Economist on Wall Street (Peter L. Bernstein's Finance Classics) E-Book

Peter L. Bernstein

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Peter L. Bernstein's Finance Classics
• Sprache: Englisch

Seitenzahl: 364

Veröffentlichungsjahr: 2008

Beschreibung

One of the foremost financial writers of his generation, Peter Bernstein has the unique ability to synthesize intellectual history and economics with the theory and practice of investment management. Now, with classic titles such as Economist on Wall Street, A Primer on Money, Banking, and Gold, and The Price of Prosperity—which have forewords by financial luminaries and new introductions by the author—you can enjoy some of the best of Bernstein in his earlier Wall Street days.

Peter Bernstein's Economist on Wall Street is a collection of writings from 1955 to 1970. The book is especially interesting because so many of Bernstein's observations reflect the most important issues of the present—the outlook for inflation and its control, the intricacies of monetary policy, the future of the dollar, and the dilemmas of household finances. Bernstein was also concerned with developments in portfolio management, including the new influence of institutional investors and rules for optimal asset mixes. He provides light touches, too, as he indulges in fantasies and philosophical musings over a wide variety of topics.

With so many years of hindsight, we should not be surprised to find some of Bernstein's predictions running awry. But why? In each instance, these forecasts were biased by memories of the past. There is a big lesson to be learned there.

Economist on Wall Street is a remarkable book, with lasting relevance and keen insights into the art of investment management, the capital markets, gold and the dollar, and the fun of being alive.

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Foreword

ORIGINAL FOREWORD

Introduction

ORIGINAL INTRODUCTION

Chapter 1 - PRIORITIES IS . . .

Chapter 2 - THE FEEL OF THE MARKET

THE FULBRIGHT HEARINGS: A BLESSING IN DISGUISE?

A SHORT WALK THROUGH THE LONG RUN

THE INSTITUTIONAL SPECULATOR

IS INSTITUTIONAL TRADING ACTIVITY EXCESSIVE?

THE ANATOMY OF THE BEAR

WHAT IS VOLUME TELLING US?

THE NEW DIMENSIONS OF TRADING ACTIVITY

THE GOLD CRISIS AND THE SECURITY MARKETS

GROWTH COMPANIES VERSUS GROWTH STOCKS

Chapter 3 - INFLATION AND THE ECONOMY

INFLATION-MONGERING

DEFICITS AND INFLATION: AN ANALYSIS OF THE INTERRELATIONSHIPS

INFLATION AND STOCK PRICES: A JUMBLE OF MYTHS

INFLATION REVISITED

CAN—AND SHOULD—TAXES STOP INFLATION?

CAN WE SOCK IT TO THEM IN 1969 AS WE SOCKED IT TO THEM IN 1968?

INFLATION: THE WRONG MEDICINE

Chapter 4 - GOLD AND THE BALANCE OF PAYMENTS

GOLD IS STILL GOOD AS GOLD

THE THREADS OF GOLD FROM SCHENECTADY TO LONDON

À LA RECHERCHE DU TEMPS PASSÉ

DEVALUATION, DEFICITS, AND DELUSIONS

THE COMMON MARKET: CHALLENGE OR SALVATION?

IS THE DOLLAR STILL NUMBER ONE?

Chapter 5 - HOW WRONG CAN YOU BE?

THE AMERICAN STOCK EXCHANGE: PROSPECTS FOR FUTURE GROWTH

Chapter 6 - THE ECONOMIST AS PORTFOLIO MANAGER

THE STRATEGY OF MODERN PENSION-FUND INVESTMENT

IS THE CULT OF THE EQUITY DEAD?

HAVE YOU MET MR. JONES?

NOTES ON PORTFOLIO PLANNING

HOW NOT TO LOSE MONEY ON TAX SWITCHES

Chapter 7 - PHILOSOPHY AND FANTASY

“THE PRICE OF PROSPERITY”—INFLATED OR DEFLATED?

IS WORK NECESSARY?

CAN BUSINESS GRASP THE FUTURE?

THE EVIL CONGLOMERATE: MYTH OR REALITY?

IS GOLD THE ONLY THING THAT’S KEEPING US HONEST?

A MODEST PROPOSAL

AN IMMODEST PROPOSAL

INDEX

Copyright © 1970, 2008 by Peter L. Bernstein. All rights reserved.

Published by John Wiley &Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. Originally published by The Macmillan Company in 1970.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, [phone], fax [phone], or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, [phone], fax [phone], or online at www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at [phone], outside the United States at [phone] or fax [phone].

Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com.

Library of Congress Cataloging-in-Publication Data:

Bernstein, Peter L. Economist on Wall Street :notes on the sanctity of gold, the value of money, the security of investments, and other delusions / Peter L. Bernstein ;foreword by Arthur Levitt Jr. p. cm.

eISBN : 978-0-470-43519-9

1. United States—Economic conditions—1961-1971. 2. Stock exchanges—United States. I. Title. HC106.6.B46 2008 330.973’0924—dc22 2008028075

For Robert L. Heilbroner

NEW FOREWORD

I have known Peter Bernstein, professionally and socially, for 35 years. Over that time the many and constantly changing sides of this remarkable person’s intellect and personality have defied easy categorization. As anyone who has followed his career knows, Peter is brilliant, charming, and highly principled. Those of us who have worked closely with him also know him as an empathetic, proud, playful, and sometimes prickly person. Taken together, it’s these traits that have anchored my own respect for him over our long and multifaceted relationship.

I first met Peter during the early 1970s when I was a partner in the brokerage firm called Carter, Berlind, Weill, and Levitt (CBWL). We were mostly a retail-oriented firm with a modest research presence, struggling to break into the institutional and investment banking space. I had heard of Peter at the time; he was a commanding presence on Wall Street—especially compared to our fledging enterprise. It would be a real coup for us if we could convince Peter and his firm to join with ours. Undaunted, I approached a friend, Hal Edelstein, who was an associate with Bernstein-Macaulay, about whether his small but well-regarded investment advisory firm would consider a relationship with CBWL. When Hal indicated interest in this suggestion, I immediately enlisted our senior partner, Arthur Carter, to join me in persuading Peter to merge Bernstein-Macaulay with our firm. We believed that Peter’s personal stature, together with his firm’s highly regarded clientele, would be an image-boosting move that might open institutional and high-end doors that might never have been accessible to our small firm.

Carter’s charm and persistence won the day, and Bernstein-Macaulay became part of our enterprise, which over the years morphed into what is the Smith Barney brokerage arm of Citigroup. During the honeymoon period leading up to and following the merger, Peter displayed some of the traits I find to be frustrating and endearing. Over and over, Peter insisted upon the independence of Bernstein-Macaulay. His clients, mostly high-end professional and pension funds, must not become, as he put it, “dumping grounds for CBWL” underwritings, nor should they necessarily follow the investment recommendations of the CBWL analysts. His approach to the multiple levels of conflicts existing in the retail brokerage business was firm to the point of stubbornness. Peter’s integrity was unimpeachable, and he helped set a tone for ethical behavior that, unfortunately, is hard to find in many Wall Street offices today.

As CBWL grew, Peter became a strong management presence—a wise and measured voice among a group of ambitious and often impetuous Wall Street wannabes. And as the two firms integrated, a deeply collegial relationship developed, and Peter started to accompany our brokers and analysts as they pitched for business. Over time, Peter became the centerpiece of many client conferences and dinners—and an invaluable part of our team. I remember clearly that as our firm started to grow, our investment bankers implored Peter to invest our clients’ money in companies such as Tech AeroFoam, Arlen Properties, and Omega Alpha. “Conflict, conflict, conflict,” muttered Peter to the frustration of our bankers and the benefit of his clients. On another occasion, Sandy Weill brought in a piece of business, the Topper Toy Company, that caught Peter’s eye. In spite of Peter’s and Sandy’s analytic skills, they missed the improper accounting for toys that were booked as sales but returnable. This played out in a significant financial loss to a number of the firm’s best clients and was a hit to the firm’s reputation as well. To his credit, Peter blamed no one and accepted the responsibility for the kind of bad call that can plague almost everyone in the business of managing risks.

In addition to a towering intellect and superb analytic skills, Peter is at heart a people person. Quickly, he became the most respected and beloved partner of all his employees, and he used that personal touch to lighten the mood and close the deal.

For example, one of our firm’s earliest partners, Clarence Jones, made an effort to attract banking business from a number of African and Caribbean nations, and Peter became the centerpiece of these pitches. One of the warmest memories of my career is recalling Peter—the scholarly and pixieish economist—going head-to-head with the Zambians to convince them to use the services of CBWL-Hayden Stone to underwrite their debt. On another occasion, we acquired our first branch in Beverly Hills from a failing firm, and had to move quickly to persuade the 12 brokers in the acquired office to stay with CBWL. Peter and I, plus our new branch manager, Herb Khaner, traveled west and regaled the new recruits with reasons they should join the team. They were interested, but then asked us to join them at a nightclub in the Valley. Little did we know that this was to be an evening of dancing, drinking, and general revelry. Without going into details, let me just report that Peter’s good-natured participation sealed the deal.

Indeed, getting to know one’s partners on a personal level is one of the benefits of a growing firm, and those relationships soon become part of the culture. Peter was a guest at our home, as my wife and I have been at his. Indeed, I’ll never forget our first visit to his apartment near Sutton Place. I knew Peter as this former Williams College economics professor, rigorous with his data, serious about his commitment to his clients, and an astute businessman to boot. So imagine my surprise upon entering his apartment, when I saw two rabbits hopping around his home—a beautiful home decorated with a large collection of ceramic bunnies. From that moment on, Peter was the “bunny man” (although never within his earshot). And to me, that playfulness along with his brilliance are the parts of Peter’s character that make him such an extraordinary human being, one I am privileged to call a friend.

—Arthur Levitt Jr.

ORIGINAL FOREWORD

I suspect I first learned Peter Bernstein’s approach to economics when he asked me to take care of his pet rabbit one summer a few years ago while he and his wife went on vacation. It was a chore I undertook with some trepidation, having had no previous experience in the care and feeding of rabbits. All I knew was that rabbits weren’t supposed to make especially good house pets, being somewhat balky and not at all of the same devoted nature as dogs of my acquaintance. But Prospero, who was named aptly enough after Bernstein’s first book, The Price of Prosperity, quickly made a convert of me; he soon began frolicking around like a playful pup and would sometimes even come running when I called his name. What was most revealing about this experience was that Bernstein had been unwilling to accept the widely held view that rabbits had to be unresponsive pets. This unwillingness to accept any point of view without extensive scrutiny is perhaps the cornerstone of his thinking.

It is probably typical of Peter Bernstein, moreover, that he would have a pet of such a rare and independent type. The fact is that Bernstein, whose iconoclastic writings you will be sampling in this volume, is a rare and independent man himself: rare in that he is one of the few people I know who is equally skillful as a practicing economist and as a professional investment manager of other people’s money, and independent in that his philosophical approach is a constant questioning of what others have come to accept as conventional wisdom.

As you will see in the essays presented here, Bernstein’s forte is scrutinizing what are generally believed to be basic truths, examining them in the light of empirical evidence and from that refreshing perspective coming to conclusions that would escape those with a less inquisitive frame of reference. This book, then, is the result of a continuing quest for economic knowledge—specifically in the area of the stock market.

Bernstein’s provocative thought process seems to have been anticipated some decades ago by no less an economist than John Maynard Keynes, who is, by the way, quite obviously one of Bernstein’s forebears. In his General Theory, Keynes described the process of professional investment and suggested that success in the field was akin to being able to pick the winner in a beauty contest. His point was that it was not enough to select the girl you yourself believe to be prettiest, nor, for that matter, the one you think the average opinion of the judges will pick as the prettiest. Rather, Keynes wrote, we have reached a third level, “where we devote our intelligences to anticipating what average opinion expects the average opinion to be.”

It is on this third level that one begins to understand what is at the heart of Peter Bernstein’s writings. Indeed, the fact that an idea or a belief is widely held in his view may very well make it suspect—or at least subject to rigorous questioning. The results of this probing have produced such work as his essays on the true role of gold in international monetary affairs, what government deficits really mean for prices, and how inflation influences stock prices over the long run—all of which are included in the pages following.

What to me is most striking about Bernstein’s work, though, is his ability to bring clarity to even the most abstruse economic thinking. He has the ability to take a complex concept and make it simple, rendering it comprehensible to the lay reader and still interesting to the professional one. But unlike many others writing in the field, he shuns the emotional and visceral reaction and gravitates by instinct toward a rational and logical point of view.

To measure the extent of Bernstein’s influence as a writer and an economist one need only look back to the days of the Kennedy Administration, an era when the government’s fiscal responsibility to smooth out peaks and troughs in business activity—and the New Economics itself—had far less credibility than it does today. The biggest stumbling block to the tax cut the Administration had proposed was the United States Congress, and that legislative body, as so frequently happens, was something less than knowledgeable on the new direction economic policy was taking—specifically, the belief that a tax cut, contrary to the prevailing view, could be used to spur industry to new heights even in prosperous times. It thus fell to Bernstein and his longtime friend and fellow economist, Robert L. Heilbroner, to turn out a book that would explain the Administration’s remedies to the public and, more important, to the Congress. The result was the immensely popular A Primer on Government Spending, produced after a series of marathon writing sessions starting at six o’clock in the morning, and published in a matter of weeks by Random House. Many believe this book, which was presented to every Senator and Congressman, helped to pave the way for the eventual passage of the tax-cut bill. The kind of analytical work it contained may be seen beginning on page 91, where the question of whether government deficits must necessarily lead to inflation is examined in detail.

This has been an age marked by the somewhat mystical quest for something called “investment performance”—a process by which one investment manager tries to outperform all others and tending to minimize personal relationships with clients. But through it all Bernstein’s credo has remained a simple one. As he once told a reporter: “We feel our clients are people, not money, and the name of the game is their happiness.” Underlying this personal view, one senses a strong social theory. The leitmotif running through his work is that the end result of economics and investment is that somehow people must be clothed and housed and fed. To accomplish this he has been an advocate of higher taxes, more government spending, and indeed, greater control of the economy by federal government. Not surprisingly, this approach has made Bernstein a bit of a maverick in Wall Street.

I have known Peter Bernstein as a student, employee, colleague, and friend over the past decade, the period during which most of the work in this book was being produced. I have learned an enormous amount from him over those years, and it is my hope that the readers of this book will find their exposure to Bernstein’s thinking an equally enlightening experience.

—Gilbert E. Kaplan

NEW INTRODUCTION

The origins of this book go back much farther than one might infer from looking at the contents. Its true origin was in 1934, or 36 years before its actual publication date. I was only 15 years old in 1934, but that was the year my father launched a new investment counsel firm called Bernstein-Macaulay, Inc. Macaulay was Frederick R. Macaulay, a distinguished academic in the process of writing a tome on the history of the bond markets.

My father’s choice of starting out as an investment counselor instead of going into the brokerage business is interesting. Investment counseling was a young profession in those days, with only a handful of firms in the business. Indeed, most investors had never heard of it. Investment counselors render advice for a fee based on the size of the funds under management rather than in return for brokerage revenue. This arrangement, which is standard in the money management business today, has eliminated the long-standing conflict of interest that arises when an investor takes advice from a broker who makes money only when the client trades. A long-term, buy-and-hold kind of investor does little to fatten the pockets of his “customer’s man” and is not likely to receive much attention. With a fee-based arrangement, activity plays no role in the advisor’s compensation or in the nature and frequency of advice given. Indeed, for most of its existence, Bernstein-Macaulay was so sensitive to conflict of interest problems that it would not even recommend a broker to its clients.

Before going into the world of stock and bond markets, my father had managed a manufacturing business he had inherited from his father. In 1929, he received a buy-out offer from a competitor at a price he never expected to see. He could not resist and sold out. As he described what happened next, he turned right around and invested the proceeds in the stock market at prices nobody had ever expected to see. He then invested his common stock holdings as his contribution to the partnership capital of a new brokerage firm he and a few friends were organizing. The firm had a short and not especially happy life. In 1933, when stock prices were about a third of what they were when my father had bought his stocks—and against his fervent objections—his partners chickened out. They insisted on liquidating the remaining assets of the firm, including my father’s deeply depressed stock holdings.

A natural optimist and an unshakable believer in his own viewpoints, my father was convinced the market had already seen the bottom and that a great bull market lay ahead. In the spring of 1934, he borrowed $15,000 from a rich uncle and launched Bernstein-Macaulay, Inc., attracting as clients a few close friends who still had enough capital left to make the venture worthwhile. Stocks at that moment were about double the low of June 1932, and prices moved sideways for about a year. But then they took off.

The clientele grew, my father added associates to the firm who also brought in business, and he greatly enjoyed himself in the process. Part of the fun was writing a monthly letter, ostensibly to inform clients of the firm’s views of the markets and the economy, but my father also hoped the letters would attract new clients. He had graduated from Harvard in 1902, and George Lyman Kittredge’s course on Shakespeare had a lifelong influence on his enthusiasm for language, words, and literary style. The Bernstein-Macaulay letters were a wonderful opportunity for him to display and savor his talents as a writer. At home, the letters became known as “the release,” and the word was not idly chosen.

My father died suddenly in 1951. At that time, I was working at a small commercial bank in New York, where I was involved in everything: lending money to small businesses, supervising the foreign department, and managing the securities portfolio. The work was enjoyable, my associates were good people and eager to advance my skills, and the pay was adequate. I had every indication I was launched on my lifetime career.

But when my father died and the future of Bernstein-Macaulay was at stake, my family put a lot of pressure on me to leave the bank and join my father’s organization. They were convinced the firm would fall apart without my presence and my mother’s financial security would be in danger. I was still reluctant—as I put it, I had no desire to become a social worker to the rich. But then my father’s first client and best friend called me up and said he would without doubt remove his account unless I joined up. That clinched it and I gave in. That nice man subsequently became my stepfather and also introduced me to the wonderful woman I married in 1972, shortly after my first wife had died.

The prospect of writing the monthly Bernstein-Macaulay letters—the release—was an important element in my capitulation to the family pressures. Putting my views into good English was a joy I had inherited from my father. Writing had been a preoccupation at high school and college and has always been an vital part of my life (and my livelihood as well). I took over the task of writing the releases the very first month I was at Bernstein-Macaulay, although my older associate, Linhart Stearns, filled in on rare occasions. Linnie wrote one of the best and funniest issues ever, “A Modest Proposal,” which appears here on page 273.

In those days, we referred to the letters more formally as “bulletins,” as you will note throughout the book, but they were always “the release” in my heart and I have continued that form of reference to this very day in the letters we publish in the consulting firm I established when I finally left Bernstein-Macaulay in 1972.

The largest share of the material in this volume is composed of samples of the releases, but the book does contain a few articles written for outside publications. The most important of these, “Growth Companies versus Growth Stocks,” was published in the Harvard Business Review in September 1956 and runs from pages 51 to 82. Although I had previously published two papers in scholarly journals, this article attracted a great deal of attention in Wall Street and established my reputation as a writer and an authority in the field of investing. After this, I was off and running.

The idea of buying a stock explicitly for its future earnings instead of its current earnings was a novel strategy in the 1950s, although growth stock investing came to dominate stock market investing in the 1960s and has played a vital role ever since. This type of investing involved paying a higher price than customary relative to current earnings and accepting a lower dividend yield as well. My article, original for its day, explained why this counterintuitive way of pricing stocks and valuing dividends was an acceptable approach to equity investing, and even preferable, under some conditions, to focusing on current earnings and seeking a high dividend return.

The range of material here is wide, from commentaries on current events in the capital markets and the economy to history of all sorts, a good deal of philosophy, and wide-ranging discussions of the outlook for inflation and the role of gold. Part of the fun of writing the releases was the opportunity to break away from the nitty-gritty of investing and explore more of the world around us. Those pieces consistently reflect the liberal views I held with such strong convictions at that time—and still do hold, although with convictions less absolute than in the old days. The best of these, in my view, are “Priorities Is . . .” (page 1) and “Is Work Necessary?” (page 238).

With the hindsight of more than 35 years, some of the current commentary and forecasts in the book look foolish. That is to be expected. We never know what the future holds and surely have not even a hint of what the world will look like 30-odd years ahead. But some of these releases looked foolish in the shorter run, say, within the next five years.

There was a common theme in those errors. At every opportunity, I am lighthearted about the threat of peacetime inflation. I believed with increasing conviction that the American economy’s massive productive power, ingenuity, unmatched resources, competitive environment, robust financial strength, and appetite for risk taking would be able to deal with any adverse conditions that might arise. The extraordinary track record of stable or declining peacetime prices in the long history of our economy had repeatedly demonstrated how, under capitalism, supply overtakes demand and naturally keeps inflation in check.

This track record was violated only after my book was published. In the early 1970s Richard Nixon put through a huge increase in government spending to finance the war in Vietnam and persuaded the Federal Reserve to go lightly in restricting growth of the money supply—a process that nearly turned the United States into a banana republic and came to an end only after the redoubtable Paul Volcker assumed the chairmanship of the Fed in August 1979.

There is, finally, another common element running throughout the book, a view I still hold with the highest convictions. The objective of equity investing is survival. In the patois of today’s professional investors, the objective of survival is just a straightforward way of saying that risk management is the secret of success. We have no control over what kinds of returns we will earn; we can only estimate, figure, and then hope. Risk is the key variable under our control.

Making a killing is a hope, not a strategy. The same goes for trying to beat the market. Taking risks so high that all can be lost is a strategy, but it is not the strategy I would choose. In the long run, equity investing has to be a positive-sum game or the capitalist economy will grind to a bitter end. That may, indeed, come about, but then a strategy built on the objective of survival is all the more important. If the outcome is the happier one, and the system does endure, time will bring sufficient reward to justify the forbearance that the survival strategy demands.

Looking back at the material in this book after the passage of nearly 40 years, do I find myself wiser today? Are there passages here I wish I had not written? If I had it to do over again, would I say it differently?

To answer the latter questions first, I admit there is one expression in this book I wish I could have eliminated. There is a superfluity of “of course” throughout the text. It is an expression I have come to detest. “Of course such-and-such is the case” conveys the snobbish message that readers are expected to know all about such-and-such but are so stupid they need this reminder from an author who is smarter and better informed than they are. I bridle every time I encounter it as a reader and am ashamed to have used with such abandon in the texts in this book.

The more interesting and difficult questions are whether I find myself wiser and whether I would say things differently were I to have the chance to rewrite these documents. I think all investors should find themselves wiser over time, because experience is a teacher—and there probably is no better teacher in the field of investing. Unfortunately, experience can also lead you astray, so it has to be used with discretion, as I indicate just shortly.

In any case, there was nothing else but experience to go on when I started off as an investment counselor. The readings I did were all superficial, with the exception of Benjamin Graham.1 Furthermore, there was no theory of investing to guide us. We built the practice of investing on folklore, rules of thumb, and the experience of older associates (which served me badly, because my older associates were grizzled veterans of the Great Crash and could not accept the postwar bull market’s vitality and staying power).

But theory matters. I have learned a lot about the theory of investing since 1970, and that knowledge might have been helpful in analyzing some of the problems I tackled here. In fact, I have written two books about the theory of investment, published in 1992 and 2007, and have read and listened to more theoretical material than I care to remember. Theory introduces a discipline and orderliness in thinking that experience can seldom provide. I do think about some of these problems differently as a result of what theory has taught me.

But the theoretical work carried out between 1952 and 1972 by eight Nobel Prize winners and their associates was not even beginning to attract the attention of practitioners in the late 1960s. I did not know it even existed. Perhaps the material in the book would have been richer if the theoretical material had been available to practitioners like me—but I suspect the subject matter of my writings and even the course of events would also have been different if the abstractions of the theoretical work had captured our interest. As a result, my writings would have covered other kinds of topics and answered other kinds of questions. So the issue is moot.

ORIGINAL INTRODUCTION

People in Wall Street spend an inordinate amount of time telling one another things that are wrong, that the listener has heard already, and that he will soon be repeating to someone else. But if all the myths and homilies of the conventional wisdom were true, wouldn’t all of us be rich?

Some of us are, but most of us are not.That is because the money game is a lot tougher to win than the advertisements, the market letters, and the friendly telephone calls would lead us to believe.

Of course, orthodoxy, particularly when it is embellished by constant repetition, is almost always reassuring to the person who hears it. When one deals constantly with the unknown and when every decision means taking another risk, the warm familiarity of what one has heard before (even if it is wrong) provides an urgently needed sense of security. The unknown is frightening enough: Why exacerbate matters by listening to the unfamiliar and radical ideas that someone else may put forth?

But the hard truth is that investment success comes most generously to those who are able to swim upstream; majority opinion is already reflected in the current level of security prices. Hence, the essays in this book represent an effort to cut through the heavy sludge of received doctrine, to test, and occasionally to ridicule, the things that most people spend most of their time telling one another about the economy, the stock market, and the art of portfolio management.

I am, in fact, continually amazed by the refusal of human beings to see what is right in front of their eyes on those occasions when what they see contradicts what they believe to be true. Thus, they believe that inflation is a time to take money out of the savings bank and to buy stocks, when, instead, stocks tend to go down during inflationary periods and to go up when prices are stable. They worship the golden calf, when, instead, gold has been about the worst investment that anyone could have made over the past 20 or 30 years. They look at business and businessmen as the foundations of our society, when, at every turn, these foundations show signs of crumbling and are at the very least held up to the most searching inquiry by the young and the radicals.

I am amused—and aggravated—above all by the repeated questioning on the part of prospective clients as to the rate of return they can “reasonably expect” from their investments in the future, as though the stock market were an accommodation machine that will provide them with whatever level of affluence they seek. These people simply refuse to believe that the future is always unknown to all of us. Yet, the art of successful investing begins with the humility of facing up to the unknown.

Hence, the common thread that runs through the essays in this book is the conviction that the future is not going to be where the other fellow tells you that you will find it; more likely, you should be striking out in quite a different direction.

Of course, we would be fools to run against the crowd all the time, and contrary thinking for its own sake is more a neurotic than a constructive activity. But the investor who blindly follows majority predictions and standard forecasts usually ends up in the ditch. My purpose here, in fact, is to show that the process of thinking with one’s ears closed, difficult as it may be, is the only reliable path to profit.

I therefore urge the reader to pay some attention to the dates of publication of the various essays that follow, all of which appeared between 1955 and 1970. Most of them set forth controversial minority opinions at the time they were printed—and, in retrospect, I find that, the lonelier I felt in the positions I took, the more accurate my forecasts turned out to be.

Most of the selections are monthly bulletins that I wrote for the clients and friends of my investment-counsel firm, Bernstein-Macaulay, Inc.; space limitations forced me to be as concise and to the point as possible in the articulation of my opinions in these particular pieces. The balance of the essays is articles or speeches prepared over the same span of 15 years or so. I have preceded each major grouping of essays with an introduction, describing the major ideas expressed and occasionally helping the reader to understand the historical setting of something that was written in the past; where appropriate, I have written a postscript—“What Happened Afterward”—to individual pieces, so that the reader will have some sense of the accuracy of the predictions made. One section, in fact, is designed to show how wrong one can be in this game of trying to guess the future.

In this connection, I stress once again that these essays should be read with one eye on the date of publication. The topicality of what they have to say seems to bear surprisingly little relation to the amount of time that has passed since I wrote them.

Although the selections in each chapter appear in rough chronological progression, I have not hesitated to place something out of that order if that would give it added interest or help the sequence of argument.

I want to express my thanks to Herbert Nagourny, who originally suggested the format for this book, and to Mrs. Arthur Nolan, for endlessly patient and accurate assistance in preparing it for publication. My wife’s enthusiasm and encouragement were essential; the dedication to my friend is an acknowledgment of a sense of gratitude that surpasses the possibilities of verbal expression.

Chapter 1

PRIORITIES IS . . .2

A fourteen-year-old boy died apparently of an overdose of pills yesterday, only hours after the Board of Education said it had no funds for security guards to fight narcotics problems at the school he attended. . . . Mayor Lindsay said, “This is a regrettable tragedy and I will ask for a full report on the incident from the Police Commissioner.”

—New York Times, February 17, 1970

Priorities is when you have reports instead of money to save human lives. Priorities is when you have a boom in office building downtown and urban decay uptown. Priorities is when we grumble about paying higher rates for electricity and simultaneously grumble about air pollution from the local utility. Priorities is when we can afford to drop bombs on houses inVietnam and can’t find the financing to build houses at home. Priorities is when we cut back on appropriations for education and ask for extra appropriations for antiballistic missiles. Priorities is when you can take a walk on the moon but are afraid to walk down your own street. Priorities is when the Governor won’t ask for higher taxes in an election year and then there is no money to provide a cheap and efficient public transportation service. Priorities is when we are willing to spend money to buy television sets to sit home and see thoughtful programs about the problems of our society that we don’t want to spend any money to do anything about.

“Priorities” has been a cool word in the past. Today—and for many days to come—it will be the hottest word in our vocabulary.

For much of our history, including most years since the end of World War II, the American economy has operated with a margin of idle capacity and unemployed workers, so that increased demands from one area or another could be met with relatively little difficulty. Guns and butter was the cry. We could even have guns and butter and road-building and schools for a good deal of the time.

But now, as we look ahead into a new decade, the grammar is changing. For all the “and’s” read “or.” Affluent as we may be, the needs of our cities and our educational systems and our starved supply of housing and our defense establishment and our aspirations for more leisure and our burgeoning supply of 20- to 30-year-olds add up to astronomical numbers that even our fabulously productive economy cannot meet.

This means we will have to make some important choices. To a greater extent than most people realize, however, we have already locked ourselves into some crucially important choices. This will make the significance of selecting priorities even greater than it might have been otherwise.

To begin at the beginning: the direction in which we are moving and the largest of the deficiencies we are trying to overcome are all enormously capital-using. In other words, they require a large investment in labor and resources for a long period of time before they begin to bear fruit in quantity. Urban renewal, housing, education, public transportation, the drive against pollution, hospital building, and doctor training, to name just a few of the things we are in a hurry to accomplish, will absorb massive amounts of resources and will show results only gradually.

Furthermore, all of them require financing. Few of us have the ready cash to pay for a home without a mortgage, and the federal and local governments must have more tax revenues or borrow more money if they are to increase their expenditures. At the same time, as a result of the drastic drain on corporate liquidity in recent years, even moderate rates of business expansion now require high levels of external financing. In short, the urgent needs of our society imply intense pressures on our capital markets. This comes at a time when we are already absorbing a colossal volume of financing and when our usually efficient capital markets are groaning under the strain.

Since the external financing requirements of business are likely to remain high, since the unsatisfied demand for mortgages is enormous and growing daily, since state and local governments will have a clear need for tremendous sums, since the appetite of our defense establishment seems to be insatiable, and since major domestic federal programs are clamoring for attention, the probability is that we will have neither the real nor the financial resources to accomplish everything that we would like to accomplish.

Now there is one way to do it. Although business has insufficient cash flow to finance its expansion internally and although state and local governments are hard pressed to cover their expenditures right now, we could solve a lot of problems if the federal government could operate at a surplus. This would have a double advantage: The federal government would make no claims on the capital markets and, in fact, would be repaying debt out of the budget surplus and therefore putting money back into the coffers of the individual and institutional investors who buy the securities that businesses and local governments offer for sale. This is something of an oversimplication, because it depends to some extent on who pays the taxes, but the general concept is valid nevertheless.

If the federal government is to operate at a surplus and hence both relieve and replenish the capital markets, that means that revenues must exceed outlays. Which way are we to do it? By increasing revenues or by restraining expenditures? The degree to which the federal government can fulfill its share of improving the quality of life in the United States depends precisely upon this choice.

The problem is that the choice has already been made. The haste to remove the Johnson tax surcharge and the ultimate implications of the tax reform bill of 1969 both mean that the revenues of the federal government in the years ahead will be many billions of dollars less than they would have been if the choice had been made the other way. But this also means that the level of federal spending is going to be many billions of dollars less than it would have been otherwise. The only other choice is to persist in the disruption of our capital markets, to squeeze housing still further—or to revert to some type of credit control and rationing.

It is possible, perhaps even likely, that state and local governments will tax away the federal tax savings that Congress voted us last year and will therefore be able to fund some programs that might otherwise have been carried out on the federal level. Some people would even welcome a shift of responsibilities along these lines, and it does have certain attractions. However, it has two serious disadvantages. First, the citizens who end up paying higher state and local taxes may not be the same ones who get the full benefit of the federal tax savings. Second, the revenue-raising abilities of the states vary enormously: the rich states can improve themselves rapidly while the poorer states fall further behind. When projects are financed by the federal government, we can manage things in a more equitable fashion.

But we had best face up to the implications of what Congress has decided for us: The priority of our private pocketbooks is more important than the priority of our public needs. The federal government is going to have to count its pennies with great care.The question is not guns or butter, but guns or schools (and for “schools” you can read the whole array of urgent domestic programs).

How large a defense establishment can we afford? No question is more important today for our social and economic well-being. Note, the question is not: how large a defense establishment do we want? We have set up our priorities in such a way that we simply cannot have everything we might like the federal government to give us.We have to make the choice, no matter how difficult, now and in no uncertain terms.