By Walter Updegrave
December 16, 2009

From MONEY Senior Editor Walter Updegrave:

The late Paul Samuelson, America’s first Nobel Laureate in economics, will rightly be remembered for the mathematical rigor he brought to his field and for helping turn the dismal science into one that — occasionally at least — can brighten people’s lives by helping shape public policy.

But I can tell you from first-hand experience that Samuelson, who died this Sunday at the age of 94, also had some interesting insights into investing and the stock market.

I interviewed Samuelson in 1999 for a MONEY article I was writing that questioned a number of investing “truths,” including the then unchallengeable notion that stocks are guaranteed to outperform bonds over the long term. Doing such a story was no easy feat in the late ’90s. This was a time when irrationally exuberant investors clutched copies of Jeremy Siegel’s Stocks For the Long Run and James Glassman’s Dow 36,000 with the same fervor that throngs of Chinese had once waved copies of Mao’s Little Red Book over their heads at party rallies.

So I thought I’d see what, if anything, The Great Man — then in his eighties, semi-retired and spending winters playing tennis in Florida — had to say about the stock frenzy that dominated the land.

I approached him with some trepidation. After all, this was the guy who wrote the book on economics, literally. Samuelson’s Economics has been used by generations of students, including moi, when I took Econ 101 back at the Wharton School in the early 1970s. Samuelson and Milton Friedman were rock stars to economics majors at the University of Pennsylvania. I thought that perhaps he would give me a few brusque comments and maybe repeat his famous quote about the unreliability of the stock market as a predictive tool (“The stock market has forecast nine of the last five recessions”). If I were lucky, perhaps I’d come away with a usable quote for my story.

In fact, he spent a good 40 minutes on the phone with me, dazzling me with both his intellect and his charm.

We got off to a rocky start, though, or at least I did. The professor began his tour of the investing landscape with technical references to Bernoulli utility functions, stationary probabilistic processes, Tobin’s Q and the logarithmic utility of wealth. My head was spinning, much like during my undergraduate days at Dietrich Hall.

But just when I began to worry that this conversation would do nothing except show me I desperately needed a refresher course in economics, Samuelson outlined the flaws in the “stocks will always overcome” ideology that was prevalent through the go-go 1990s.

He began by explaining that one measure of stocks’ invincibility — the oft-repeated claim in the late ’90s that stocks had outperformed bonds in all 168 30-year holding periods over the 180 or so years from the early 19th through the late 20th century — wasn’t as ironclad as it seemed. For one thing, since those 30-year periods overlap, they aren’t 168 separate cases of stocks beating bonds over 30-year spans. They really represent just six discrete instances — hardly enough data on which to base definitive conclusions.

But he made another even more telling point — namely, that the 180 years’ worth of returns that stock zealots in the last ’90s brandished as undisputable proof of superiority are all part of one experience, the history of the U.S. markets since 1800 or so. But there’s nothing to say that events couldn’t have unfolded differently, or that that they have to play out the same way with every run of 180 years.

Samuelson then suggested a little thought experiment: Write down stock returns for every minute or every hour or every day for the past 200 years on pieces of paper, put them into a big bowl or hat and mix thoroughly. “Now let’s draw out a new history of 200 years,” he continued. “And let’s do that so we have 20,000 different histories.” He noted that in most of these alternate histories, the probability increases that you’ll be ahead the longer you invest. “But with the same remorseless certainty,” he explained, “there will be some long periods when you will lose, and the longer the horizon the greater the amount of loss. But of course you don’t see these alternative runs of history.”

In short, he was cautioning against taking one experience, the one we know, and assuming that there’s a guarantee things must unfold the same way in the future.

As our conversation wound down, he mused about investment bubbles, noting that they can continue to inflate for a long time, but ultimately they’re unsustainable. The only question is how they’ll end.

That said, he also made it clear he wasn’t suggesting that people should just sell out of the stock market. “But you shouldn’t be in it for the wrong reason,” he told me, one big wrong reason being the belief that, no matter their selling price, stocks are somehow foreordained to outperform.

I’ve thought about that interview a number of times as the stock market has performed its gyrations over the past 10 years. And one observation in particular that Samuelson made to me then always seems to come back to mind. He said that he felt that much of what people spouted as investing truth during the ’90s boom was actually dogma. “You know what dogma is, don’t you?” he asked. “It’s a truth that’s so truthful it must not be questioned.”

Even at an advanced age Paul Samuelson didn’t hesitate to challenge reigning orthodoxies. Economists and investors alike would do well to follow his example.


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