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Monday, June 30, 2008
Reading List: Wealth, War, and Wisdom
- Biggs, Barton. Wealth, War, and Wisdom. Hoboken, NJ: John Wiley & Sons, 2008. ISBN 978-0-470-22307-9.
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Many people, myself included, who have followed financial markets for
an extended period of time, have come to believe what may seem, to
those who have not, a very curious and even mystical thing: that
markets, aggregating the individual knowledge and expectations of
their multitude of participants, have an uncanny way of “knowing”
what the future holds. In retrospect, one can often look at a chart
of broad market indices and see that the market “called”
grand turning points by putting in a long-term bottom or top, even
when those turning points were perceived by few if any people
at the time. One of the noisiest buzzwords of the “Web 2.0”
hype machine is “crowdsourcing”, yet financial markets
have been doing precisely that for centuries, and in an environment
in which the individual participants are not just contributing to
some ratty, ephemeral Web site, but rather putting their own net
worth on the line.
In this book the author, who has spent his long career as a
securities analyst and hedge fund manager, and was a
pioneer of investing in emerging global markets, looks at
the greatest global cataclysm of the twentieth century—World
War II—and explores how well financial markets in
the countries involved identified the key trends and
turning points in the conflict. The results persuasively support
the “wisdom of the market” viewpoint and are a
convincing argument that “the market knows”, even when
its individual participants, media and opinion leaders, and
politicians do not. Consider: the British stock market put in an
all-time historic bottom in June 1940, just as Hitler toured
occupied Paris and, in retrospect, Nazi expansionism in the West
reached its peak. Many Britons expected a German invasion in the
near future, and the Battle of Britain and the Blitz were
still in the future, and yet the market rallied
throughout these dark days. Somehow the market seems to have known
that with the successful evacuation of the British Expeditionary
Force from Dunkerque and the fall of France, the situation, however
dire, was as bad as it was going to get.
In the United States, the Dow Jones Industrial Average declined
throughout 1941 as war clouds darkened, fell further after
Pearl Harbor and the fall of the Philippines, but put in an
all-time bottom in 1942 coincident with the battles of
the Coral Sea and Midway which, in retrospect, but not at the
time, were seen as the key inflection point of the Pacific war.
Note that at this time the U.S. was also at war with Germany
and Italy but had not engaged either in a land battle, and yet
somehow the market “knew” that, whatever the
sacrifices to come, the darkest days were behind.
The wisdom of the markets was also apparent in the ultimate losers
of the conflict, although government price-fixing and disruption
of markets as things got worse obscured the message. The
German CDAX index peaked precisely when the Barbarossa invasion
of the Soviet Union was turned back within sight of the spires of
the Kremlin. At this point the German army was intact, the Soviet
breadbasket was occupied, and the Red Army was in disarray, yet
somehow the market knew that this was the high point. The
great defeat at Stalingrad and the roll-back of the Nazi invaders
were all in the future, but despite propaganda, censorship of letters
from soldiers at the front, and all the control of information a
totalitarian society can employ, once again the market called
the turning point. In Italy, where rampant inflation obscured
nominal price indices, the inflation-adjusted BCI index put in
its high at precisely the moment Mussolini made his alliance
with Hitler, and it was all downhill from there, both for
Italy and its stock market, despite rampant euphoria at the time.
In Japan, the market was heavily manipulated by the Ministry of
Finance and tight control of war news denied investors information
to independently assess the war situation, but by 1943 the market
had peaked in real terms and declined into a collapse thereafter.
In occupied countries, where markets were allowed to function,
they provided insight into the sympathies of their participants.
The French market is particularly enlightening. Clearly, the
investor class was completely on-board with the German
occupation and Vichy. In real terms, the market soared after
the capitulation of France and peaked with the defeat at
Stalingrad, then declined consistently thereafter, with only
a little blip with the liberation of Paris. But then the French
stock market wouldn't be French if it weren't perverse,
would it?
Throughout, the author discusses how individuals living in both the
winners and losers of the war could have best preserved their wealth
and selves, and this is instructive for folks interested in saving
their asses and assets the next time the Four Horsemen sortie from
Hell's own stable. Interestingly, according to Biggs's analysis, so-called
“defensive” investments such as government and top-rated
corporate bonds and short-term government paper (“Treasury Bills”)
performed poorly as stores of wealth in the victor countries and
disastrously in the vanquished. In those societies where equity markets
survived the war (obviously, this excludes those countries in Eastern
Europe occupied by the Soviet Union), stocks were the best financial
instrument in preserving value, although in many cases they did
decline precipitously over the period of the war. How do you ride
out a cataclysm like World War II? There are three key ways: diversification,
diversification, and diversification. You need to diversify across
financial and real assets, including (diversified) portfolios of
stocks, bonds, and bills, as well as real assets such as farmland,
real estate, and hard assets (gold, jewelry, etc.) for really hard
times. You further need to diversify internationally: not just in
the assets you own, but where you keep them. Exchange controls can come
into existence with the stroke of a pen, and that offshore bank
account you keep “just in case” may be all you have
if the worst comes to pass. Thinking about it in that way, do you
have enough there? Finally, you need to diversify your own options
in the world and think about what you'd do if things really
start to go South, and you need to think about it now,
not then. As the author notes in the penultimate paragraph:
…the rich are almost always too complacent, because they cherish the illusion that when things start to go bad, they will have time to extricate themselves and their wealth. It never works that way. Events move much faster than anyone expects, and the barbarians are on top of you before you can escape. … It is expensive to move early, but it is far better to be early than to be late.
This is a quirky book, and not free of flaws. Biggs is a connoisseur of amusing historical anecdotes and sprinkles them throughout the text. I found them a welcome leavening of a narrative filled with human tragedy, folly, and destruction of wealth, but some may consider them a distraction and out of place. There are far more copy-editing errors in this book (including dismayingly many difficulties with the humble apostrophe) than I would expect in a Wiley main catalogue title. But that said, if you haven't discovered the wisdom of the markets for yourself, and are worried about riding out the uncertainties of what appears to be a bumpy patch ahead, this is an excellent place to start.
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