Martin a decade of delusions; from speculative contagion to the great recession (2011)

ffirs.indd ii 4/1/11 8:14:46 AM A Decade of Delusions ffirs.indd i 4/1/11 8:14:45 AM ffirs.indd ii 4/1/11 8:14:46 AM A Decade of Delusions From Speculative Contagion to the Great Recession Frank K Martin John Wiley & Sons, Inc ffirs.indd iii 4/1/11 8:14:46 AM Copyright © 2011 by Frank K Martin All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada 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, (978) 750-8400, fax (978) 646-8600, 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, (201) 748-6011, fax (201) 748-6008, or online at http://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 (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002 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: Martin, Frank K A decade of delusions : from speculative contagion to the great recession / Frank K Martin p cm Includes index ISBN 978-1-118-00456-2 (cloth); ISBN 978-1-118-07814-3 (ebk); ISBN 978-1-118-07815-0 (ebk); ISBN 978-1-118-07816-7 (ebk) Investments—United States Finance—United States—History— 21st century Financial crises—United States Speculation—United States I Title HG4910.M349 2011 332.60973 — dc22 2011004110 Printed in the United States of America 10 ffirs.indd iv 4/1/11 8:14:46 AM May the few who profit from this book be mindful of the many who cannot ffirs.indd v 4/1/11 8:14:46 AM ffirs.indd vi 4/1/11 8:14:46 AM Contents Foreword Preface Chapter Chapter xi xvii Lead Us Not into Temptation May Reason Prevail Patience and Persistence The Dean of Wall Street Revisited The Investor’s Dilemma It’s a Numbers Game The Supremacy of Earnings “Stealth Compensation” Conclusion 12 19 20 22 36 42 Techno Babble, Techno Bubble 43 A Tale of Two Markets Back to the Future? Warren Buffett on the Stock Market Is the Internet the Answer? What’s a Long-Term Investor to Do? Investment Redefined 45 53 58 65 68 69 vii toc.indd vii 4/1/11 12:51:18 PM viii Chapter Chapter Chapter Chapter Chapter toc.indd viii contents “Pop!!”.com 75 Risk: No Longer an Afterthought Investment Strategy: Is It Time for Technology? Is There a Snowball Rolling Our Way, Gathering Mass and Speed? The Art/Science of Managing Risk Baby Boomers: Whither Goest Thou? The Internet and IPO Frenzy Fool’s Gold Goliaths Slain 76 83 87 88 99 100 101 102 Swimming against the Current 113 Prelude to Our Investment “Strategy” Interest Rates: It Had Better Be Uphill from Here The Power of Popular Delusions The Mind of Crowds Investment Consultants: The Great Middleman Myth 116 127 131 139 142 The “Greenspan Put” Again 145 Investment Strategy The Reckoning Sober in the Morning Micro versus Macro The Margin-of-Safety Paradox Waiting Patiently for Those Hanging Curves 146 149 151 151 153 154 Only Fools Rush In 159 The Rogues Gallery, 2003 Vintage Making Progress in the Post-Bubble Environment How Did We Get Here in the First Place? The Apogee of the Mutual-Fund Boom The Great Abdication of Fiduciary Responsibility: The Defined-Contribution Plan Where the Buck Really Stops 160 164 171 181 Expanding Concern: A Bigger Bubble? 197 Maybe the Markets Are Not Random? A Short History of Financial Euphoria Fully Deluded Earnings: Penance (?) in the Cuff-Links Cooler Run for the Roses: Of Pawns, Guinea Pigs and “Retail Investors” 200 218 188 192 222 231 4/1/11 12:51:18 PM bepil.indd 436 4/1/11 7:59:19 AM Index 1987 market correction, 47, 56, 134, 291, 357 1998 –2004 summary, 253 –268 2000 –2009 investment performance, 409 – 412 2000 –2010 overview, 407– 409 401(k)s, 173, 181, 188 –192, 308, 331 See also Retirement plans 9/11, 65, 125, 152 Abelson, Alan, 73, 94 –95, 185 Above-average bias, 258 Accountability, 430 Accounting, role of, 25 –27 Acquisition reserves, 31–33 Adjustable rate mortgage (ARM), 294, 296 –298 Aftermath characteristics of financial crises, 399 – 400 Against the Gods: The Remarkable Story of Risk (Bernstein), 57, 221, 310 Agency dilemma, 430 Airline industry, 63 – 65 Amazon.com, 23 –24, 72, 82, 98 American Association of Retired Persons (AARP), 151 Amplification mechanisms, 174 –175 Analysis of individual businesses, 17–19 Analytical vs intuitive thinking, 416 – 418 Anchoring, 176, 258 Annual reports: 1998, 1– 42 1999, 43 –74 2000, 75 –112 2001, 113 –144 437 bindex.indd 437 4/1/11 5:39:17 PM 438 index Annual reports (Continued ) 2002, 145 –158 2003, 159 –196 2004, 197–252 2005, 269 –337 2007, 362 –380 2008, 382 – 403 2009, 404 – 425 Arrow, Kenneth, 136, 315 Arthur Andersen, 160 Art of Thinking, The (Dimnet), 198 Asset-backed securities (ABSs), 384 Asset classifications, 352 –353 AT&T, 29 –30 Atlas Shrugged (Rand), 195, 238 Austrian business-cycle theory, 397 Auto industry, 62 Availability bias, 117, 131, 153 Babson, Roger, 219, 366 Baby Boomers, 99 –100, 179 Bailouts, 170, 284 Bank consolidations/earnings, 320 –322 Bank of America, 299 Barnes, Martin, 129 Baruch, Bernard, 13, 132 Base-rate neglect, 259 Beane, Billy, 210, 249 Bear Stearns, 344, 345 Behavioral economics, 174 –177, 306, 311 Beresford, Dennis, 38 Berkshire Hathaway, 42, 58, 68, 193 B shares issuance, 54 –55 cash holdings, 243 –246 effects of 9/11 on, 152 Bernanke, Ben, 282, 286 –292, 297 bindex.indd 438 Bernoulli, Daniel, 311–312 Bernstein, Peter, 57, 221, 250, 310, 325 –327, 400 – 403 Beta, 88, 123 Bezos, Jeff, 72 Biases in reasoning, 258 –259 “Big bath” charge, 29 “Black Monday” crash of 1987, 47, 56, 134, 291, 357 Black Swan: The Impact of the Highly Improbable (Taleb), 377 Boards of directors ethics, 192 –195 Bond-interest coupon, 10 –11 Bond prices, –12 Bond quality, 11 Bonds See also Fixed-income securities corporate, 129 purpose of, 93 Treasuries, 48 –50, 129 valuation of, vs stocks, 98 yields, 118 –119, 128 –130 Bonhoeffer, Dietrich, 364 Bookstaber, Richard, 371 Book value, 22 Boom-and-bust market cycles, 19 –20 Boston Chicken, 73 –74 Bridgewater Associates, 98 Budget deficit, 287 Buffett, Warren, –3, 42, 44, 151 See also Berkshire Hathaway on bond investing, 244 –245 on cash holdings, 243 –246 and corporate integrity, 195 on derivatives, 313, 375 –376 on fear, 247 investing philosophy, 66 – 68, 156 –157, 201–206, 251 4/1/11 5:39:17 PM Index on investing principles, 268 on investor behavior, 116 –121 limits to abilities, 57–58 on market behavior, 57 patience of, 244 portfolio allocations, 166 on remediation, 368 and risk avoidance, 340 –342 and risk management, 51, 122 –126 search for successor, 340, 351, 364 –365 and secular cycles, 200, 351 views on stock market, 58 – 61 Bull! A History of the Boom, 1982 –1999 (Maher), 208 Business of Economics, The (Kay), 268 Business risk, 89, 91 Capital Cities/ABC, 33 Capital gains, vs dividends, 15 –16 Capitalism, 329 –332, 334 Capitalism, Socialism, and Democracy (Schumpeter), 65 Cash holding, justification of, 240 –243 Cendant, 34 –35 Central Bank intervention, 358 –360 Chesterton, Gilbert, 199 Chevron USA, 136 China, 278 Cisco, 72 Citigroup, 39, 370 Clayton Homes, 193 CNBC, 73, 129, 148, 149, 179 Coca-Cola, 5, 6, 22 –24, 72, 208 Collateralized mortgage obligation (CMO), 385 bindex.indd 439 439 Collins, Jim, 390 Common stocks See also Stock price histories; Stocks declines in 2000, 96 –97 valuation of, 169 –171, 398 – 400 Common Stocks as Long Term Investments (Smith), 16, 118 Compensation of executives, 36 – 42, 402 Compounding, 378, 409 Consultants, 142 –144 Consumer Price Index (CPI), 179 Consumer spending, 396 Core earnings, 226 –231 Cornfeld, Bernie, 185, 235 Corporate bonds, 129 Corporate integrity, 192 –195 Counterparty risk, 375 –379 Credit-default swaps (CDS), 371–379 Credit risk escalation, 293 Credit spreads chart, 358 Crisis aftermath characteristics, 399 – 400 Crisis recovery, 388 –389, 394 –397 Crowd, The (Le Bon, Gustave), 132, 137, 235 Crowd psychology, 132 –138, 235, 358 Currency trading, 109 Current-account deficit, 206 Cyclical vs secular trends, 351 Day trading, 70 –71, 73, 173, 180 Debt, impact on economic system behavior, 354 –355 Debt structures and limits, 353 –355 Debt-to-GDP ratio, 275, 276 –277 4/1/11 5:39:17 PM 440 index Debt vs equity, 48 –50 Deep Survival: Who Lives, Who Dies, and Why (Gonzales), 390 Defaults, 94 –95 Defined-benefit plans, 189 Defined-contribution plans, 188 –192 Deindividualization, 138 Dell Computer, 72 Delusions, and investor behavior, 131–138 gold, 135 Internet/technology stocks, 136 –137 oil, 136 takeovers, 137, 141 Demon of Our Own Design— Markets, Hedge Funds, and the Perils of Financial Innovation (Bookstaber), 343 Derivatives, 215 –216, 313, 369 –370 See also Options Buffett on, 375 –376 classification of, 353 collateralized mortgage obligation (CMO), 385 credit-default swaps (CDS), 371–379 mortgage-backed security (MBS), 276, 373 Deutsche Bank, 376 Distribution of wealth, 303 –304 Diversification, 164 –165, 266 –267 Dividends, vs capital gains, 15 –16 Dot-com start-ups, 101 Double counting, 275 Dow 100,000: Fact or Fiction (Kadlec), 147 bindex.indd 440 Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market (Glassman and Hassett), 147 Dow 40,000: Strategies for Profiting from the Greatest Bull Market in History (Elias), 147 Druckenmiller, Stanley, 109 –112 Dugan, John C., 282, 292 –294, 299 Duration, 10 –11 Earnings, 22 –36 acquisition reserves, 31–33 adjustments to, 226 –231 ceteris paribus, 28 effect of stock buybacks on, 41 estimating, 224 –225 fully deluded, 222 –231 purchase acquisition accounting, 33 –36 restructuring charges, 27–31 revenue recognition, 36 role of accounting, 25 –27 S&P 500 “core” earnings, 226 –231 shortfalls in, 48 Earnings growth, 231 Earnings management, 27, 160, 167–168 Earnings power, 22 Ebbers, Bernie, 160 Economic multiplier, 277 Economic resiliency, 291 Economic stimulus package, 395 Efficient-market hypothesis, 265 Efficient-market thesis, 176 –177 Eisenberg, Mike, 187 EMC, 89 –90 4/1/11 5:39:18 PM Index Emotions, role in investing, 391–393 Employment Retirement Income Security Act of 1974 (ERISA), 181 Enron, 161, 193 Epidemics, 175 –176 Equity-risk premium, 171 Equity vs debt, 48 –50 Essays on Freedom and Power (Acton), 194 Ethics, of boards of directors, 192 –195 Executive compensation, 36 – 42, 402 Expected returns, 122, 170 –171 Extraordinary Popular Delusions and the Madness of Crowds (Mackay), 132, 231 Faber, Marc, 84 – 85, 211–212, 221, 278, 328 –329 Falls from grace, 102 –112 Fannie Mae, 214, 286, 309, 312 FASB See Financial Accounting Standards Board (FASB) Fear, effects of, 391–393 Federal debt, 229 Federal Reserve: effects of rate cut, 358 –360 motives for rate cut, 355 –361 rate cut, 349 Fidelity Investments, 188 Financial Accounting Standards Board (FASB), 35, 37–38, 40, 223 Financial economy, 212 –213, 221, 330 –331, 335 bindex.indd 441 441 Financial euphoria, historical overview, 218 –222 Financial innovation, 333 Financial-instability hypothesis (FIH), 354, 355 Financial risk, 89, 91 Financial services sector, 319 –321, 322 Fink, Matthew P., 183 –184, 185 –186 Fisher, Irving, 366 Fixed-income securities, –12, 82 – 83, 93 –96, 128 –130 See also Bonds Focus, 264 Fooled by Randomness— The Hidden Role of Chance in Life and in the Markets (Taleb), 201, 377 Ford, 62 – 63, 64 Foreign investors, 50, 278 Foreign stocks, declines in 2000, 97 Forward earnings, 225 Frankl, Viktor, 271 Freddie Mac, 160, 286, 309 Free markets, 254 –257 Fully deluded earnings, 222 –231 GAAP See Generally accepted accounting principles (GAAP) Galbraith, John Kenneth, 218 –220, 255, 270 Gambling, 173, 248 –249, 313 Gates, Bill, 37 General Electric, 18 Generally accepted accounting principles (GAAP), 25 –26 General Motors, 62 – 63, 103, 104, 190 –191 4/1/11 5:39:18 PM 442 index Genetic technologies, 178 Giannini, Amadeo, 300 Gibbon, Edward, 12, 13 Gillette, – 6, 22 –24, 208 Glassman, James K., 147–148 Glass-Steagall Act, 280, 285, 384 Glisan, Ben, 161 Global savings glut, 292 Goldfarb, Bob, 202 Goldman Sachs, 344, 376, 386 Gold Rush mentality, 20 –22 Gold speculation, 135 Gold standard, 337 Gonzales, Laurence, 390 Good to Great (Collins), 390 Goodwill amortization, 35, 226 Goodwill-impairment charge, 226, 228 –230 Goodwin, Doris Kearns, 286 Google, 23, 24, 63, 64 Government debt, 400 Graham, Benjamin, 3, 44 on analysis of businesses, 17–19 on boom-and-bust market cycles, 19 –20 on Gold Rush mentality, 20 –22 on investor behavior, 69 –70 on market crash of 1929, 153 and new-era hypothesis, 15 –17 quoted, 57 and risk management, 51 on security analysis, 13 –15 Grant, Jim, 222 –223, 268, 274, 359 Grasso, Dick, 161 Great Bubble, 72, 169, 171–181 Great Crash, 1929, The (Galbraith), 218 bindex.indd 442 Great Depression, 298 events leading up to, 332 –333, 366 risk aversion from, 388, 402 Great Recession, 382 Greenspan, Alan, 27, 153, 170, 288 –292 on credit markets, 283 –284 on current-account deficit, 206 and housing Bubble, 297 interest rate cuts, 204 –205 on “irrational exuberance,” 56 –57 reasons for rate cut, 356 on risk, 279 –280 Gross domestic product (GDP), 116 ratio of total debt to, 275 relationship to stock prices, 60 total stock market value to, 120 Growth vs value investing, 46 – 48 Harned, David Bailey, 209 Hassett, Kevin A., 147–148 Hayek, Friedrich, 397 Hedge funds, 377–378 Amaranth, 357 Long-Term Capital Management, 106, 107, 312, 345, 357 Soros Fund Management, 109 –112 Tiger Management, 103 –108 Herd instinct, 174 –175 Heuristics, 258 –259, 315 High-risk mortgage products, 294 –295 High Tech/High Touch (Naisbitt), 178 Hindsight bias, 176 History, learning from, 130 –131 4/1/11 5:39:18 PM Index History of Interest Rates, A (Sylla and Homer), 128 Home equity, 78, 307–308 Home prices, 290, 301–306, 370 Housing Bubble, 300 –310, 324, 408 Housing market, 214 –215, 300 –306 See also Home prices; Housing Bubble Hurdle rates, 245 IBM, 31–32 Illusory correlation, 20 Industrial sector, 321–322 Inflation decline, 173 Inflation Rates and Bond Yields chart, 274 Information cascades, 175 –176 Initial public offerings (IPOs), 73 –74, 101 Insider selling, 100 Institutional investors, 331, 431 Insuring portfolios, 126 Interest-only products (IOs), 294 Interest rates, 127–130, 173 effect on housing market, 295, 297–298 relationship to stock prices, 273 Interest Rates, the Markets, and the New Financial World (Kaufman), 285 International funds, 100 Internet: early availability of, 172 effects on brokerage industry, 71 novelty of, 177 online trading, 174 Internet stocks, 65 – 67, 100 –101 See also Technology stocks bindex.indd 443 443 Intuitive vs analytical thinking, 416 – 418 Investing, patience in, 154 –155 Investing focus, 264 Investing for growth vs value, 46 – 48 Investing restraint, benefits of, 151 Investment Advisers Act (1940), 280 Investment Company Act (1940), 181, 280 Investment Company Institute (ICI), 182 Investment consultants, 142 –144 Investment vs savings, 401 Investor behavior, 69 –70, 116 –121, 131–138 See also Behavioral economics; Crowd psychology Investors, foreign, 50 IPOs (initial public offerings), 73 –74 “Irrational exuberance,” 56, 147–149, 171–181 Irrational Exuberance (Shiller), 133, 171–176, 300 –301 Janus Capital Group, 108 –109 Japan, 288, 305 JP Morgan Chase, 376, 377 Junk bonds, 82, 94 –95, 141, 374 –375, 433 Kaufman, Henry, 285 Kay, John, 268 Kellogg, 30 –31 Keynes, John Maynard, 118, 119, 147, 148, 315, 329, 354 Klarman, Seth, 327–329 Kohn, Donald, 355, 357–358 Kozlowski, Dennis, 162 4/1/11 5:39:18 PM 444 index Law of compensation, 431– 432 Laws, 280, 286, 331 Lay, Ken, 161 Leavitt, Arthur, 27 Le Bon, Gustave, 132, 137–138, 140, 235 Legg Mason Value Trust, 411 Lehman Brothers, 344 Lending standards, 293 –294 Leuthold, Steve, 100 Leverage, 307, 359 Lewis, Michael, 210, 223 Lincoln, Abraham, 286 Liquidity preference, 434 Longleaf Partners, 410 Long-Term Capital Management (LTCM), 106, 107, 312, 345, 357 Long-term investing, 68 – 69, 71, 415 Lotteries, 173, 248 –249 Mackay, Charles, 132 –133, 231 Macroeconomic market analysis, 165 Macro policy, 203 –205 Madoff, Bernard, 387 Man’s Search for Meaning (Frankl), 271 Marginal buyer, 303 Margin of safety, 51, 80, 91 See also Risk Market Cap versus GNP chart, 213, 273 Market crash of 1929, 13 –15, 20 –22, 153, 366 Market cyclicality, 53 –54 Market value to GNP/GDP, 273, 334 Markowitz, Harry, 265, 266 bindex.indd 444 Martin, William McChesney, 336 Martin Capital Management (MCM): investment performance history, 404 – 405 vs S&P 500, 406 Materialism, 172, 178 Mathematics of patience, 244 –247 Mathematics of valuation, 155 –157 McColl, Hugh, 301 MCI Communications, 32 –33 Means mindset, 272 Media, 179 Merrill Lynch, 345, 370 Microsoft, 37, 72, 85 – 86, 96 Micro vs macro, 151–152 Middlemen, 142 –144 Milken, Michael, 141, 218, 221, 433 Miller, Bill, 411 Minsky, Hyman, 329 –332 “Minsky moment,” 349, 353 Mistakes, learning from, 428 – 429 Modern portfolio theory (MPT), 44, 79 – 80, 88 – 89, 120, 164, 264 –266 Moneyball (Lewis), 210, 223 Money-manager capitalism, 330 –331 Money market funds, 99 –100 Montier, James, 391, 392 Moody’s, 385 Moral hazard, 430 Moral Man and Immoral Society (Niebuhr), 131 Morgan Stanley, 187, 376, 386 Mortgage-backed security (MBS), 276, 373 Mortgage loans, 275 –276 4/1/11 5:39:18 PM Index Mortgage products: adjustable-rate mortgages (ARMs), 296 –298 mortgage-backed security (MBS), 276, 373 piggyback mortgages, 294 reduced-documentation mortgage, 294 –295 Munger, Charlie, 120, 144, 247, 300, 346 Mutual funds, 72, 107–108, 181–188 cash flows into equities, 239 changes in distribution of, 184 –185 fees, 187 and financial cycles, 239 industry misconduct, 185 –188 margin of safety, 238 owner demographics, 183 –184 regulation of, 186 –187 and retail investors, 233 and retirement plans, 181–183 Naisbitt, John, 178 Nasdaq Bubble, 171–181 See also Technology Bubble Nasdaq composite index: 2000 crash of, 77, 78 proper valuation of, 84 – 85 National debt, 396 Net debt outstanding, 214 New-era hypothesis, 15 –17 New-era principles, 268 New York Stock Exchange Member Firms Customers’ Margin Debt, 307 Nixon, Richard, 336 Noland, Doug, 283 –286, 335 bindex.indd 445 445 Nominal interest rate declines, 173 Nonrecurring charges, 27–31 North American Securities Administrators Association (NASAA), 73 Northern Rock, 359 NorthPoint Communications Group, 95 –96 Norwitz, Steve, 100 Oil prices, 11–12 Oil speculation, 136 Olstein, Robert, 26 –27 Opportunity recognition, 124 –125 Opportunity sets, 259 –260 Optimistic bias, 258 Option issuance expensing, 228 Options: allotment of, 286 as portfolio insurance, 126 for risk management, 342 –348 use, as compensation, 36 – 40 Options expense, 226, 228 Other people’s money (OPM), 385 Overconfidence bias, 176 Palm (Pilot), 104, 105, 209 Pascal, Blaise, 125, 158, 169, 279 Pascal’s Wager, 169, 279, 289 Pass-through securities, 276 Patience: How We Wait Upon the World (Harned), 209 Patience in investing, 209, 244 –247, 263 –264 Paulson, Henry, 378, 386, 394 –395 Paulson, John, 378 –379 Payment-option ARMs, 294 Pension-expense adjustments, 228 4/1/11 5:39:19 PM 446 index Pension funds/plans, 173, 181, 188 –192, 235, 236 –237 See also 401(k)s; Retirement plans P/E (price/earnings) ratios, 224 –225, 321, 417– 420 Permanent loss of capital, Piggyback mortgages, 294 Political economy phenomenon, 333 Ponzi, Carlos “Charles,” 73 –74 Ponzi schemes, 73 –74, 174 –175 Pooling, 33 –36 Portfolio allocations, 240 –243 Portfolio concentration, 267 Portfolio insurance, 126 Portfolio price volatility, 164 Present value model, 155 –157 Priceline.com, 88 – 89, 104 Price/earnings (P/E) ratios, 224 –225, 321, 417– 420 Price uptrends, 290 Pricing risk, 351 Probability theory, 262 Profit margins, 231 Psychology See Behavioral economics Puchalla, John, 94 Purchase acquisition accounting, 33 –36 Purchased goodwill, 34 Put options, 342 –348 Quality of Earnings Report (Olstein), 27 Quants, The (Patterson), 347 Raines, Frank, 215 Rand, Ayn, 238, 371 Ratings agencies, 385 bindex.indd 446 Rationality, 257–259 Real economy, 212 –213, 221, 335 Real estate crisis See Housing Bubble Real estate market, historical perspective, 301 Rearview-mirror investing, 119, 152, 190, 323 Recovery from crises, 388 –389, 394 –397 Redistribution, 78 Reduced-documentation mortgage, 294 –295 Reed, John, 39 Regression to the mean, 261–263 Regulation, 280 Regulation Q, 288 Reinhart, Carmen, 428, 430 Reported earnings, 225, 230 Residential mortgages, 294 Restructuring charges, 27–31 Retail investors, 231–235 Retiree concerns, 150 –151 Retirement plans, 173, 181–183 See also Pension funds/plans defined-benefit plan, 189 defined-contribution plans/ 401(k)s, 188 –192 Revenue recognition, 36 Reverse wealth effect, 15 Reversion to the mean, 57 Revsine, Lawrence, 25 –26 Risk See also Margin of safety and common stocks, 171 counterparty, 375 –379 decoupling of, 387–388 defined, 88 and diversification, 266 –267 and fear, 391–392 4/1/11 5:39:19 PM Index and Internet stocks, 100 –101 and IPOs, 101 and mortgage loans, 384 price volatility as measure of, 92 respect for, 433 – 434 and securitizations, 386 vs uncertainty, 354 Risk aversion, 298, 328, 388, 400 – 403, 413 Risk avoidance, 340 –342 Risk layering, 295 Risk management, 50 –53, 76 – 83, 122 –126 art and science of, 88 –98 beta, 88 mathematically based, 310 –315 trade-offs, 414 – 415 use of options for, 342 –348 Risk/return relationship, 260 –261, 388 Risks/rewards, 248 Risk tolerance, 95 –96 Robber barons, 163 Robertson, Julian, Jr., 47– 48, 102 –108, 111 Roditi, Nicholas, 111 Rogoff, Ken, 428, 430 Ruane, Bill, 201 Rukeyser, Louis, 223 S&P 500: as benchmark, 224 core earnings, 226 –231 core earnings adjustments, 320 earnings, 317–323 earnings overview, 166 –169 historical charts, 167 sector breakdown, 318 bindex.indd 447 447 Salomon Brothers, 385 Sarbanes-Oxley Act of 2002, 280 Savings vs investment, 401 Schiller, Johann von, 137 Schumpeter, Joseph, 65, 329, 333 Secular cycles, 200 –201, 212, 222, 279 Secular trends, vs cycles, 351 Securities Act (1933), 280 Securities & Exchange Act (1934), 280 Securities & Exchange Commission (SEC), 186 –187 Securitizations, 285, 331, 369, 384 –386, 396 Security Analysis (Graham and Dodd), 13 –14, 69, 102, 153 Security analysts, 27 September 11, 2001, 65, 125, 152 Sequoia, 410 Shareholder equity, 22 Sheehan, Fred, Jr., 335 Shiller, Robert, 171–176, 300 –301, 305 Shiller’s “Graham” 10-year moving average price/earnings ratio, 417– 420 Short History of Financial Euphoria, A (Galbraith), 255, 270 Short-term investing, 72 See also Day trading Siegel, Jeremy, 52, 148 Significant information, recognizing, 364 –365 Skilling, Jeffrey, 161 Smith, Adam, 314 Smith, Edgar Lawrence, 118 “Snowball effect,” 394 –397 4/1/11 5:39:19 PM 448 index Social Security, 192, 229 Solutions, pragmatic vs philosophical, 432 – 433 Soros, George, 109 –112 Soros Fund Management, 109 –112 Southwest Airlines, 65 Sovereign Investment Vehicles, 370 Speculative Bubble of the 1920s, 118 –119, 132 See also Stock market crash of 1929 Standard & Poor’s, 385 Standard Oil of Indiana, 136 Stealth compensation, 36 – 42, 237 Steinhardt, Michael, 110 Stewart, Martha, 160, 315 –316 Stock buybacks, 40 – 42 Stockdale Paradox, 389 –390, 393 Stock for payment, 101 Stock market Bubble, 301–309 See also Technology bubble Stock market crash of 1929, 13 –15, 20 –22, 153, 366 Stock options See Options Stock price histories: Amazon.com, 23 Bear Stearns, 343 Citigroup, 39 Coca-Cola, EMC, 90 Ford, 64 General Electric, 18 General Motors, 63 Gillette, Goldman Sachs, 344 Google, 24, 64 IBM, 32 Janus Capital Group, 108 Lehman Brothers, 344 bindex.indd 448 Merrill Lynch, 345 Microsoft, 37 Nasdaq composite index, 66 Nikkei 225, 97 Priceline.com, 89 Walt Disney, 33 WorldCom, 32 Yahoo!, 23 Stock prices, and interest rates, 274 Stocks: performance, vs bonds, 48 –50 valuation of, vs bonds, 98 yields, vs bonds, 118 –119 Stocks for the Long Term (Siegel), 16 Stout, Mike, 276, 313 Structured products, 369 –370, 384 Stumpf, John, 368 Subprime mortgage crisis, 369 –370, 422 See also Housing Bubble; Mortgage products Success, Frankl on, 271 Superinvestor Digest (Klarman), 328 Sutton, Willie, 223 Swartz, Mark, 162 Sylla, Richard, 128 Taleb, Nassim, 201–202, 377 Taxes, 52 corporate tax breaks, 228 –229 and stock repurchase plans, 41 tax-law changes, 331 Tax-exempt security certificates, 127 Team of Rivals— The Political Genius of Abraham Lincoln, 286 Technology Bubble, 324, 408 and Janus Capital Group, 108, 109 and Soros Fund Management, 109 –112 4/1/11 5:39:20 PM Index Technology stocks: 1999 growth, 45 – 46 2000 crash of, 76 – 83 assessing future value of, 83 – 87 Telecommunications industry, 324 This Time Is Different: Eight Centuries of Financial Folly (Rogoff and Reinhart), 428 Thrift paradox, 396, 423 Tiger Management, 103 –108 Total Credit Market Debt chart, 213, 273 Total debt to GDP, 273, 334 –335 Trade deficit, 287 Trading volume, 173 –174, 180 Transportation industry, 63 – 65 Treasury bonds, 48 –50, 82, 127, 129 Trump, Donald, 315 –316 Tulip mania, 72 Twain, Mark, and investing, 52 –53 Tyco, 162 Unemployment, 399 Unisys, 103 United Airlines, 139 –140 US Airways, 103, 104 U.S current-account deficit, 206 Valuation, 153 –155 mathematics of, 155 –157 Shiller’s “Graham” 10-year moving average price/earnings ratio, 417– 420 bindex.indd 449 449 Valuation risk, 89, 91 Value investing, 46 – 48, 411– 412 Vanguard Group, 188 Verizon, 95 –96 Volatility, 164, 407 Wall Street: compensation of executives, 402 as crisis epicenter, 349, 352 –360, 385 Walmart, 72, 278 Walt Disney, 33 Warburg, Paul, 219 Warsh, Kevin, 356 Wealth-to-income ratio, 290 Welling, Kate, 371, 391 Where the Money Was (Sutton), 223 Willful ignorance, 236 –237, 295 Wilshire 5000, 207, 214, 275, 335 Wolf, Martin, 399 WorldCom, 160 and R&D write-offs, 32 –33 stock price history, 32 Y2K, 76 Yahoo!, 23 –24, 72 Yardeni, Ed, 129 Yield curve, 10 Zero coupon bonds, 10 –11 Zweig, Jason, 391–392 4/1/11 5:39:20 PM bindex.indd 450 4/1/11 5:39:20 PM ... He was as pleased as I to have his artwork bring smiles to the faces of readers of a book that sought to treat the subject at hand as more than just the dismal science as it is often characterized... data, in the spring of 2000 By the late fall of 2002, approximately $8 trillion of illusory, inflated value—roughly half of which can be attributed to the savaging of stocks making up the Nasdaq... bulwark of the original The 1998 through 2004 Martin Capital Management annual reports are largely intact Most additions to the original text are bracketed; a modest number of changes to the