in concentric circles from pebbles falling into water. The source of these investment
pebbles is the United States. The dynamic force behind the rise of post-
World War II equity markets has been academic research coming out of U.S.
universities. The availability of cheap computer time, cheap graduate student
labor, and creative senior professors (six of whom have now received the Nobel
Prize in Economics) has contributed to the development of concepts like the
capital asset pricing model, the efficient market hypothesis, and performance
measurement, as well as the growth of derivatives markets.
Not every investment technique is appropriate at every place around the
world at the same time. Ideas radiate, interfere with one another, and produce
new patterns, then reach the periphery at the same time as new stimuli occur at
the origin. Technology and communications accelerate the speed of ideas radiating
outward until, finally, the impact reaches emerging markets. As the process
is repeated, it is accelerated further.
We can divide the investment world into three parts—the United States,
developed (ex-U.S.) markets, and emerging markets. Most U.S. institutional investors
have dedicated teams covering each of these segments. In some cases, they
have specialized teams within each team segmented by geography.
The investment world was reshaped immediately after World War II. In
fact, if we go back farther, we can gauge the present long-wave bull market from
the Battle of Midway in 1942. If we look at equity styles since then, we see that
there have been two major waves, each lasting one or two decades. And a third
may have begun.
1945–1970
Right after World War II, a widely anticipated global depression was expected—
a common occurrence after nearly every major world conflict. Surprisingly, in
the United States, a major interest in equities prompted the success of a handful
of companies that became known as the nifty fifty. These companies dominated
in managerial skills, product R&D [research and development], and financial resources.
Investors remained skeptical about economic progress throughout this
growth era, and markets faced the traditional wall of doubt, the trellis up which
green investment ivy must climb.
“Buy high, sell higher” dominated investment styles over this period. Supply
and demand for equities became the watchword more than underlying valuation.
To adapt a phrase from a quantum physicist, “there appeared to be an
underlying price spin tilted in the direction of the positive”—other things being
equal, something that had gone up would go up more. Another description
might be the economics of increasing returns. Eventually, the era ended with the
shock of 1967 and the subsequent decline of growth funds in the sharp market
downturn in the United States during the 1973–1974 period.
The developed (ex-U.S.) markets—essentially those of the advanced countries
that were the major protagonists in World War II, whether victor or vanquished—
during this period were dominated by international reconstruction
programs. The Marshall Plan in Europe and its counterpart under the administration
of General MacArthur in Japan and Asia led the way. These programs
were typically centered around infrastructure improvement and, with the exception
of the U.K., did not produce much in the way of private equity development
until the second half of the period, when government programs became
directly supportive of private development activities.
What we know now as emerging markets were, in the immediate post-
World War II period, dominated by programs for subsistence largely to stave off
famine and disease and to provide other necessities of basic living. At that time,
these nations were not worried about the development of market economies but
rather about how to eat and clothe and shelter themselves.
1970–1990
The post-World War II era and its corollary in other markets of the world ended
after a generation, almost simultaneously, with academic studies on efficient
markets achieving prominence in the United States. Firms capitalized on this
phase shift by introducing index products and popularizing valuation shifts and
new valuation techniques that are all price-related. As the dictum shifted to “buy
low, sell high,” it was characterized by the emergence of new investment folk heroes
like Warren Buffett. A few firms, Batterymarch among them, popularized
valuation techniques for institutional investors, giving voice to this newly
emerged market style in the United States.
In Europe and Asia, internationally dominant companies, which looked
very much like the nifty fifty, appeared popular for investing. Siemens, Hitachi,
Sony, Philips, Bayer, and their counterparts became components of more venturesome
U.S. institutional portfolios and appeared as the first equity holdings
of some of the more fixed-income-oriented institutional holdings outside the
United States.
And exactly the same pattern seen in the United States during 1945–1970
was repeated, except in different places, in different markets.
Development institutions then shifted their attention from the devastated
areas of World War II to the poorer countries suffering from population explosion.
In many cases, these were agrarian-based economies with little ability to
soften the shocks and cycles inherent in farming. These markets that had previously
been worrying about subsistence began to establish the basis for market
economies. Largely influenced by government programs, some of these countries
began developing market structures.
Since 1990
For the United States today, characterizing the investment style is somewhat
more speculative. In my view, the appropriate investment style is far more flexible,
eclectic, and quick—almost trading-oriented. These are the very skills that
large institutions find almost impossible to exploit for organizational reasons. Institutional
investors are organized around consultants and the need for extensive
documentation, preventing, almost completely, the flexibility that is demanded
to make money by today’s market responses to external shocks.
Today’s institutional investors are like the medieval troops standing in line
wearing bright uniforms, waiting to be slaughtered by the drably clad guerrillas
standing behind trees. Which would you prefer to be in today’s market climate:
a British Redcoat or a member of Ethan Allen’s Green Mountain Boys? We
know the outcome from the Revolutionary period and Vietnam and Tito’s Yugoslavia,
and I think we can predict the outcome for U.S. investment styles.
Value, the watchword of the U.S. market in the preceding twenty years,
has now shifted to Japan and Europe. Japan and Japanese investors characteristically
adopt the same investment style, all at the same time. In Europe, the development
is a bit slower because investors are maintaining a traditional
stock-picking investment practice. We do know, however, that the establishment
of quantitative research groups in almost all the major investment institutions—
and their attraction to indexing—clearly is an exact replication of earlier, successful
investment practices in the United States.
Again, several decades intervened, and the initial U.S. phase moved over
one step. Now, emerging markets reflect the nifty fifty period—or at least, they
did until the start of the Asian crisis in July 1997. Global enterprises can be
found in the most unlikely places and the investment goal is to find world-class
companies in unexpected places at unexpected prices. It is still possible: Those
enterprises that are strong in emerging markets tend to get stronger, because
management resources and externally provided finance tend to be in short supply
and limited in those markets.
Old growth stock managers from developed markets who see such companies
can feel instantly at home. They know what it was like, because they have
been there before. They have the opportunity to live a third professional life, seeing
the nifty fifty again, in a new market.
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