio, and The Wall Street Journal quoted him thus: “If everybody buys at the same time, who will we sell to?”

  There were those who were prepared to write off the thirty-one million shareholders as far as liquidity was concerned. Liquidity means not only the smoothness of the market but the depth of the market. This point of view maintained that you heard only of panic-stricken institutions suddenly dumping thousands of shares, creating 10- and 20-point air pockets in stocks. You never heard of the quiet, orderly, day-by-day functions that went on without comment. Anyway, it was said, the Public dealt mostly through half a dozen brokerage firms, and a buy or sell recommendation from one of those could move a whole battalion of individuals, with the same net effect as an institution.

  In order to get a better perspective on what had gone on, I had lunch with my friend Odd-Lot Robert. A little micro look at the macro scene, as the learned economists would say. An odd-lotter, you will recall, is one who buys or sells less than a hundred shares. There are theories around that the way to make money is to do the opposite of what the odd-lotters do, and there are services that keep track of this. I asked Robert how he had done in the past couple of years.

  “Not very well,” he said. “But better than my friends. Of course, you have to remember that we are not exactly little old ladies. We do not just buy Telephone and sit with it. A good thing, too, because Telephone has gone from seventy to forty, and over the last six years you could have lost damn near half your money in good old Ma Bell and not even have had any fun. But my friends and I—frankly, we’re prepared to speculate.”

  I asked Robert how his friends had done.

  “Terrible,” he said. “At least the market hasn’t changed my life. But take my dentist’s wife. During the early sixties, she got very interested in the market, she studied very hard, she worked the thing like mad, and I must say, she hit it like a fixed slot machine. I mean, she must have made a couple hundred grand. I think she even got out pretty well in 68, but she couldn’t stay away.”

  “She gave it back?”

  “She gave most of it back, she went into a deep depression, and now she’s in group therapy. The other members of the group say she thinks she was the stocks, and when they melted away, so did she, like the Wicked Witch of the West in the Wizard of Oz. Or was it the North? The one who just faded out from under her hat. Then I have another friend who also made a lot of money. He was in his early fifties and he was going to retire. He hated his job, and he was going to leave it, finally, and then he lost a hell of a lot of money and he’s still at the job and he’s out of the market.”

  “But it didn’t change your life?”

  “No, I never made that much in the first place. I don’t mind telling you, I’ve taken some very healthy losses. My Brian Lloyd went from six to one.”

  “You’re still active, though?”

  “I’m not as active as I used to be. There was one period when I almost didn’t do anything at all. This friend of my sister’s had an account with a firm, and the firm got in a lot of trouble, and she couldn’t get her stocks back, and there was stuff in the paper every day about brokers going busted, so I got scared. Firms closing every day, so I asked for the papers.”

  “What papers?”

  “You know, the papers, the ones the stocks are printed on.”

  “The stock certificates.”

  “Right. Of course, I didn’t want to tell my broker why I was asking—that I was afraid he might go broke. Or that maybe he didn’t have the stocks at all. Or that he was really screwed up somewhere. So I said I was making a will. I said my lawyer wanted me to have my stocks so I could make a will. My broker bought the story completely. It took a while, but he sent me the stocks.”

  “And then?”

  “Well, first I put them in the drawer of this table in the living room where we keep the bills we haven’t paid yet. Then somebody spilled coffee on the table and some of it dribbled into the drawer, I’m not quite sure how. None of the coffee actually got onto the stocks, it just got onto the bills, but I had to move them. I mean, a stock with coffee on it is still probably legal, but what if I wanted to sell it—and you know, some stores won’t take a torn five-dollar bill—and what if I sold a stock and the buyer said, ‘Hey, wait a minute, this one has coffee on it.’ So I moved the stocks to my dresser drawer.”

  “In your bedroom.”

  “Yeah, under my socks. But every time I got a pair of socks out, I would see some of those turkeys, it would make my stomach turn sour. Also, if I sold one, I had to take it out of the dresser drawer and mail it back, and that was a drag, and then if I bought something they had to mail me the new one, and it was always late and I was wondering if they’d screwed up somewhere. Finally I got tired of all the mailing, and I didn’t hear so much about the problems any more, so I mailed the stocks back to the broker. I told him the will was all made and the lawyer was through, and he bought that story completely.”

  “You didn’t sell when the market went down?”

  “No, my stuff went down too fast, and then I didn’t want to take the loss. Actually, when the market was going down, I wanted to sell short. I wanted to be going in the same direction as the market, for once. But my broker wouldn’t let me. And then, when things were really going down, I had a funny feeling. I wanted everything to collapse. I mean really collapse.”

  “So you could buy at the bottom, like 1932?”

  “Well, yes, if I had any money, but that wasn’t my main thought. When things were really going down, I figured if the market really collapsed, that would be the end of our government, and we’d have socialism or something. I thought, What the hell, let’s have socialism.”

  “You still feel that way?”

  “No, I hollered at my broker a lot and got it out of my system. The most depressing thing of all is when they don’t list your stocks in the paper any more. I really like looking up my stocks in the paper, and when they’re not there, it really hurts. I look at the odd-lot figures, too. The odd-lotters were selling, all the way down. That’s one of the reasons I didn’t sell. I didn’t want to be an odd-lotter.”

  I wanted to pursue the question of liquidity, so I told Robert there was controversy over the specialists on the floor, and over contentions that the liquidity, the orderly market, was disappearing. The structure of the market was changing, and maybe stocks were more volatile. Robert could buy a stock at 20, and find it at 16 twenty minutes later because an institutional seller has appeared. He wasn’t greatly disturbed.

  “Twenty to sixteen, a few points more or less, what the hell, it might work the other way too. Maybe I’d buy it at twenty and that big mother would move it to twenty-four. You can’t quibble over a few points. I want a stock to have a move I can really see.”

  Then I said there was controversy about accounting procedures and about what earnings really are. Some maintain that the small investor couldn’t hope to sort those things out. Could he?

  “I pay attention to the earnings, but I pay more attention to the mathematics of the whole thing.”

  “The mathematics?”

  “Yeah, like when my broker says, ‘I think this one has ten points in it,’ then I watch to see if it makes the ten points. Hell, all I want is a break. If I have a stock that’s thirty, and it goes to forty, and then it goes to nine, I had my chance, I could have sold it at forty. It’s my own fault. But I do need a break like that, say, ten points.”

  “You had a stock like that?”

  “My Hy-Grade Foods went from thirty to eighty and then to nine. But we hung on, and it finally made it back to thirty, and I got out with a two-hundred-dollar profit.”

  Still another controversy, I said, continuing to probe, was the institutional investor and the information they seemed to get before the small investor.

  “Oh, hell, everybody knows that, and the funds have computers and research and all that. I think the strategy for the small investor is to jump aboard once he sees that the big boys are moving the market. My broker knows some of them, so we get some inside information once in a while. I got some myself. It was a stock related to those gambling casinos in the Bahamas. The stock was down from twenty to eight because it was thought there might be some trouble with the Bahamas government. Then I heard from some guys I was working with that a report was coming out that would be very good for the casinos. So I bought some.”

  “What happened?”

  “The stock went to seven, and now it’s four. It’s very cheap on earnings. You ought to buy some.”

  I asked Robert how he felt in general now.

  “When the market was going down, I asked my broker why it was going down. He said ‘Nixon. The market has no confidence in Nixon.’ Then it went up again and I asked him if it had confidence in Nixon now. He said it wasn’t Nixon, it was the funds buying, and foreigners. I don’t see how it can have been Nixon on the way down and not on the way up, but my broker is brighter than most of them, so he must know.”

  If Robert had done so badly, why did he think his broker was better than most?

  “For one thing, he’s still in business. That’s no joke. I got into a cab at La Guardia a couple of months ago and I got to talking to the cabdriver, and this cabdriver had been a broker with one of the houses that went busted. I asked him if he still followed the market and he said not so much anymore.

  “Look, I know some things aren’t fair. Take the commissions. I was watching a stock called Data Lease Financial. It used to sell at twenty-nine, so when it got to two, I figured, How low can it go, and I bought two hundred shares. They charged me a twenty-one-dollar commission for the two hundred, a four-hundred-dollar order. And I guess another twenty-one dollars to sell. That’s more than ten percent in commissions. What the hell, the track is only seventeen percent and that at least goes to the government, the track is gambling, sort of socially disapproved, and the market is getting up near the track. Except for the big boys. The big boys don’t pay any commissions at all.

  “But what am I going to do, write my congressman? It’s the only wheel in town. Listen, I have friends who had accounts, they’re small investors just like me, and they can’t even get a broker. Nobody wants them. You’re lucky to have a broker these days; first your broker has to survive, then he has to keep you, they keep trying to shove you into some mutual fund where you wouldn’t be able to watch the stocks. I have a good relationship with my broker, so I don’t think he would drop me, but when I holler I don’t holler too much, even about a ten percent commission.

  “My wife wants me to get out of the market. She says the market makes her feel insecure, and she wants to buy a piece of land or put another room on the house or something, if we have any money left.”

  “Are you going to do that?”

  “I suppose it makes more sense, my house has gone up more than any of my stocks—and so have the taxes on it, I might add. But I can’t give it up now. I might be quitting just at the bottom. And if I couldn’t look my stocks up in the paper, I’d really miss it. Part of my life that I enjoy would be gone.”

  Are Odd-Lot Robert and his cousins in or out of the market? With all the quantification going on of security prices, volume and movements, and all the computer memories chock-full, still no one knows whether the Public is in or out of the market, or even more important, how their individual portfolios have done. We have the most elaborate machinery possible for tracking prices, but that is like bending over the buffalo tracks and saying, “Yes, many buffalo go this way.” Very good if there are a lot of buffalo all going in the same direction. The Investment Company Institute can tell us whether, on balance, mutual funds are being bought or sold; the Federal Reserve can tell us whether there are minus signs on lines 30 and 31 of its Flow of Funds computer print-out (mutual funds and “other corp. shares”), and even where some of the money might be going, perhaps bonds (line 27), savings accounts at commercial banks (line 22), or savings and loans (line 23). (For your very own Flow of Funds print-out, a little more up-to-date, you can ask the same people I do, the Board of Governors of the Federal Reserve System of the United States, Constitution Ave. and 20th St. N.W., Washington, D.C. 20551.) Pollster Albert Sindlinger says the number of individual accounts has dropped 10 percent; yet at the same time margin debits can quadruple and volume can increase, which traditionally mean the Public is increasing its participation.