The Lessons of Stock Market Crashes

In December 1993 a bodyguard was assigned to protect me. At the time I was working for Globes newspaper, writing its daily coverage of trade on the Tel Aviv Stock Exchange. Like many others in the media, I repeatedly cautioned against shares that were trading at unreasonable prices, against improper practices such the manipulation of shares, which at that time was being done openly, and against the dangers of a market in which the boom had already brought it to the point of corruption.

I also covered the oil exploration industry, during the heady days when the smoke rising from the Yam-2 marine oil drilling of the Isramco partnership took the whole market up with it. Joe Elmaliach and Armand Hammer, the Israeli and American partners in Isramco, proudly displayed a bottle of oil extracted from Yam-2 and reveled at the sight of Isramco participation units, which shot up by thousands of percent.

My warnings that the discovery at Yam-2 was far from being economical - the drilling never matured into a commercial well - could not outweigh the wild fantasies and feelings aroused by "signs of oil" among the investing public.

The warnings did not cool the bourse, but did cause the switchboard at Globes to receive 30-40 threatening phone calls against me daily. My bodyguard was assigned following those threats. He did his job for two months. Then, on February 8, 1994 the warnings came true, the stock market plummeted and the telephone fell silent.

Tempers flared when the stock market soared. The collapse quenched the flames in one fell swoop, as investors found themselves busy coping with their losses - and not with attacking those who warned them. The insanity was over.

Anyone who seeks comfort in the fact that 2003 is very different from the bubble of 1993 can do so. Stock market reporters no longer wander around with bodyguards. The current rise in the markets, economic or non-economic as it may be, is not even close to the "irrational euphoria" that characterized the markets a decade ago. From that perspective - and from that perspective only - the markets today are much safer. They do not bear the glaring signs of a market that has lost its senses, and therefore has to crash.

That is not the only difference. In January 1994, just a month before the crash, I published an investigative article on the level of management of the institutional bodies - meaning the provident funds. I checked the management fees charged by each body and the extent of the assets managed by it, compared to its investment in human resources to manage its investments. I argued that these institutional investors were collecting hundreds of millions of shekels in management fees and investing only a fraction of this in the quality of their management. My list was headed by the most prominent example of all - the most important institutional body at that time - Bank Hapoalim's pension fund group, Gmulot, with NIS 30 billion in investments managed by just six professionals.

"NIS 5 billion per person" was the headline of that article. It was not precise. In effect, there was only one person managing Gmulot at that time - the aggressive deputy CEO, Eilon Tzabari. Four months later Tzabari was arrested by investigators of the Israel Securities Authority.

At a press conference held after the arrest, then-deputy CEO of Hapoalim, Shimon Ravid, attacked the media and accused it of a lack of understanding.

"What do you mean, NIS 5 billion per person," he stormed. "Everyone knows that most of the provident fund's assets are invested in bonds, and bonds don't need managing."

No deputy of any bank today would dare say that the bond portfolio does not require meticulous investment management. The bond portfolios of institutional investors are now managed according to economic models - part of the revolution in the professionalism of provident funds, insurance companies and mutual funds. These days the institutional investors are aided by departments of analysts, macro-economists, auditors and investment managers who specialize in derivatives, structured instruments, swaps, strips, spiders, venture capital, zero-coupons, etc. Over the past decade Israel has been catching up with the accepted investment management norms of the Western world.

Israel is also catching up to the accepted supervision norms in the West. The proper disclosure revolution, led by Arie Mientkavich in the early 1990s, continues to bear fruit - and the Israeli market is enjoying disclosure and auditing norms that would not shame much more mature markets.

From almost every perspective the market today is mature, orderly, transparent and more exposed than it was. Still, one fundamental thing has not changed: the lust for money. It was the driving force behind the markets in 1993-94; it also drove the markets up in 2004, and is the force that at some stage always causes markets to lose touch with reality.

The next collapse of the stock market has already been marked on the calendar. Such a collapse is inevitable and only its timing is unknown. Despite the fatalism that shrouds the cycles of ups and downs on the stock market, the markets themselves are not fatalistic. There have been and will be collapses, but the markets can rise and flourish between them and after them.

The frequency of the collapses, their relative intensity and mainly the extent of their damage to the general public - these are the influential factors. The unfolding of collapses so far have been at the public's expense. It is the public that picks the market up again, following the tremendous demand for shares, and it is the public that drags it down when fleeing in droves. The public thus becomes the market's cannon fodder - the last to come aboard when prices are at their highest and the first to leave when prices bottom out.

The public's destiny to lose most of its money in a crash spawns a different type of fatalism - of a public that stays away from the stock market. Always. Anyone who wants to risk the losses that he will inevitably suffer in the market also abstains from the profits that the market has to offer him. That is another type of loss that the public suffers.

Does the public have to lose on the stock market? The lesson of 1993 predicts in the affirmative. The jury is still out on 2003's lessons. There is hope that the revolution in the professionalism of the institutional investors and the revolution in proper disclosure by the supervisors will lead to a better market. One in which losses are not compulsory.

We can also hope that the real lesson of the market's cyclical nature (1983, 1993, 2003), the lesson of humility, will yet be learned. This is the humility that no one is wiser than the market - even when the writing is on the wall, as it was in December 1993 and January 1994, no one could read it - so the market must be accepted as it is. Collapses will come and go and will remain unpredictable.

One can only invest in the market consistently and for the long term, at times of both boom and bust, as the only way to get the best out of the market.

If the public would internalize this lesson, perhaps there would be more hope for its investments in the bourse.