A Tale Of Two Fridays

The following, written by Nick Murray, is used here with permission . . .

A TALE OF TWO FRIDAYS

This is a story about two Fridays, separated by exactly 21 years.

Specifically, it’s an anecdotal recitation of the economic, financial and market disasters that have relentlessly plagued America and the world between those two Fridays, and of the remarkable – indeed, almost unbelievable – place that these disasters left us, 21 years later to the day.

The first of the two Fridays was October 16th, 1987. It was a pretty significant down day in the American stock market, after two consecutive but not terribly ominous declines on the Wednesday and the Thursday.

Stocks had actually been having a fairly difficult time since late August. Gold and commodity prices were rising with inflation concerns; interest rates had turned noticeably higher for the same reason. Equity valuations were historically very high, rendering the market vulnerable to some sort of correction.

But nothing on that Friday suggested the magnitude of what was to happen the next trading day: Monday, October 19, 1987. From the opening bell, stocks declined catastrophically. Because of a huge imbalance of sell orders, specialists on the floor of the New York Stock Exchange were unable even to begin trading some stocks for an hour and more.

Prices fell relentlessly throughout the day – and then accelerated, in a panic-driven rout, in the last ninety minutes of trading. When the tape stopped running, long after the close, the market was found to have fallen in excess of 23% -- the largest one-day decline in history, before or since.

Time magazine’s cover expressed the universal consensus: “THE CRASH: After a wild week on Wall Street, the world is different.”

Not long afterward, in 1990-91, came a cataclysmic collapse in the real estate and banking industries. Any number of major banks were said to be teetering on the brink of insolvency, as the value of the collateral on their portfolios of home mortgages sank below the mortgage balances.

The savings and loan system in our country was liquidated under the auspices of a new federal agency, the Resolution Trust Company. A war loomed in the deserts of Kuwait. The first real recession in almost a decade took hold of the economy. And the stock market spiraled down into bear market territory.

Time’s cover showed silent film star Harold Lloyd hanging from a clock tower, and headlined: “HIGH ANXIETY: Looming recession, government paralysis and the threat of war are giving Americans a case of the jitters.”

Soon enough came the terrible summer of 1998: Russia, which had been the world’s hottest stock market the year before, defaulted on its sovereign debt, rendering its currency worthless. The largest hedge fund that had ever existed, Long-Term Capital Management, vaporized all its equity; it was found to be still holding billions of dollars of positions which, if they had to be settled all at once, would have caused the global trading system to cease to function. And, like malignant dominos, the world’s emerging markets and economies collapsed, in what came to be known as Asian Contagion 2.

All this brought on a bear market of incredible violence and suddenness in the U.S. No one was safe: even Warren Buffett’s shareholdings in his Berkshire Hathaway declined by over six billion dollars in 45 days.

Time’s cover showed an uptrending chart suddenly breaking and falling to the bottom of the frame, plunging people trying to stand upon it into an abyss. The headline: “IS THE BOOM OVER?”

Not very long afterward came the bursting, in early 2000, of the greatest stock market bubble of all time, as the dot.com mania crashed, and seven trillion dollars worth of equity values – four trillion on NASDAQ alone – turned to ashes. The country was once again gripped by recession. Then came the terrorist atrocities of September 11, 2001. And soon after, the horror of Enron, with all the corporate and accounting scandals that surfaced for months in its foul wake.

A howling bear – in fedora, rep tie and wingtip shoes – graced the cover of Time.

Then, in mid-2007 – with the stock market barely above its levels of seven years earlier – the housing market in this country collapsed, uncovering a seemingly bottomless cesspool of defaulting loans and worthless derivatives. These hundreds of billions of dollars in losses cascaded into a credit crisis that ultimately froze the financial system of the entire world, and sent our stock market into (at this writing) its third deepest bear market since the 1929 – 32 event.

Time’s cover featured a stark black-and-white photo of a line of destitute men waiting at a Depression-era soup kitchen.

This brings us up to the second Friday which bookends our litany of disaster: October 17, 2008 – 21 years to the day (if not precisely the date) after our story began – and, not coincidentally, only one day after the  greatest single-day percentage decline in the S&P 500 since October 19, 1987.

And where, after all this destruction and chaos, did equity values stand on the second Friday – five bear markets later -- compared to the first?

Dear reader: on a total-return basis (that is, price change plus dividends), the broad equity market stood just about five times higher on October 17, 2008 than it did on October 16, 1987.

Five times higher.

This startling truth may suggest -- to the long-term, goal-focused investor – a couple of very important conclusions.

The first is that what really matters isn’t the temporary erasure of equity values which happens during this or that evanescent crisis. It’s the staggering increases in values (and dividends) which take place in the great expansions which resume after – and ultimately overwhelm the effects of – even the most significant setbacks.

And the second is that the most reliable source of the accretion and maintenance of real wealth remains, as it always has been, the ownership of diversified portfolios of the great companies in America and the world.

Gold, and oil, and “new era” technologies, and condos in Palm Beach, and exotic hedge funds, and numberless other financial fads have always strutted and will always strut their hour upon the stage, drawing the hard-earned savings of the greedy and the credulous to destruction.

While the earnings, cash flows, dividends and share prices of mainstream equities march on – through crisis after cataclysm after unimaginable disaster – to fund the most cherished goals of the patient, disciplined long-term equity investor.

Take a good look around. Try not to think too much about where the values of the great companies are today, late in this fifth major bear market in just 21 years.

Try to imagine – if you can – where they will be 21 years from now.

© 2008 Nick Murray. All rights reserved. Used by permission.