When History Teaches the Wrong Lesson


Mr. Shenkman is the editor of HNN.

Note: This article was published last October.

In a conversation last week with my stockbroker, he made the point that I shouldn't be worried about the market's decline. The market will bounce back, he insisted, as it always has. A few days later I received from a friend a chart forwarded by a pension planner that illustrated how the market had responded to crises in the past half century. After each crisis there was a dip followed by an even greater rise. The chart was supposed to reassure people in my friend's company that they should keep socking away money in their IRAs.

What my broker and the pension planner were doing, whether they knew it or not, was playing historian. We all do this, even if we hated history in school. As Carl Becker famously wrote years ago, everyman is his own historian. Put most simply, we use the history we have personally experienced to help guide our decisions. Or, like the pension planner, we put great faith in a chart that somebody else has prepared if it reinforces the lessons life has taught us. The lesson life obviously taught the pension planner, who probably was at his desk during the Crash of 1987, was that markets recover quickly.

The trouble with playing historian is that it's not a game for amateurs. When people rely on their own experience in drawing lessons about the past their base of information is incomplete. It's as if they use as a resource in writing a paper a set of the Encyclopedia Britannica that includes only volumes one and two. They may find in those volumes some of the information they need, but probably not everything they need. And because they never have the chance to look through the other volumes they don't know what they don't know. And what they do learn from volumes one and two is only what an encyclopedia includes. So they miss the nuances, the stuff of history that makes life so complicated.

So what am I saying? I am saying to investors that history is complicated and may not go as you think it will based on what you yourself have experienced. Maybe you should think like an investor who had lived through the Crash of 1929. Or it may be the case that the history that is relevant this time around isn't even American history at all. Maybe it's Japanese history. Maybe what you need to have experienced was the steady year by year decline in the Japanese stock market that has left stock prices half of what they were a decade ago.

Playing historian it turns out is not for sissies. It's a treacherous game. An investor who plays the game badly could end up dead broke. And yet amazingly few people seem to realize this. Thinking history is simple to master they draw a couple of easy conclusions and then wager their family fortunes on them, as if they were playing with Monopoly money, not real money.

History is not irrelevant just because the lessons it teaches are unclear. There's plenty to be learned from the past. One thing I've learned from studying the crash of 1929 is that investors who have benefited for years from a boom have a hard time believing the boom is over. Six months after the worst crash in history investors delighted in small signs that the boom was back and plunged into the market. As Frederick Lewis Allen was to report,"speculators, big and little, convinced that what had caught them was no more than a downturn in the business cycle, that the bottom had been passed, and that the prosperity band wagon was getting under way again, leaped in to recoup their losses. ... a Little Bull Market was under way." By the Spring it slowly became clear that investors had been misled by their own giddy optimism."A new day was not dawning," wrote Allen."This light in the economic skies was only the afterglow of the old one." By summer the market was lower than it was Black Tuesday. By then people had stopped believing President Hoover, who along with so many others had been caught up in the Little Bull Market. Prosperity was not just around the corner.

Studies show that human beings do not like change. One of the changes they like least--and find hardest to understand--is a switch in their fortunes, particularly when the switch is adverse. Thus, a person who has experienced good times will find it much harder to accept the onset of bad times than the other way around. A person used to bad times always has hope. A person who has enjoyed good times has to give up hope (at least in the near term), which is very disagreeable.

So history does indeed have a few lessons to offer. But if you're thinking of playing historian, beware. A lot of people who have came to regret it.

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Patricia Thompson - 3/7/2002

I'm sure researchers have noted it was a combination of national events, international events, and psychosocial phenomena that effected the political and economic crash of each of those markets. Yet, each different from the other by evolutionary changes, changes that occur because people learn from their mistakes, though sometimes slowly.
I say a new 'animal' will emerge from the challenges of the day. Wealth, eventually, will be defined differently than what hoarders wish or even from those manipulaters of false riches want. History considered as a whole, and not just in isolated perspectives, shows empires rise and fall. We've got to look at greed for what it is and move beyond the limited restraints of materialism. A 'want' based trading system built on lies, thievery and murder will burst from its own avarice. . . then again maybe that's the idea.