Back in 1955, the cameras of CBS newsmagazine See It Now stepped inside Benjamin Graham’s classroom at Columbia University and captured the legendary investor mid-lecture. The result is a fifteen-minute segment that, absent a time machine, will be the closest any of us ever get to sitting there in person and learning directly from the man who shaped the careers of so many super-investors.
Dean Courtney Brown joined Graham that day in fielding questions from the students on such still-relevant topics as overheated markets, inflationary fears, and those pesky psychological pitfalls that trip up so many players of the money game.
What makes the extant footage of this lecture so special is that, for the first time, we see Graham’s charisma and gift for teaching. Reading his books, we get the ideas. But watching him in action, we are able to better understand the man. (And don’t sleep on Dean Brown, who offers up some wise commentary of his own.)
My favorite moment comes at the very end — and really hammers home what I hope to accomplish with this newsletter. If I had to boil my thesis down to a single sentence, it would be this: You can outsource your stock-picking, but you can’t outsource your conviction. Index funds and professional money managers can do a lot, but they can’t endure for you through manias, panics, and unending noise.
TV Host: There is no shortage of experts on the market.
As for us, we’re barely able to tell the difference between a bull and a bear — so we sat in on part of a seminar at the graduate school of business at Columbia University. After all, it’s older than the stock exchange. We thought professors familiar with the language of the Street might treat the market with detachment. Dean Courtney Brown and Professor Benjamin Graham were instructing future brokers and customers’ men.
Here is See It Now’s short course in the market.
Courtney Brown: First, let me give a caution — [though] I hardly need give it to a group of informed students such as you. No one knows precisely why the market behaves as it behaves, either in retrospect or in prospect.
The best we can do, as you all know, is express informed judgments — but it is important that those judgments be informed.
We do know that there has been a substantial rise and that rise has been going on for a number of years, particularly since the middle of 1953. And we do know that the rate of that rise has been very rapid — uncomfortably like that of the 1928/29 period. It has resulted in a lot of comparisons being made in the press.
Moreover, the present level of stock prices — as measured by the Dow Jones averages — is about equal to [and], indeed, a little above the peaks of 1929.
A number of explanations have been advanced regarding the stock market rise that suggests it may reflect a return to inflationary conditions. This doesn’t seem to me to be very convincing. First, because there is no evidence of inflation in the behavior of commodity prices — either at the wholesale or at the retail level. And there hasn’t been over the past year and a half. Extraordinary stability in the behavior of those indexes. There is so much surplus capacity around in almost every direction that it is hard to conceive of a strong inflationary trend reasserting itself at this time.
Still another explanation is that the stock market has gone up because there has been a return of that kind of speculative fever that has, from time to time in the past, gripped the country, [like with] the Florida land boom, the 1929 stock boom. They have occurred in history, as you know, all the way back from the tulip speculations in Holland. I suspect there’s a certain element of truth in this one.
However, it doesn’t seem to me that it gives us too much of a concern because there has been no feeding of this fever by the injection of credit.
I think it is important for us to observe that the amount of brokers’ loans — loans made to brokers for the financing of securities of their customers that have been bought on margin — are less than $2 billion at present. In 1929, they were in excess of $8.5 billion and there is now a larger volume of securities on the stock exchange.
Now, gentlemen, Professor Graham will pick up the story at that point.
Benjamin Graham: One of the comparisons that’s interesting is one not between [now and] 1929, which is so long ago, but 1950, which is only a few years ago. It would be very proper to ask why are prices twice as much [now] as they were [then] when the earnings of companies — both in ’54 and probably in 1955 — are less than they were in 1950. That is an extraordinary difference.
The explanation cannot be found in any mathematics, but it has to be found in investor psychology. You can have an extraordinary difference in the price level merely because not only speculators but investors themselves are looking at the situation through rose-colored glasses rather than dark blue glasses.
It may well be true that the underlying psychology of the American people has not changed so much and that what the American people have been waiting for, for many years, has been an excuse for going back to the speculative attitudes which used to characterize them from time to time. Now, if that is so, then the present situation can carry a very large degree of danger to people who are now becoming interested in common stocks for the first time. It would seem, if history counts for anything, that the stock market is much more likely than not to advance to a point of real danger.
Q: You said that stock prices now are not too high, but that you fear they will go higher. Well, then, are you recommending a decline?
Brown: May I defend you on that? (Laughs)
Graham: Yes, go right ahead.
Brown: Those who have watched the security market’s behavior over the years has become more and more impressed with the fact that stocks always go too high on the upside and tend to go too low on the downside. The swings, in other words, are always more dramatic and the amplitude of change is greater than might normally be justified by an analytical appraisal of the values that are represented there.
I think what Professor Graham had to say was that his analysis of a series of underlying values would indicate that the stock prices are just about in line with where they might properly be. However, from experience, that would be the least likely thing to happen — that stocks would just stabilize right here.
Now, if it’s the least likely thing to happen and you have to select a probability between going up further or down further, because of the strong momentum that they have had I think I would be inclined to agree with him that the more probable direction would be towards somewhat higher levels.
Q: Normally, when stockholders believed the stock market was too high, they switched from stocks to cash. Now, many people feel that due to the capital gains tax, they are not free to act. They are, what you might say, locked in. What effect does this have on the stock market in general?
Brown: There’s no question about the fact that it does discourage some sales that might otherwise be made because one selling stocks and trying to replace them would have to replace them at substantially lower prices to come out even after paying the capital gains tax.
However, that’s not the only reason people are reluctant to sell stocks and buy bonds. Stocks are still yielding ~4.5% on the basis of current dividend payments, whereas bonds of prime quality are closer to 3%. Here, again, we find a contrast with the situation in 1929, when stocks were yielding ~3.5% and prime bonds closer to 5%.
Q: In addition to raising margin requirements, should the federal government take other measures to check a speculative boom in the stock market and which method is the better?
Graham: My own opinion would be that the Federal Reserve should first exhaust the possibilities of raising the margin requirements to 100% — and then consider very seriously before they imposed other sanctions.
Brown: If needed.
Q: What is the significance of the broadening public participation in stock purchasing and ownership?
Brown: There are probably two elements there that are important. One, the broadening participation of the public in stock purchases is one measure of the degree of speculative fever that we were talking about before.
However, subject to that being controlled — and I believe that it can be controlled, as Professor Graham indicated — over and above that, there is broad social significance to that, it seems to me. What it, in essential terms, means is that the ownership of American industry is being more widely dispersed among more and more people. This has very favorable repercussions in terms of our political and social life.
Q: Are Wall Street professionals usually more accurate in the short term than in their long-term forecasts? If not, why not?
Graham: Well, we’ve been following that interesting question for a generation or more — and I must say frankly that our studies indicate that you have your choice between tossing coins and taking the consensus of expert opinion. The results are just about the same in each case.
Your question as to why they are not more dependable is a very good one and an interesting one. My own explanation for that is this — that everybody on Wall Street is so smart that their brilliance offsets each other and that whatever they know is already reflected in the level of stock prices, pretty much, and consequently what happens in the future represents what they don’t know.
Q: Would you kindly comment on an item appearing in the newspaper to the effect that while 45% of buying today is on margin, the money borrowed is equal to only 1% of listed stock?
Brown: The amount of trading on the stock exchange is a very small part of the total value of all the securities that are listed thereon. When you say that the total amount of borrowing on margin financed by brokers’ loans is only 1% of the value, it is a reconcilable figure. You can’t reconcile it unless you have the detailed data with you, but it isn’t incompatible in any way.
Graham: I might add a point on that, Dean Brown, and that is that the slow increase in brokers’ loans as compared with 45% marginal trade would indicate that a good deal of the marginal trading is between people who are taking in each other’s washing. That is, the marginal buyers are buying from sellers who were previously on margin. That’s why the rate of growth of brokers’ loans is so much smaller now than it had been in the 1920s, when I think a good deal of the selling had come from long-term owners and really smart people who were selling out to the suckers.
Q: You’re correct in stating that there’s been no inflation in ’54, but there also appear to be several long-term inflationary points in the economy today. Deficit spending is supposed to be continued by the government, the easy money policy is expected to continue, the question of increased union wages, the talk about increased minimum wage, and the talk about a guaranteed wage. All these and, on top of this, the road program of $101 billion which the government just announced. These seem to me to be long-term inflationary things in the U.S. economy.
Brown: That question has a good many angles on it, so perhaps we both better try it. Professor Graham, why don’t you take the first crack?
Graham: Well, I think there are two answers to that in my mind. The first is that, acknowledging that there are inflationary elements in governmental policy as it’s now being carried out, it may be argued that those are just necessary to keep things on an even keel because, without them, we might have some in-built deflationary factors in the way business operates through increased productivity, capacity, and so forth.
Brown: I’ve been impressed with the possibility of labor costs as an inflationary factor, but a rise in wages does not necessarily mean a rise in labor costs. It depends upon the relationship of the rate of change in wages and the rate of change in output per man-hour or productivity.
If wages are related to productivity as, you know, they were in the General Motors contract, there is no necessary inflationary consequence to be anticipated. However, apart from that, it’s entirely possible that if wages go ahead faster than changes in productivity, they could be a seriously inflationary factor.
Q: On the basis of your recent answer with regard to the psychological impact of the present condition of the market on the small investor, do you discount the entire theory of dollar averaging?
Graham: I think there’s no doubt that, accepting your premise, the man who puts the same amount of money in the market year after year for the next twenty years, let’s say, has a great chance of coming out ahead regardless of when he begins and particularly regardless if he should begin now.
You have to allow for the human nature factor that no man can really say definitely just how he’s going to behave over the next ten to twenty years. There is danger that people [who] start with the idea of being systematic investors over the next ten to twenty years may change their attitude as the market fluctuates.
In the first instance, [they] put more money into the market because they become speculators; and, secondly, [they] get disgusted and scared and don’t buy at all later on when prices get low. It’s a psychological danger [for all investors] that fault [lies] not in the stars or in the system, but in ourselves.
A very wise man, a polymath who was offered multiple posts in a variety of departments at Columbia, he left active investment after achieving a modicum of wealth by modern standards. Like Jack Bogle he believed you should leave the game when you have "enough."
I completely agree with Graham: you need to have conviction, and yes, forecasts are a waste of time. But they make money for the industry because they sell 'peace of mind' and a 'less uncertain future.'