Read Old Books
Guest post by Ted Lamade, Managing Director at The Carnegie Institution for Science
Occasionally, you come across something that really makes you think. This happened to me not too long ago after watching a YouTube clip of a guy named Neal Foard revealing an important lesson he learned from his father.
Foard tells the story of how as a teenager, he read a business book and couldn’t wait to share its “revelations” with his father. Yet when he eventually did, he was surprised by his father’s response. Instead of heaping praise on this book’s brilliant insights, his father said,
“Do yourself a favor. Read old books (as opposed to these “how-to” manuals). What you are going to discover is that anything in them that is still true today will be true forever.”
Foard took his father’s advice and started reading books that had been published many years earlier. In doing so, he learned a valuable lesson earlier than most. In Foard’s words,
“Human beings don’t change. It’s the same sad, silly mistakes and the ridiculous comedy of existence back then as it is now.”
Failing to learn from others’ mistakes is one of life’s greatest mysteries. Despite having nearly unlimited access to examples of others making all kinds of mistakes, people repeatedly fail to learn from past generations.
The question is, why? Is it due to a belief that “this time will be different?” Maybe we are just hard-wired to live in the moment and disregard the past? Or, could it be because people simply need to experience things for themselves in order to learn from them? The answer likely resides at the confluence of all three.
Believe it or not, this post is not in response to Silicon Valley Bank’s recent failure. In fact, SVB wasn’t even in the news when I started writing it. Yet, SVB’s demise is a quintessential example of not learning from the past on several levels:
· Under-appreciating the risks associated with over-concentration in a single industry? Check — SVB catered almost exclusively to the highly correlated tech, biotech, and venture industries. When each struggled and needed cash, SVB was hit with withdrawals all at once.
· Poor risk management? Check — SVB committed the cardinal sin of borrowing short and lending long to get more yield, only to forget about maturity and mark-to-market risk.
· Poor messaging? Check — SVB scared depositors and markets when they poorly communicated the reason for their equity raise in response to rising deposit withdrawals.
· Unintended consequences? Check — Following the GFC, the Fed forced banks to hold more “high quality assets”. When Covid hit, the Fed (and the federal government) injected massive amounts of liquidity into the markets and economy. As a result, many banks used this excess liquidity to buy highly rated assets with low interest rates and long maturities. Then, in order to squash inflation, the Fed reversed course and increased rates at the fastest pace in history. As a result, when rates rose, it left banks sitting on billions of underwater bonds.
SVB’s customers were not blameless either, especially institutions and larger customers. Most notably, when their deposits reached the FDIC limit of $250,000, most should have swept their excess funds into U.S. treasuries.
Now, did this all happen extremely quickly? Yes. Did it surprise nearly everyone? Absolutely. However, it shouldn’t have. After all , SVB is far from the first bank to fail because of a lack of diversification and/or poor risk management practices. It is also not the first time that Fed rate hikes have caused a crack in the system.
Yet, as sobering as this all may be, there is a silver lining. If the majority of people (and therefore investors) continuously fail to learn from others’ mistakes, shouldn’t there be significant value in being in the minority that does? Of course, but how? One way to start is by reading old books.
Over the past two decades, books have become endangered species. The reason is that instead of listening to Foard’s father’s advice, investors have favored watching or reading outlets such as Bloomberg, CNBC, blogs, and countless tweets. Knowing this, and in an attempt to heed Foard’s father’s advice, I spent the past few weeks skimming and reading a number of old books (some that I had already read and others I had not.)
These books covered a variety of topics — including (a) history of pandemics, (b) the future of the energy industry following the inflation ridden 1970’s, (c) a perspective on global trade, (d) a biography of Bernard Baruch, (e) Ebay’s founding, and most recently, (f) a book about the New York Yankees. In doing so, I learned a number of things I wasn’t aware of (and I am guessing you weren’t either):
· Did you know that the Spanish Flu did not originate in Spain, but rather in the U.S. when a soldier contracted it on a farm in Kansas when home on leave? Or the fact that this soldier spread it to countless other soldiers who were then shipped to Europe to fight in World War I? Or that the U.S. government prohibited the media from covering it?
· Did you know that the smartest energy analysts more than forty years ago were convinced the U.S. and the world was on the verge of a massive natural gas shortage that would cripple the global economy?
· Were you aware that much of the early technological advances in the U.S. were direct thefts of European intellectual property?
· Did you know that New York Yankee great Yogi Berra took three years out of his career to fight in World War II, including landing on Utah Beach on D-Day?
On one hand, some things have certainly changed since these books were we written. Most notably, I don’t think we will see Major Leaguers serving in the military anytime soon. Yet, these books also highlight many ways how things have not changed, and likely will not for years to come. Namely, (a) people will always react irrationally and be driven by fear in response to something like a global pandemic, (b) forecasts are as futile today as they have ever been (especially in the commodity sector), and (c) technological theft has been happening for centuries and will continue to happen, especially when a rising nation is chasing an incumbent one.
Knowing this, I set out to find an investing equivalent. I eventually came across a classic book titled, “The Money Masters,” which was written in 1980 and its sequel, “The New Money Masters,” which was written in 1989. In each case, the author, John Train, interviewed a dozen of the most successful investors from the prior decade. Their insights did not disappoint. In fact, they provided an endless number of durable and long-lasting lessons, the vast majority of which are as true today as they were forty and fifty years ago.
“When an entire industry is in a crisis, with two or three major companies bankrupt or on the verge of it, the whole industry is ready for a bounce, as long as there is something in the situation that should change the fundamentals.”
Said another way, this is the definition of “crisis investing”. So long as an industry isn’t headed towards complete obsolescence, at some point prices will reach such depressed levels that the prospective returns will become very attractive. Today, will regional banks become obsolescent? If they don’t, someone is likely going to make a lot of money buying them at the discounts we are currently seeing.
“Investing resembles another competitive pursuit – war. From time to time a new technique appears – the short sword, the longbow, the machine gun, the tank, radar – and sweeps the field. Then the other side adopts it and parity returns.”
Wall Street specializes in developing and proliferating new ways to invest. Look no further than mutual funds a hundred years ago followed by vehicles that have included REITs, mortgage backed securities, derivatives, high yield bonds, private equity, and venture capital. Each time a new product or style of investing has arisen, the early returns for investors (and Wall Street) have typically been very strong. However, like new techniques and weapons in war, these early gains are often short-lived. In the case of war, the other side quickly responds by adopting and replicating the same weapons. In investing, large capital flows and a plethora of lesser imitators ten to wipe out alpha over time. Given how much capital has been raised by countless firms in the venture and buyout space over the past 3-4 years, I think it is a safe bet that recent vintages will generate very mediocre returns compared to earlier and smaller ones.
“The biggest problem in business is ego. Too many CEO’s are on an obsessive ego trip. The second problem is an executive who surrounds himself with yes-men. The third is a variation of the second – the executive who isolates himself. The fourth is the Peter Principle. Watch out for companies in which the mediocre people eventually get to the top – the person who waits the longest becomes the boss.”
Adam Neumann (WeWork), Elizabeth Holmes (Theranos), Richard Smith (Equifax), John Foley (Peloton), Kevin Plank (Under Armour), Steve Easterbrook (McDonalds), and Sam Bankman Fried (FTX) each personified Tisch’s warning in one way or another during this cycle. They seduced investors and eventually destroyed billions in shareholder value. Each possessed, at minimum, three of the four qualities that Tisch highlighted. They won’t be the last though. Yet, my guess is plenty of people will fall prey to the next generation of egomaniac CEO’s. They always do.
“People whose first interest is commissions or subscriptions are rarely great investors. If someone is truly great, it will make no sense for him to sell (or promote) his ideas – the rate of return will be too low. The less able may find it economically worthwhile to sell their ideas.”
Anytime you find someone selling research or providing a service that generates commissions, you should think about this quote. Ask yourself…if what they are selling (or promoting) is so valuable, why aren’t they keeping it to themselves and investing on it? Don’t get me wrong. Oftentimes, they are, but it is more likely that they are making more money by selling the ideas to you. More importantly, in order to sell you, they have to promote potentially lucrative and unique ideas. The result? These ideas likely carry substantial risk to you and little to them.
“Oftentimes you have businesses that are run by geniuses and don’t do very well. The reason? The competitors are also run by geniuses, so nobody gains an advantage. Take semiconductors: Mostek or Fairchild. The semiconductor transformed the world, but until recently the entire industry had probably lost money on balance. Only a tiny handful of companies did well. A far larger number didn’t. It is like the oil business: It transformed the world, but many of the companies haven’t done well themselves.”
Intense competition kills returns. It’s why the strongest and most durable returns are often made in unsexy, uncovered, and uninteresting industries. A simple premise, but one that is too often forgotten.
“Build a team with good collective judgment, rather than an assemblage of specialists. If you don’t understand bonds and interest rates, it is hard to understand economic cycles and therefore bonds versus industrial stocks. Similarly, if you do not understand stocks, you will have an imperfect understanding of the bond market.”
Blind spots are one of the most pervasive risks in investing. I recently asked a manager why so many smart investors got so caught up in the high valuation tech stocks that have fallen by 70% or more over the past 12-18 months. His response? “They were blinded by fear of relative underperformance and couldn’t see beyond the sector.” The irony is palpable here considering SVB’s interest rate blunder.
“I can’t believe how many people own stocks that they couldn’t explain to an eleven year old in two minutes or less why they own it or what it is. If you pinned them down, the only reason they’d give you for owning it is because ‘this sucker is going up’.”
2020-2021 will go down as one of the most speculative bubbles in history as the hottest companies attached to the narratives of “work-from-home”, “the virtual future has been pulled forward”, and the “metaverse” appreciated in value by 100% or more in a single year. Lynch warned us, but instead of reading old books and listening to sage advice like his, many investors followed people like Mike Minervini on CNBC when he faked a “bad connection” after being asked about a company his fund invested in (Upstart), but that he knew nothing about.
In order to gain an advantage or a establish a better understanding of the current situation, the natural tendency is to acquire the newest technology, obtain the most up-to-date data, and seek advice from “experts”. This is understandable. When you do this, it feels like you are looking ahead. Yet, if Neil Foard’s father is correct, the key might be to resist this temptation and opt instead to look to the past by dusting off some old books. With the turmoil we are currently experiencing, these books will remind you that we have been through many challenging periods before. This is simply the next in line.