The Investment Gurus

First up: the legendary Roger W. Babson

As long as there have been stock markets, there have been people telling others how to invest in them. Most toil in obscurity. A tiny percentage become celebrities.

Some of these rare types, like Warren Buffett, owe their fame to demonstrated personal success in the markets. Others become superstars with a single call – usually warning of a crash.  On October 11, 1987, Elaine Garzarelli, a young-but-rising researcher at a Wall Street firm, said in a TV interview that a plunge was coming. Two days later she said her analysis of basic economic and market indicators suggested the Dow would lose as much as a fifth of its value. The market plummeted six days later and, almost literally overnight, Garzarelli became a superstar. The media doted on her. Investors and traders hung on her every word.

This sort of celebrity is understandable. After all, someone who foresees what everyone else misses must surely be so good she can do even better in less dramatic circumstances. But, funny thing, that’s seldom true.

Garzarelli is a case in point. After 1987, she continued to use the same analytical system that supposedly called the crash but the mutual fund she managed did poorly. In 1994, the fund was closed and Garzarelli's firm showed its former superstar the door.

But there is a third type of celebrity advisor. To me, they’re much more interesting than the other two.

They have theories. And systems. And complex charts. They often speak a baroque jargon riddled with terms they invented. They offer insights about markets, but their wisdom, they assure you, runs deeper than money. Their theories and systems and complex charts actually reveal fundamental, history-shaping forces at work in human affairs. Their thinking changes everything. They are full-on gurus.

This is the first of a series of posts about the history of market gurus and wacky ideas. I’ll tell these stories without a lot of commentary about why they’re relevant today. But they are so relevant. The same psychology that led people to be suckered by charlatans and cranks and silly ideas in the past is very much present today. (It’s the only way I can make sense of NFTs, for one thing. But maybe that’s just me.)

I very much doubt the history of people falling for pseudo-science and salesmanship will ever cease to be relevant.

Roger W. Babson

For Americans lucky enough to be heavily invested in the stock market, September 5, 1929, promised to be another glorious day. Stocks had been rising skyward for nine years but the previous year and a half had been especially stupendous. The value of AT&T shares had almost doubled. General Electric had more than doubled. Westinghouse had almost tripled. RCA had quintupled. Investors were giddy. Who wouldn’t want to dance the Charleston and get drunk on bathtub gin?

But there were a few, lonely grumps at the party. One of them gave a speech that morning in Massachusetts.

“Sooner or later,” warned Roger Babson, “a crash is coming, and it may be a terrific one.”

In the first decades of the 20th century, Babson had built a small empire by being among the first of a growing number of analysts to collect statistics for use in business. He had also promoted the then-novel idea that the various parts of the economy were interconnected, allowing the economy as a whole to be analyzed and forecast. This was part of a much broader shift toward empiricism and study. And for this, Babson has, and deserves, a respected, if modest, spot in the history books.

But Babson also built a second small empire telling investors what was coming and how to capitalize. His success here was not owed to personal success in investment. It was the product of Babson’s indisputable genius for self-promotion. With relentless campaigns of advertising and commentary, Babson ensured that anyone with money in the market was as familiar with the name Roger Babson as they were with Babe Ruth.

Investors could hardly ignore a dire warning from the famous Roger Babson, so when news of Babson’s speech reached Wall Street that afternoon, stocks plunged. The decline was brief, as bargain-hunters rushed in. The losses were erased entirely within two weeks. But the sell-off was sharp enough that the market gave it a name. It was the “Babson break.”

Little dramas like this play out daily in stock markets and the “Babson break” would have been forgotten as quickly as all the other ephemera if Roger Babson was merely famous. But he was also lucky.

In late September, the market slumped again, but this time it didn’t reverse. In October, the market wobbled. On October 24th, it went into full cardiac arrest. The great Wall Street Crash of 1929 was underway.

It’s hard to overstate how shocking the crash was. The vast majority of expert observers had been sure the jazz would play and the gin would pour long into the 1930s. Stocks have reached “what looks like a permanently high plateau,” the renowned economist Irving Fisher had declared several days before stocks plunged. An invasion from Mars could hardly have stunned investors more than the Great Crash.

Fisher’s declaration became instantly infamous following the crash and even today it can be found on any list of history’s worst predictions. But what is mostly forgotten is something everyone in 1929 knew: Irving Fisher’s speech and his declaration of confidence in the market was specifically directed at the gloomy prognosis of the Eeyore of Massachusetts, Roger Babson. So Fisher’s ignominy was Babson’s glory.

The crash was a catastrophe for everyone from great industrialists to stock brokers to the ordinary working people who never put a dime in stocks but would soon find themselves muttering the motto of the Great Depression, “buddy, can you spare a dime?” But not Roger W. Babson. The crash made him The Man Who Saw It Coming. He was a sage. A visionary. In November, 1929, when Babson wrote an article that blamed the carnage on (oddly) Congress, the New York Times ran it on the front page.

Nation called Babson “the lion among stock-market prognosticators.” The New Yorker called him “the prophet of doom.” Everyone wanted to hear from the great Roger Babson, and as the nation spiralled deeper into despair, Babson got very rich. In 1932, as bankruptcies cascaded through the economy, banks failed by the thousands, and unemployment approached 25 percent, Babson’s income was roughly $114,000 – or almost $2.4 million in today’s dollars.

When Babson died in 1967, at the age of 91, his estate – despite decades of lavish philanthropic spending – was worth $77 million in today’s money.

But then, you may think that’s not unreasonable. Babson did call the great crash of 1929, after all. Given the almost universal failure of others to see it coming, that was an enormous accomplishment. Surely it showed that Roger W. Babson had some truly profound insight that others lacked. Even today, Babson’s triumph is often cited as one of the most spectacular feats of forecasting in the history of the field.

But I have omitted a few salient details from this story. They are usually omitted when Babson’s big call is cited.

One is something that Babson was frank about all along. His prediction of a coming crash in September, 1929, wasn’t the first time he made that call. He said it the year before. And the year before that. And the year before that.

Now, remember that Babson said a crash was coming “sooner or later.” That is impressive only if you think the crash came the month after he made his call. That’s heavy on the “sooner.” But in reality, the crash came “later.” Much, much later.

And note that the “later” has no expiry date. The party could have continued for a decade or more but as long as a crash came, eventually, someday, Babson would have been right. It was classic, “heads, I win, tails, you flip again” language.

But let’s set aside such trivia and focus on Babson’s reasoning. Why did he think stocks would plunge? This is almost never mentioned when Babson’s triumph is cited. And that’s a shame because it’s the most interesting part.

For his entire adult life, Roger Babson loved Sir Isaac Newton. Crazy for him. When Babson got rich, he spent a small fortune buying original Newton manuscripts and anything else related to the man. He even bought a room in Newton’s house, had it dismantled, shipped across the Atlantic, and reassembled in Massachusetts.

Why the Newton-mania? Babson thought Newton’s Third Law was the universe’s secret decoder ring. The Third Law, as you may recall, is “for every action, there is an equal and opposite reaction.” When I sit on a chair, I exert downward force on the chair. That is an action. The chain exerts an equal and opposite upward force. And I am suspended in air. Physics.

Babson thought the Third Law could explain pretty much everything, including all of human affairs. Which naturally covers stock markets.

How Newton’s Third Law applies to stock markets is not immediately evident to most people, but Babson figured it out: Stocks rise, don’t they? That’s an action. Therefore, an equal and opposite reaction must occur. What goes up, must come down. It’s physics.

On this scientific basis, Babson developed an elaborate system in which he took charts of stock movements and drew a horizontal line through them. Do that and when the stock goes above the line and stays there for a while, then descends until it’s below the line, it will form a little mountain-like shape, with the line as its base. Babson shaded in that area. He did the same for periods when the stock went below the line. Then he adjusted the line so that the total shaded area above the line roughly equaled the total shaded area below the line.

With that, Babson knew the line revealed the stock’s norm. If the stock was trading above that, it must eventually decline -- and take an exactly offsetting trip below the line. It must. There’s no escaping it. This is physics, remember.

In his 1955 book about the great crash of 1929, John Kenneth Galbraith ridiculed Babson’s methods. “They involved a hocus-pocus of lines and areas on a chart. Intuition, and possibly even mysticism, played a part.” Anyone who looked with even a smidge of skepticism would draw a similar conclusion. But for the most part, people didn’t look at Babson’s methods. He called a crash when everyone else was calling for more good times. And there was a crash. That was all that mattered.

However flawed Babson’s methods may have been for forecasting, they were supremely effective in the marketing of Roger W. Babson. That’s because ordinary human psychology inclines people to take what has happened most recently and extend it into the future. If the market is soaring, it will soar. If it’s crashing, it will crash. This is a big reason why people rush into bubbles, making bigger bubbles, and run away after bubbles burst: Buy high, sell low, repeat. And experts aren’t much better. When markets are clearly moving strongly in one direction or the other, it is routine to find most experts calling for more of the same.

But Babson’s methods meant he was always taking the contrarian position. If you really want to attract attention – and Babson really wanted to attract attention – a contrarian call is always the right call.

There’s one more detail missing from stories about how Babson called the crash of 1929. What did he forecast after the crash?

In 1930, President Herbert Hoover and the business elite did their best to cheer up the markets. The worst is over, they said. A big rally is coming. You don’t want to miss out. Babson advised his followers to steer clear. The markets hadn’t been down long enough, or deep enough, to counterbalance the up years of the 1920s.

There was indeed a rally that year but it was followed by further steep declines. Babson was right again!

But in May, 1931, Roger W. Babson, the lion among stock-market prognosticators, consulted his charts, shaded in the ups and downs, and drew an earth-shaking conclusion: The down finally matched the up.

The ghost of Sir Isaac Newton smiled.

Babson urged his enormous following to get back into stocks and published a book entitled Cheer Up! Better Times Ahead! In 1932, the unofficial campaign song of Franklin Roosevelt was Happy Days Are Here Again.Babson was sure that about to become a statement of fact.

As it turned out, happy days were not here again. The Great Depression lasted the remainder of the decade -- longer than the Roaring Twenties -- and it wasn’t until 1954 that the Dow Jones Index got back to where it was in September, 1929. That’s a violation of the laws of physics, one might say. But it happened.

An investor who followed Roger Babson’s advice in the 1920s would have missed almost all the boom of that decade. An investor who followed Babson’s advice in the 1930s would have borne much of the brunt of that decade’s long stagnation. And yet the failure of Babson to replicate his one famous prediction -- or even to not be catastrophically wrong -- seemed to do little damage to his reputation. Hundreds of newspapers continued to run his weekly column on investing and audiences remained eager customers for Babson’s thoughts. Even in the depths of the depression his businesses did well. In 1936, Babson’s personal income hit $190,000 – or $3.8 million in today’s dollars.

In 1940, Babson ran for the presidency as the candidate of the National Prohibition Party, arguing that alcohol prohibition was a swell policy and should be given another chance. He lost.

He later used his enormous wealth to found Babson College and the Gravity Research Foundation. The latter was an extension of Babson’s Newton-mania – recall the famous apple – and Babson charged it with discovering how the gravitational pull of the sun and the moon influence human behaviour, and other such weighty matters. He was particularly intrigued by the possibilities of perpetual motion machines and anti-gravity substances that would allow people and objects to hover and fly.  The legendary science writer Martin Gardner called the foundation “perhaps the most useless scientific project of the 20th century.”

Not all Babson’s charitable endeavours were for nought. To help unemployed stonecutters during the Depression, Babson hired them to carve words of wisdom into boulders in a forest near his hometown. To this day, hikers wandering the forest are greeted with such inspirational thoughts as “be on time,” “keep out of debt,” “study,” “be clean,” and “help mother.”

I shall resist making a Jordan Peterson joke here and conclude thusly: That is solid advice.