Financial History's Biggest Lessons and How Past Crashes Can Guide Your Investing with Mark Higgins (EP.204)

0:28We all need to make smart decisions with our money. of Investing in U.S. Financial History, a book that I'm going to link to in the show notes at thelongterminvestor.com because it won all sorts of awards in 2024. And it makes sense because he has such great insights into how past market crises as well as investor behaviors consistently repeat themselves, which offers a lot of valuable lessons for anyone looking to build a resilient portfolio. So our conversation touches a whole wide range of issues like how historical crashes and market panics can shape investor psychology. We explore how political and inflationary pressures influence markets today.

1:10And we really try to focus on some of the timeless strategies for making informed investment decisions and when history is helpful with that and when it isn't. But before we can dive into this fascinating discussion, if you're looking to gain clarity around your own financial future, I'd encourage you to visit callwithpeter.com, schedule a call with me. It'll give you the opportunity to learn more about how my team at PlanCorp can help you design a personalized strategy that aligns with your goals, values, and priorities. Now, here is my conversation with Mark Higgins. Welcome to The Long-Term Investor.

1:50I am your host, Peter Lazaroff. And today, I'm joined by Mark Higgins, author of the book, Investing in US Financial History. Mark, thank you so much for joining the show today. Thank you for having me on, Peter. I'm excited. If you all are watching us on YouTube or on Cheddar, be sure to subscribe. You can go to thelongterminvestor.com. If you're in your podcast app, just go ahead and subscribe anywhere you are. That way, when you're listening to the podcast version, you are the first to hear people like Mark's insights. And Mark's book is unbelievably thorough. I think just level set. Maybe you can share with us why you feel like it's so important for investors to study financial history, particularly the US's financial history.

2:33Well, the US has gone through, first of all, just focusing on the US. It's just gone through a lot of cycles and it's the biggest economy now and the biggest capital market. So that was the reason to focus on the US and why it's valuable elsewhere. And then secondly, and this is the thing that never ceases to amaze me, is human behavior does not evolve and change that fast. Technology does, but human behavior and evolution is very, very slow. And people make the same mistakes over and over and over again, especially in financial markets. And when you think about it, if you're an advisor or you're an investor, you develop wisdom with time but you don't have to wait you can literally read books absorb the memories of other people that nobody else remembers and be prepared and avoid making the same mistakes and take opportunities that a lot of people don't exist and having gone through this process it never ceases to amaze me how few people take advantage of that and instead just try to rely on their life experience and develop wisdom as they age that's the short answer it's a little long, but that's the short answer.

3:39I think that's great. And because I felt like one of the key takeaways of the book is that financial history repeats itself, you also seem to highlight it repeats itself, but never exactly in the same way. So how do you feel like investors should think about regime changes in markets? And how do you even distinguish between a short-term correction in the beginning of a new regime? That's very hard in the moment. But the bigger thing, if you look at the media, you would think there's a regime change happening every week. And at the end of the day, the big changes don't occur that often. And the way I wrote the book is there's really six parts over a little over 230 years.

4:21And I would define the parts by major regime change. Usually a war or some type of natural event is usually what it is. And they last on an average 40 years. A lot of people think in terms of market cycles is five or 10 years. Maybe the little cycles are five and 10 years, but the big ones are not. But you never know until time passes. Now, I would argue now we actually are in a transition. And we can talk about what that is. But most people will talk about Trump as being the disruptor, and he is. But underneath the surface, my belief is that the U.S. is finally coming to terms with spending beyond its means, overextending itself internationally.

5:00And it's finally coming to terms with the chronic fiscal deficits, the mounting debt that can't be sustained underneath the surfaces driving it. That's not, I am apolitical, I just observe. But to me, we are at an inflection point with respect to that trend. And that is the current underneath a lot of what we're seeing right now. Honing in the word inflection point doesn't mean it has to be bad. Does that mean, in your opinion, it just means we're getting to the place where we have to do something? Yeah, and they're very disruptive periods. They're very contentious. I would argue the last one, part six of the book starts after the great inflation is tamed in 1982.

5:41And if you look at the 60s and 70s, people forget this. There was a lot of civil unrest. There was a pretty ugly war in Vietnam. There was the worst inflationary period in history from 1965 to 1982. So they are very contentious periods. Clearly, this is not an exception. It's funny, as you say, people forget about the 60s. And I think if you reflect on the average age of a market participant today, that person wasn't alive in the 60s. And if they were, they weren't investing. And I think this kind of plays back to your earlier point of history repeating itself, maybe just not exactly the same way because of all the different combinations that can happen in a global economy, in a global market.

6:25Is that right? Yeah. And this is where it pays to go really far back in time because COVID was a perfect example. It's what prompted writing this book that you have to figure out what pattern is repeating. And it's not all usually in the same time period. So the initial panic, World War I came out of nowhere. And you saw the the same panic during the July 1914, when World War I just kind of appeared and the whole world shut down. The New York Stock Exchange actually shut down for four and a half months. So that was like the initial panic of COVID in March 2020. But then you have to fast forward to after COVID ended, the inflation looked a lot like the 1919 to 1920 inflation after the Spanish flu ended and World War I ended simultaneously and for a lot of the same reasons.

7:11And then after inflation was persisting, wasn't transitory, was persisting too long. The Fed's aggressive response looked a lot like 1919 and 1920. But in my opinion, they bailed out too quick. And this was a mistake that was made in the late 1960s and early 1970s, when the Fed got too tentative in terms of tightening monetary policy to extinguish inflation. And that's what allowed inflation to last. So you got to be able to rewind and pattern match to different time periods. And you can have three or four year span where they're almost 100 years apart in terms of where you're drawing your lessons from.

7:50Do you feel like there can be lessons learned from both how past administrations and central banks have influenced the financial markets? Yeah. And the big mistakes in the Federal Reserve's history, which is roughly 110 years, were failing to backstop the banking system in the early 1930s and their massive thousands bank failures. It would be as if the Federal Reserve didn't intervene in 2007 to 2009. Then secondly, the great inflation. And what's concerning now is, and you actually just saw an announcement the past couple of days is there is political pressure on the Fed to ease rates with Jerome Powell being called too late.

8:30That's accurate in terms of the initial phase of COVID inflation, but it's actually the opposite in the late phase. In my very strong opinion, they should have kept policy tighter for longer. And there's real risk here that we could repeat the error of the great inflation. I mean, inflation has been running at elevated levels for roughly four years. And this is the kind of thing where once inflation expectations start rising and it starts affecting behavior and how people are projecting prices, how companies are setting pricing policy, that's a big problem. And then when you throw the inflationary flames, you fan the inflationary flames with tariffs.

9:07Now, that's short term. It's really a change in price, but people aren't going to know the difference. And that could be a problem. You know, one thing that strikes me is obviously there's a lot of political uncertainty now, and that impacts things like Fed policy. It impacts things like how corporations invest or don't in their businesses or hire or don't in their businesses. But having studied so many different time periods yourself, do you feel like the market's reaction to political uncertainty has changed over time? My gut is not as much as people think that we have had very contentious political situations in the past that people don't remember.

9:45I actually just posted something on LinkedIn today on political bullying of the Fed. It's not new. I mean, this was both Nixon and Johnson did it actually did a lot worse than at least right now, did it worse than what Trump's doing. Andrew Jackson killed the second bank of the United States, which was the second central bank of the United States. Congress renewed the charter in 1832 and he vetoed it. And yet he's on the$20 bill. To his credit, he also almost eliminated of the federal debt. So, you know, he wasn't, he did some good things too, but getting rid of the central bank was not good. It was a big factor in the panic of 1837, which led to the depression in the 1840.

10:23Most people don't realize the federal government has never defaulted on the debt. Eight states did and the territory, Florida was a territory at the time. So long story short, we have seen very contentious times. People think I'm naive, but I do think we will get through this. This is actually typical of an inflection type point. That doesn't mean it's going to be painless. And we can already see that today. But I do think we'll get through this. Well, for whatever it's worth, I feel like you are the opposite of naive. You've already said one thing where I'm like, oh, man, I wish more people knew that.

10:54Or I didn't know that. I think, again, the study of history is so important. And something, though, that I will hear from time to time from people when you quote historical data or even anecdotal narrative driven parts of history to try to share a lesson or try to instill good behavior. The thing that always comes out of people's mouths are, yeah, but this time is different. I mean, what do you say to that? Yeah, it's usually not. You know, the one thing I will say that can be legitimate in that regard is the way I wrote this book, and I didn't intend to do this. It just kind of happened. When COVID hit, I wanted to go back in time to see if there's any precedent.

11:32And I just started reading financial history. And I originally only went back like 50 years. And every time I would read something, I'd be like, well, I have to understand this in order to understand what I'm reading now. And I kept going back in time and back in time and time. I actually went before 1790. But I decided if I was going to write a book on the financial history of the United States, 1790 was the right place to start with Alexander Hamilton programs, his financial programs that repaired the credit of the United States. and then I just read literally for three and a half years just slowly read myself to the present and I noticed as I was doing that that a lot of people you know journalists definitely politicians they're very lazy with history they have a narrative and they'll cherry pick something from the past to support that narrative and it's not relevant I do understand that frustration when people say you know it's different this time because a lot of times it is because they're cherry picking the wrong time period for analysis.

12:27But if you pick the right pattern, based on a deep knowledge of how things transpired, it's usually not different. I don't know if that answers the question. No, that's fascinating. I absolutely love it. And, you know, investing as a whole, I feel like even in my relatively short career, so I'm not quite at 20 years in the profession, but getting close to it. And I think of just the amount of change I've seen there, but there are some constants. I would like to sort of test some of my beliefs against your study, specifically with the role of stocks. Do you feel like the role of stocks has evolved at all in investor portfolios over the past century?

13:05Well, I mean, it definitely has. And this really started with legislation in 1933 and 1934. It's funny, if you go back to the 1800s, it was a circus in markets. Market manipulation was legal, Insider trading was legal. And it was just a circus. And literally, two of the more prominent, they were called stock operators back then in the late 1800s, were Daniel Drew and Jim Fisk. And they're manipulators, they're clowns. And they literally came from a circus. Both of them learned a lot of their little tricks, literally working in a circus, in a traveling circus. So it was really crazy. Then 1933 and 1934 outlawed that and required a lot of disclosure.

13:47And after that, stock investing became safer, perceived as safer. And then in the 1960s, I write about this in the book, Merrill Lynch is the one that really brought stocks to Main Street. So they have evolved in terms of the breadth of people who have investments in stocks. And it has evolved in terms of the safety of investing in stocks, given regulation. But I think the biggest change today is less on the stock front and more on the alternative investments front. I work more with institutional investors and large individuals as well. But that has really expanded its reach in a way that, you know, I don't know if we want to go down this rabbit hole, but in a way that is really damaging, in my opinion.

14:33Sure. I mean, tell me more. I certainly see that myself. Tell me more about what it is that you're seeing that's different. it. Essentially, I wrote an article recently for the Museum of American Finance called A 45-Year Flood, The History of Alternative Asset Classes. And there are a couple of big inflection points, but the biggest one was when David Swenson, who was a very successful chief investment officer at the Yale Investments Office, which had tremendous performance since he joined in 1985, but especially in his first 15 years. And he wrote this book called Pioneering Portfolio Management and outlined what he did.

15:08And a lot of what he did now, he was successful at alternative investing, not just accessing it, you know, venture capital and buyout funds and hedge funds. But people interpreted the book as, well, if I just allocate to these asset classes, I'm going to get Yale-like returns, or maybe not entirely Yale-like returns, but better returns. It hasn't worked. And the evidence is really starting to pile up now, particularly over the last 10 years, that this is adding a lot of fees to portfolios. It's adding a lot of unnecessary complexity to portfolios and people don't seem to be catching on yet. Well, it's easier to sell, which is part of my opinion of why it's become so popular is that it's easier for Wall Street to sell to advisors and easier for advisors to sell to individuals.

15:52And it's really interesting. And I've had episodes on this in the past, and we even do a little bit of it with a certain subset of institutional or ultra high net worth individuals. And my feeling on it is always that if it were free, I'd be very excited for it. But it's not free. It's very expensive. And then after that, there's lots of shades of gray. Bigger picture, step back. As I was reading through your book, there's a number of big themes. And I'm hoping maybe I can tease them out with some pretty high level, broad questions. We've already talked and you, I think, even opened with how investor behavior hasn't really changed much in the last hundred years.

16:33What's one behavioral trap that you think is most dangerous today? And how has it shown up historically? It's herd behavior. I mean, it is just endless. There's a great quote that I always use. And I recently, during the editorial board of the Museum of American Finance, and it's the CEO, David Cowan's favorite quote, he always tells me. It's from J. Pierpont Morgan, who, you know, J.P. Morgan, the founder of J.P. Morgan, actually not really the founder, but the one who really made the name for J.P. Morgan. Nothing so undermines your financial judgment as the sight of your neighbor getting rich.

17:07And it is a curse that goes back as far as you can go in terms of researching financial history, whether it was the Mississippi bubble in France and then the South Sea bubble because they were copying the Mississippi bubble because they thought everyone was getting rich in France. It's just something you repeat over and over and over. And human behavior is to maybe it's because, you know, people saw a watering hole or something like that. It made sense. There's plenty of water. So you follow the person who found it. But the opposite is true in investing. If you follow and invest in something after it's had a long run, the odds are you're going to get it on the top.

17:41Not always, but the odds are you're going to get it on the top and then it's going to decline and you're going to sell and do exactly the opposite of what you're supposed to. And if there's one universal thing that I see, it's that is it's succumbing to herd behavior. That certainly sticks out to me when I'm reading about financial history. And it's easy for me to flash back to moments in my own career where I'm like, yeah, that's what it was like when this happened or that happened. And what's so interesting is it always seems like it's predicated on some sort of technological advancement or this idea that the world is different now.

18:14And as a result, it's like a paradigm shift. And as a result, you have to do this. And I think what's hard, at least in my experience, watching people want to get into an asset that's going to the moon, as they say. There can be good ideas and there are facts. People are using facts a lot of times, but they're not always relevant facts. And the price you pay does seem to matter quite a bit. Now, I'm kind of curious, a lot of bubbles end in market crisis, thinking big picture on some of your learnings. What do you think is a historical market crisis that is most misunderstood by today's investors?

18:49The Great Depression. Well, there are a couple, but what I didn't appreciate when I was studying the Great Depression is how much it caused World War II. I definitely do not think World War II would have happened if not for the Great Depression. And there are a couple of misconceptions. One, that the Great Crash caused it. It didn't really. It was, I mean, it was a trigger, but the Great Depression could have been managed had the Fed not allowed the banking system to implode. And that's why people were so scared in 2007 and 2009. But what people don't realize is how dangerous depressions are. People behave very differently when assets are scarce.

19:23The cost of the Great Depression was the Nazi party was almost gone. Hitler was on his last legs in the late 1920s. The depression just wiped out wealth in Germany. There's a lot of resentment from the Treaty of Versailles, and it really fueled the reemergence of the Nazi party. But it was actually more impactful in Japan. Japan is naturally short on natural resources. So when the depression just decimated their economy and the trade wars were actually very impactful in Japan, too, they needed natural resources. They're starving and they attacked Manchuria. They attacked China. Eventually, they swept into Southeast Asia.

20:00The United States cut off their oil and they attacked Pearl Harbor. So there's a misunderstanding of the cause of the Great Depression linking it to the stock market crash. But I think more importantly, people don't understand how deadly the Great Depression was because of its role. And in my opinion, World War II would not have happened if not for the Depression. That's fascinating. And I'm curious, based on your research, you think of all the different experiences investors have had and had to live through. Granted, I haven't lived through the full history, but us as a collective species have lived through this history.

20:36What do you see as being the single most important change an investor could make today to improve their odds of long-term success, given what we as a humanity have experienced thus far? There are two things. If I had to choose one, it would probably be understanding your return objectives and your risk tolerance and defining risk tolerance by what are you going to do when the market goes down 50 %? Because at some point it will, maybe even more. And by the way, the newspapers don't look very good when the market goes down 50%. There's a reason it's going down 50%. So really getting that and sticking to it.

21:13So if you're 60 % equities and the market drops 30%, don't freak out and sell the remaining equity position or lower the remaining equity position. That's a recipe if you're a disaster. And then secondly, is don't use active managers. I'm a huge proponent, and it's not based, you know, I'm at index fund advisors, because I found a place that matched my philosophy, not I'm at index fund advisors, therefore I'm promoting index funds. And the thing I've learned is markets are just ruthlessly efficient. I mean, can people beat them? Yes. But it is very, very difficult. It's a small number of people that can do it.

21:53And unless you are really on the border of insanity in terms of your obsession, and you're probably not going to beat the market, whether you're an institution or an individual too, by the way, I think it applies equally to institutions. It's just the market's going to, it's ruthless and it's going to get you eventually. I couldn't agree with you more. I think a lot of people, particularly individual investors, whether they're managing their money themselves or using an advisor, they can say out loud that they believe that you can't beat the market, but then they do things or want to do things that are exactly that.

22:26So for example, for the past 15 years, I can't tell you how many people have wanted to reduce their international exposure and increase their US exposure. Well, that's an example of trying to beat the market. Now, this comes to mind because today, for the first time in over a decade, I got an email with somebody wanting to increase their international exposure. I go, oh my God, it's finally happening. I'm like, no, no. But for the same reason that you can't change the one making changes is trying to beat the market. And I feel bad. You know, I know we have clients who listen to this podcast. I have family friends.

22:59The common line I hear is, I'm not a market timer, but... And dot, dot, dot. Don't you think this, that, and the other. It's funny. If we're to use historical insights to build a portfolio from scratch, I think you hit the nail on the head. You're going to try to avoid active management in your fund selection and in your actual management yourself of the portfolio. Don't you think? Yeah. Yeah. And the analogy I use, have you ever seen that movie Heat? I don't think I have. With Robert De Niro and Al Pacino. So it's this movie about Robert De Niro has this gang of, you know, they do high-end burglaries of banks, millions of dollars.

23:33And there's a scene, Al Pacino's just this obsessed detective just trying to get him. And they actually do some research on Al Pacino. And John Voight, who plays a friend of Robert De Niro, is talking to him about this bank heist that's going to be huge and telling him, This guy's too crazy. He's going to get you. You should pass on this one. De Niro decides to do it. And during the conversation, Voight just says, this guy can swing and miss. You can't miss once. And that's really what active management is. Al Pacino is the market. It has all the time on its side. It's just going to nail you once and you have to be perfect.

24:11And if you're not perfect, it's going to get you. And if it doesn't get you this year, it'll get you next year. If you somehow outlast it for 30 years, it's going to get your heirs or the next investment committee member that's going to come in. It will get you eventually. And that's the way I look at it. So you mentioned at some point in the book that history is a guide, not a prophecy. How do you feel like investors misuse historical data? Are there traps that you can avoid from overfitting the data or being too confident in these historical comparisons? We talked about that a little. I think there's a lot of cherry picking.

24:44The McKinley tariffs are a great example of that, where people, it's not so much anymore, but we're justifying the aggressive tariff policy of the Trump administration by comparing to McKinley. I actually wrote about that period, and I never mentioned the tariffs for two reasons. One, for really the first 110, 120 years, tariffs were the main way that the federal government would raise money. There was no income tax. So it was very different back then. And then two, they were already at relatively high level, just increased them a bit more. And more importantly, it just didn't play a role in that time period, 1896 to 1906.

25:22It was an amazing period in US financial history. It was called the American Commercial Invasion. But what essentially happened is the United States had been working for 50 years on perfecting precision manufacturing and mass manufacturing, whereas Europe was more custom manufacturing. You had huge discoveries of natural resources. You had a railroad infrastructure built out to get everything to market. And that is really what caused the huge trade surpluses at the turn of the 20th century. Tariffs had very little to do with it. So that's a great example of people using something that it's just not relevant.

25:58We're recording this a few weeks before this is going to air, but I have to think tariffs are going to remain in the news for quite some time. I mean, is there any other financial history that you think you can draw some guidance for? I try to stay out of the political realm. Me too. You're just being a historian here. Well, I don't comment on anything other than policies that I think are material and I can offer something in terms of the lesson. And the tariffs actually concern me a lot if they go for a long time. They concern me, period. And the reason is, you know, there's an old saying, I got this from Jim Grant.