What can the best investment books teach us about today's markets?

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In this special Brunner Book Club episode of Connected Investor, portfolio managers James Ashworth and Julian Bishop discuss the books that have shaped their investment thinking, exploring market history, investor psychology and the power of compounding.

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Julian Bishop (JB): I think reading is a very important way of being grounded in common sense, being an expert in your field, avoiding groupthink and getting away from the noise.

James Ashworth (JA): The very effect of making money on a stock or on a tulip is that it buys up their intelligence. Just because you make money on something, you feel you’re right. People stop thinking critically and they follow the herd, they follow the masses. Everybody wants to get rich.

 

JB: Hello and welcome to Connected Investor from the Brunner Investment Trust. I'm Julian Bishop.

JA: And I'm James Ashworth.

JB: Now we spend a lot of time talking about markets, companies, economics.

JA: But some of the most useful insights come from reading about history, psychology or technology.

JB: That's right. So in this episode we're going to do something slightly different. We're going to talk about what we've been reading and how it shapes the way we think about investing.

JA: Perhaps we could even call this the Brunner Book Club. So maybe to start, Julian, would you like to talk a little bit about what you've been reading recently?

JB: Okay. So a couple of really fun tomes. First of all, a book called Recession by an economist called Tyler Goodspeed: The Real Reasons Economies Shrink and What to Do About It. And then secondly, it's a book called 1929 by Andrew Ross Sorkin.

JA: Oh, yeah, that's the recently published.

JB: Pretty recent. The Inside Story of the Greatest Crash in Wall Street History, and it is not, I would say, a particularly great book, but it's a good reminder of the euphoria that can precede stock market crashes and economic depressions. Now, interestingly, one of the conclusions of the book Recession is that there is no real way to predict a recession. There's no set period of time before an economic expansion comes to a halt, and there are no obvious, consistent or clear catalysts. There are a few patterns, though. I would say there are a few examples, such as wars.

JA: Okay.

JB: Not good. Energy shocks. Not good.

JA: So exogenous factors really.

JB: Sometimes exogenous factors. They can be fairly random, like a single bank failure creating a problem in the financial system. There's the example given, actually, in the run-up to the Great Depression. One of the causal factors was locusts. Locust plagues literally decimated agricultural crops in the Midwest.

JA: I had not heard that before. That's an interesting theory.

JB: That is an interesting theory, apparently. I didn't know this either. A locust is merely a gregarious grasshopper.

JA: Okay. Very outgoing.

JB: Yeah, very outgoing grasshopper. And they don't apparently exist anymore in North America for some reason. Not quite sure why. But the interesting thing about all of this is how quickly optimism and euphoria can shift to pessimism and despair. And that's typically what induces a recession. Some interesting things about 1929. First of all, people see it as being the end of the Roaring Twenties. Now, that expression in itself, the Roaring Twenties, did not exist in the 1920s. This was something that was used in retrospect, and most of the time people didn't feel that it was euphoric.

JA: Okay.

JB: I think that's an interesting Idea. There are obviously some parallels with today. It was a time of optimism around new technologies.

JA: Radio at that point, I guess in automobiles.

JB: So at the time, those would have been two dominant things driving stock markets, certainly. But there was also a lot of retail participation in markets. So, it was beyond the remit of professional investors. There were a lot of people punting without really understanding what they were doing, what dividends were, what companies were, what financials were, etc.

JA: With the famous story of, I think it was John Pierpont Morgan getting the stock trading tip from his shoeshine boy, and I guess that was, for him, the sign that maybe this had become a mass-market phenomenon when the shoeshine boy is giving you stock tips.

JB: And I think at that point, I'm not sure it was J.P. Morgan. I think it was somebody else. But at that point they decided it was probably time to get their money out of the markets. So I suppose the interesting bit is that history rhymes. There's been these sorts of repetitive manias throughout history that typically result at some point in a downturn, and that whilst the technology has changed, the times have changed, the presidents have changed. The human emotion doesn't. So humans are prone to greed and euphoria.

JA: Absolutely.

JB: Then fear and panic on the other side of the coin. And these are obviously very innately human conditions. So, what are you reading?

JA: Well, it's interesting. It's not the first time you've mentioned you were reading 1929. So actually, after you mentioned you were reading that, I went back and reread the classic book about the Great Depression. So this is John Kenneth Galbraith's The Great Crash, 1929, originally written, I think, in the 50s and updated a few times since.

JB: Okay.

JA: Which is a really good discussion of some of the background factors to why we had such a big stock market boom, and why the overhang afterwards and the Great Depression were quite so severe. There are many things that are different today, right? Galbraith calls out the fact that there was no lender of last resort. So when one bank failed, it had a domino effect.

JA: Monetary policy was hamstrung by trying to ensure that America remained on the gold standard. So, there wasn't the ability to flex interest rates that we would now see in a macroeconomic time of stress. And equally, on the fiscal policy side, to do with government spending and taxes, it was a tenet of faith that the balanced budget was sacrosanct. So as you went into this Great Depression and as tax revenues began to decline, the government didn't step up, it didn't increase spending. And a lot of what we now call Keynesian spending way. The government retrenched. And so you ended up with this vicious cycle of tight money, government that's not spending, withdrawing capital from the market. Bank failures continuing a domino effect. So I think it's always useful to remember how bad 1929 was, but also how much has changed since in terms of how we run the economy. So I think that was interesting.
And you made the point about how sudden these changes in mood are, how the narrative can shift really quickly. Another book I read from the same author, actually. I really like reading this. I always read it every couple of years, which is A Short History of Financial Euphoria by Galbraith. It's a really short book. It's only about 100 pages. He goes through lots of past bubbles. He goes, the classic ones: tulip mania, the South Sea Bubble, the John Law system in France, 1929. And he looks at common factors and he explicitly calls out at the end of the bubble, it always ends suddenly, and it's never really clear exactly what the catalyst has been. There will always be lots of investigations afterwards trying to work out just what it was that caused the crash. But he argues that's really not the important thing.
The important thing is effectively that everybody who could be a buyer has bought into the market. There's no more buyers. Then something... it doesn't really matter what causes that change in belief, that change in sentiment, that change in narrative. And suddenly everyone, everyone rushes for the exit. To give you the quote, talking about the crash: "This crash never comes gently. It's always accompanied by a desperate and largely unsuccessful effort to get out."

JB: Right.

JA: I think that's exactly how it feels. And as you go through like a 1929-type crash. We say in financial markets: escalator up, elevator down. Stocks go up slowly. But when they fall, they fall precipitously. And I guess that's one thing that maybe that book covered, but certainly the Galbraith book also covers.

JB: Yeah. I mean, we mentioned the sort of human element of greed, fear, euphoria, panic. But I mean, you use the word narrative, which is a posh word for story, I guess. And we are storytelling animals. I think most of these financial euphorias begin with an element of truth.

JA: Absolutely. It's always that nugget that really sets off the story. And maybe in the 1920s, it was technological change. It was the invention of radio. It was the rollout of Ford Motor vehicles very widely. There was a sense that, technology was changing and life was dramatically improving.

JB: Yeah. And then again, the dot-com bubble. Perhaps more recently with AI. Time will tell. But there's always that sort of nugget of truth to what is changing, a sense of unbridled optimism and one that often ignores economic realities. And I always think, as an investor, it's very important just to be aware of the basics of capitalism.

JB: So, for example, the need to generate cash, the laws of competition, etc. Even when demand is going up, when something is growing, competition is incredibly effective at limiting your ability to create profits.

JA: Yeah. One thing that was very interesting in this book is how he basically talks about how people making money, the very effect of them making money on a stock or on a tulip, is that it buys up their intelligence. So, in his vision, just because you make money on something, you feel you're right. You become heavily invested in this belief that you are special. You're making money. It feels good to make money. You can now buy things that you previously couldn't. And no one wants to think critically, right? And nobody likes seeing their neighbour getting rich. So, everyone else follows as well. So, you end up with this virtuous cycle or a vicious cycle where people stop thinking critically and they follow the herd. They follow the masses into the story, whether it's radio stocks or dot-com stocks in the late 90s. Everybody wants to get rich.

JB: Yeah. And everyone participates. Everyone wants to get rich quick. I often think of the Brunner Investment Trust as a sort of get-rich-slowly type of trust. Not that slowly, but a type of trust.

JA: The polar opposite of get-rich-quick schemes. You know, we're investing in companies that generate cash, grow gently, hopefully, we think, provide downside protection when markets are tough, and offer a very diverse set of risks. All these things are important, but most people don't have the luxury of time. A lot of young people in particular are in a hell of a hurry. If they hear about somebody who's made 20 or 30% in the last month, they want in. They flood in. And this happens time and time again throughout human history. So it's all reducible to a certain extent to human fallibility.

JA: The power of compounding, I guess, here is really important. The one book that I did read that I haven't brought with me is Morgan Housel's The Psychology of Money. And okay, he's a really good sort of popular finance writer. So I think when he wrote the book, Warren Buffett was worth $85 billion. But when he was 65, he was only worth $1.5 billion.

JB: A mere one.

JA: A mere one and a half. But so effectively, in percentage terms, almost all of his wealth came after he passed the age of 65 just because of the power of compounding. If you're patient and you compound your capital, if you get rich slowly, that's an incredibly powerful force. But it does, as you say, take time.

JB: So there's still hope for us, James. There's still hope for us.

JA: There's still hope.

JB: Excellent. So, we've touched there on some of the human elements. And I think you've read another book which sort of develops this a bit further. So why don't you tell us about that?

JA: This book goes even deeper into the physiology of humans effectively, and trying to understand how gains and losses, profits and losses, affect humans at a deep biological level. So, the book's called The Hour Between Dog and Wolf, written by John Coates. He was a Wall Street trader who I guess chucked it all in and became a Cambridge University neuroscientist. And he spends his time effectively understanding how people make decisions and how their hormones change depending on whether those decisions make them profits or losses. And he spends a lot of time thinking about and examining how, when a trader is on a roll or in a bull market where people are making profits every day, every position they touch, they make money on, how this virtuous circle changes them physiologically.

JA: It increases the amount of, for men in particular, testosterone in their blood. It makes them more risk-loving. They take more risk. In a bull market, that's absolutely the right thing to do, right? When the market's going up, as you take more risk, you make more money. This feeds on itself as a virtuous circle. But he talks a lot about how this also goes to extremes. You see similar things in the animal world, right? So if you imagine a rutting stag, when it beats an opponent, it gets a big shot of testosterone into its blood, which makes it more aggressive and makes it more likely to win the next battle against the next contender, which is great, but it goes to extremes, and eventually that animal takes too much risk and spends too much time in the open and is more likely to suffer basically a fatal injury. And he sort of draws the parallel to traders who take more and more risk. And then at the top everything goes wrong. And they basically get wiped out. And he also looks at the other side. So, what happens when people are in a bear market and continue to see losses day after day after day, what that does and basically humans get a stress hormone increase in their blood, cortisol, which basically hunkers your body down for a sustained siege and to deal with ongoing stress. But it impairs your ability to rationally assess risks. So, in a bear market, people don't think rationally. People see the sort of analogy he draws is that people see lions and tigers everywhere. If you think back tens of thousands of years, if you were a human on the plain, you wanted to make sure you didn't get eaten. You would be risk averse. And when you were getting stalked by a lion or a tiger or a bear, you were always focused on avoiding that sort of disaster.

JB: Yeah, yeah.

JA: Basically, you see a little bit of that creeping into individuals when they trade and when they're on a losing streak as traders.

JB: I mean, this is very pertinent at the moment. We were discussing earlier. So, there is a, a momentum index. Which is basically long a bunch of stocks that have already gone up and then short.

JA: So betting against the betting.

JB: Betting on the stocks that have previously gone down. So, it's a momentum long-short index. And at the moment it's at its most extreme year-on-year gains on record. So effectively everyone's buying what's gone up, but they're simultaneously selling everything that's gone down. And a lot of this is AI winners versus AI losers. And so, your point there about seeing fears where they don't exist is true.

JB: Everyone is poring over every existing incumbent company, particularly digital ones, and saying, oh, they're going to be ruined by AI. And I think it's totally worth thinking about whether there are false alarms amongst those stocks, because there might be some real bargains. You also mentioned the importance of compounding. And I think it's always worth remembering about compounding that if you go 10% times 10% times 10% times 10%, you rapidly get quite a lot of money. But if you do 30%, 30%, 30%, you get a lot more. But anything followed by zero equals zero.

JA: Yeah, a minus 100% wipes you out, doesn't it?

JB: Exactly. So, think intelligently and critically about absolute risk as well as upside risk. Think about what can go wrong. Make sure that your investments are robust if what you hope for and what you expect doesn't pan out. And there are ways of doing that. There's balance sheet strength, measures of operational leverage, etc., which can protect you if things don't pan out as you hope. And typically in periods of bull markets, people tend to maybe forget about that. So, I think there's some interesting lessons there. And on the whole, the physiology of winning and losing, I think that's fascinating stuff. I think with fund managers, you can tell by looking in the office who's outperforming and underperforming. The people who are outperforming are sort of walking around bolt upright, very, very confident and having a great time. And the underperformers, physically hunched, losing confidence in their own abilities, etc., etc. So that sounds like a fascinating read.

JA: It's a really interesting book. I think I read it first about ten years ago, and it's been on my reread list since. So, I finally got around to it

JB: Good stuff. Slightly unsettling though. It sort of implies that markets are driven as much by chemistry and biology as logic, and I think that helps explain why extremes happen. Markets are not just financial systems. They're human systems as well. And as we've discussed, humans are fallible. Another point that emerges from that, you know, you look at what's happening to markets. You think in theory that they're very clear, rational, logical, economic discounting machines. But there is also momentum. There's groupthink, there's herding, there's emotion.

JA: Stories, narratives.

JB: And things can carry on like that for a long time until, for whatever reason, they don't.

JA: And there's again, another quote from John Maynard Keynes. Maybe I'll try and get one into every podcast.

JB: Maybe you should.

JA: His quote that, “the market can stay irrational longer than you can stay solvent.” I guess for many investors that is a concern, right? You're seeing multiple years of a trend going against you. It's very hard to remain rational and stick with your beliefs when everyone else is telling you you're wrong.

JB: Yeah, I mean, the film The Big Short, originally a book, but the film The Big Short is very good at that. The sort of pressure that the guys who were betting against the housing bubble were under whilst it was going wrong, and the self-doubt, haemorrhaging money and...

JA: Investor Redemptions as well. I think that's the Michael Lewis book, isn't it?

JB: Exactly. And eventually, of course, got proven right. So I believe you have another book as well to discuss.

JA: I have got another book.

JB: About one of the wealthiest families in history, so tell us about that.

JA: So this is a little bit different. This is called Fortune's Children: The Fall of the House of Vanderbilt, written by the brilliantly named Arthur T. Vanderbilt II. Good name.

JB: So that's up there with Jerome K Jerome.

JA: Yes, exactly. It's a brilliant name.

JA: It's a really interesting book. Cornelius Vanderbilt was, when he died in about the 1870s, the richest man in the world. So, he turned a $100 loan from his mum into a $100 million fortune empire. So, he was phenomenally wealthy.

JB: 100 million in terms then?

JA: Tens, maybe hundreds of billions in modern money. But the really remarkable thing, which is what this story covers, is what happened in the future. And within about two or three generations, all of that money was gone. Wow.

JB: Somebody had a good time.

JA: He had a remarkable amount of money to burn through in just a few lifetimes, effectively. And it's a reminder that maybe the skills and the attitude required to accumulate money are very different from the skills and attitudes required to retain it over long periods of time. It's just a fascinating sort of study of history of what can go wrong. And it's interesting, like, lots of personal finance lessons, I guess, about living within your means and not trying to keep up with the Joneses. So lots of the money was spent effectively trying to buy their way into New York high society. They were seen as outsiders. So they threw fantastic parties, built enormous houses, built summer houses in the Hamptons. Then there's obviously bits of misfortune. They build an enormous yacht, I think at the time probably the biggest privately owned yacht. It was so big that when it sailed into the Dardanelles, the Turkish Navy attacked it because they assumed it must be owned by a foreign state. It couldn't possibly be owned by one individual. So yeah, I think that was a really interesting lesson. And obviously the Brunner Trust is an intergenerational wealth transfer vehicle. So we think a lot about long time horizons and ensuring that wealth can be transferred over time. This is perhaps a textbook example of how not to do that.

JB: Absolutely. I mean, so the Investment Trust, for those who don't know, was founded by the Brunner family in 1927. So almost 100 years ago, and the Brunner family still owned just under 30%. So, it's been used for that family to manage their wealth over a number of generations. So clearly the Brunner family fortune has been better than the Vanderbilts'.

JA: Absolutely. I think that's an undeniable conclusion.

JB: Excellent, so I suppose thinking or standing back a bit, why does this reading matter? How should investors think about this?

JA: Reading is firstly, a pleasure, right? If you've got a really interesting book that's engaging, that's a great way of passing some time.

JB: I'm not sure how I'd describe that one about recessions.

JA: I think we might need to work on your curation.

JA: Maybe we'll talk about that when we get back to the office. But it's obviously a really engaging topic. Finding a great book is a great diversion. I think what's helpful for me is it helps you understand the patterns of history. As you talked about 1929 and I talked about the Galbraith summary of financial crises, you recognise that many things are not unique. They repeat over time. In that book, Galbraith makes the point that there is no other field of human endeavour in which history counts for so little as in financial markets. Each generation comes along, they think they know better than anyone else. They've rediscovered the wheel. But reading books, particularly books about history, is a great way of reminding yourself that lots of these things have been seen before.

JB: And history rhymes.

JA: History doesn't repeat, but it rhymes, to give the old adage. It's also a great way of looking at things, basically consulting with experts on a particular topic. There are some really good books about technology out there, for example. We spend a lot of time thinking about technological disruption. Lots of the information we get given every day from the financial markets is very short term or by individuals who are not necessarily technical experts. But many of the books that you can find are effectively years' worth of study from an individual who is an expert in that field. And it gives you an education that you really couldn't get anywhere else.

JB: It gives you context. Isn't it a grounding in thoughtful reality?

JA: It gives you a longer-term frame of reference. And I think, I can't remember if it's a Winston Churchill quote, but I think he said something like, "the further back in history you can look, the further forward you can see."

JB: Oh that's good.

JA: I don't know if that works. My crystal ball always feels like it's a little bit cloudy, but I like the idea of that. You understand how we got to this situation, what developments happened previously that got us to this point. It helps you understand what is possible in the future.

JB: Yeah. And I mean, you say your crystal ball is cloudy, but the future is necessarily uncertain. And I think when you're constructing a portfolio, you need to acknowledge that and try and create a portfolio that prospers irrespective of what precisely the future holds. I think reading is a very important way of being grounded in common sense, being an expert in your field, avoiding groupthink, getting away from the noise, for want of a better expression. So if we bring that back to today's market, there's always a dominant story, narrative. Storytelling animals might be technology, it might be geopolitics, it could be something else. And it can feel very, very compelling. But history suggests that those narratives can be fragile. They can be fake. They can be real. We know that sentiment can shift quickly. So I always think it’s important to stay grounded.

JA: I think recognising that this too may pass is important, right? I mean, go back to the sort of physiological study of the human and how your body changes when you're getting gains or losses. Whatever the state of the world is today, it probably isn't permanent. Things do change.

JB: They do. Absolutely. Markets are driven by people as well as numbers. People are emotional. They're not always rational. I think history gives you a perspective on that. Reading gives you a perspective on that. And anything that helps you think more clearly is valuable.

JA: Understanding people and understanding history is just as important as understanding markets.

JB: Interlinked, I would say.

JA: Absolutely.

JB: Excellent. So, thank you. We should keep comparing books. This has been very interesting. And thank you for watching and listening to Connected Investor. If you enjoyed this episode, do follow or subscribe. And if there's a book you're reading at the moment that you would like to recommend, please get in touch. Leave a message in the chat and we would maybe even feature it in a future show. Thanks, and we'll see you next time.