Is Richard Sylla a Legendary Forecaster in Hiding?

What is the Future Outlook for the Stock Market?

If you are reading this, the odds are you read our recent CFTC that discussed the incredibly consistent pattern of returns in US equities over the last 220+ years. In that post, we showed that we are, once again, at one of those elevated points in the history of returns and valuations.

What we decided not to write in that post but will write about here is just how ridiculous the market is today. The sheer volume of securities being floated about as credible investments that lack much if any fundamental merit is simply staggering.

Bloomberg’s Matt Levine recently published a hilarious article discussing how he no longer writes about elevated price to earnings ratios or stock prices. Rather, financial institutions and markets have become captivated by “…bets on attention rather than underlying cash flows.”

Like Mr. Levine, we too believe the history of financial institutions will show regret over their newfound affinity for novelty items masquerading as investments. We have been documenting the folly of American capital markets for some time now. The Federal Reserve has made our Charts for the Curious page feel almost like a Wall of Shame recently.

The chart below is from a post by Richard Sylla in Prometheus. The wisdom it carries is free of charge on the website. The piece holds the information and writing that Sylla put together for a presentation on Venture Capital in New Media at the Columbia University Business School. In December 1999.

So the line in the poorly shaded green area showing the returns through 2009 was his FORECAST. Turns out he was spot on as the market returned -7.41% over the ensuing 10 years!

Steeped in humility, Sylla states “Economists do not have particularly good forecasting records, but in our defense I have to say we are better at forecasting what will happen than we are at predicting when it will happen.”^[1] His thinking behind such a brave forecast stemmed from common-sense sourced from the work he put into the chart above as well as a robust command of the history of manias.

Stock Return and Valuation: Common Sense

Sylla seemed hell-bent on humility. He put both his chart and what his take-aways from it were at the end of his 1999 paper.

I’d like to give the man his due for absolutely nailing a market forecast based on an epic amount of work he did to build the data underpinning it. So we are going to put his stunning work right up front here.

Look again at the graph above. Here was his thinking behind that forecast in three bullets^[2]:

• By 1999, 10 year real returns had hit levels in line with peaks observed over 200 years
• He noted that after prior periods of peak returns, the market would often go for a decade with no real return at all
• History repeats because human beings make the same mistakes again and again

We would emphasize that our update of Sylla’s work shows we are once again at an elevated period of 10 year returns and, once again, at a mind-numbing multiple of earnings.

But imagine a professor speaking to a bunch of New Media folks and telling them “not sure this is going to end well” in the heady haze of the dot.com bubble. We have no idea what that experience was like for the man^[3] but we imagine it was similar to how Buffett felt addressing newly minted Silicon Valley tycoons in 1999 in Sun Valley Idaho – a topic we revisited in our post Innovation vs. Value.

Unfortunately, nobody was listening to Professor Sylla or Warren Buffett in 2000.

Sylla to Shleifer to Buffett circa 1999

Our work has and continues to hammer home the idea that new technologies, like cleantech stocks, do not mean new or perpetually higher rates of returns for their creators. Sylla’s post in Prometheus is a testament to the value of not just numerical history but the general study of financial history. In his introduction, he writes about how the technological boom in the late 1990s is just another in a long line of breakthrough network technologies.

He makes a brief and brilliant review, starting in 1600, of how these breakthroughs in network efficiencies can lead to higher levels of financial development. Among his comments, he states “…in the early 20^th century, they again financed the spread of new network technologies of telephony, electricity distribution, radio and television, and – with the advent of the automobile – still grander road and highway networks.”^[4]

Sylla goes on to discuss how intertwined capital markets and innovation had become by 2000. His point being that as physical network technology was being increased via the explosion in internet usage, it was altering the speed and methods financial information was delivered. Specifically, “Once again we see the financial sector pouring capital resources into new technologies, while at the same time the new technologies are having a major impact on the way financial services are delivered.”^[5]

This is an economic historian’s polite way of explaining that there was a massive convergence between financial and non-financial network technology. The result was an explosion of inexperienced people receiving, communicating and acting on faster information flow. Think of the Robinhood IPO or Robinhood’s quarrel with Buffett.

He goes on to explain how, in such periods, individual and professional investors alike get “…carried away over the eventual economic-profit and financial-return prospects of the new technologies … The result … is that financial asset values first get bid up to unforeseen and previously unimaginable heights. As that is happening, the euphoria is rationalized and justified by purportedly great prospects and profit potential of new technologies.”^[6]

Sylla notes that these euphoric episodes inevitably collide with something that challenges the newly adopted status quo. Before bringing readers to a searing analysis of how 2000 looks and sounds an awful lot like the railroad bubble of the 1840s, Sylla notes (emphasis ours):

“Financial-market corrections arising from irrational exuberance over new network technological innovation often had more damaging effects of longer durations.”^[7]

The type of innovation that amplifies herding is something we discussed in our review of the first chapter in Andrei Shleifer’s book Inefficient Markets. Another piece published in 2000! We would note here, as we did in our post about Shleifer’s work, that their timing was incredible.

We posted a piece on Inflation Investing which leaned heavily on Buffett’s experiences in the 1969-1984 period to suggest that today looked an awful lot like 1969 to us. Note: emphasis on “awful.”

Let’s revisit the lesson Buffett was trying to convey back in Sun Valley in 1999 and see just how incredibly congruent these three legend’s views were. We will, once again, lean on Alice Schroder’s remarkable work, “Snowball” which documents Buffett’s life for our evidence:

Some people, [Buffett] said, were not thinking that the whole market would flourish. They just believed they could pick the winners from the rest. Swinging his arms like an orchestra conductor, [Buffett] succeeded in putting up another slide while explaining that, although innovation might lift the world out of poverty, people who invest in innovation historically have not been glad afterward.

‘[automobiles were] the most important invention, probably, of the first half of the twentieth century. It had an enormous impact on people’s lives. If you had seen at the time of the first cars how this country would develop in connection with autos, you would have said, ‘This is the place I must be.’ …. [but] autos had an enormous impact on America, but in the opposite direction on investors.’^[8] –Warren Buffett, Sun Valley, Idaho, 1999

To our readers, we ask you: what is different this time? Do you not see the painful historical resonance between today, 2007 and 2000? Do you not see that those prophesying to “pick the winners” are, based on history, likely picking the losers?