Graham Has Some Words Of Wisdom For When The Market Crashes

April 6, 2018

Graham Has Some Words Of Wisdom For When The Market Crashes

Today, we’ll continue on with our series on The Intelligent Investor and applying Benjamin Graham’s everlasting knowledge to the current market in order to avoid doing stupid things while taking advantage of others’ stupid actions.

Graham’s data goes up to 1971, so we’ll first look at his data and later discuss the insights that can be applied to the current market situation.

The main points Graham emphasizes that we can learn much from are:

  • The varying relationships between stock prices and their earnings and dividends.
  • It’s important to understand the manner in which stocks have made their underlying advance through the MANY cycles of the past century (emphasis mine).
  • Look at successive ten-year averages of earnings, dividends, and stock prices.

Graham’s Take

From 1871 to 1971, there were 19 bear markets where stocks fell from 15% to 86% from top to bottom. Yes, 86% isn’t an exaggeration and the S&P 500 even experienced an 89% drop from 1929 – 1932.

Many forget that the 1920s were one of the best periods in history based on consumerism. Does that ring a bell? That’s a story for another article. Let’s look at how Graham describes what was going on.

Figure 1: The S&P 500 from 1900 to 1971. Source: The Intelligent Investor.

Graham discussed the distinct patterns in the chart above:

  1. 1900 – 1924: 3 to 5 year market cycles with an average return of 3% per year.
  2. 1924 – 1929: Bull market.
  3. 1929 – 1933: Bear market.
  4. 1933 – 1949: Fluctuations – reached 1924 level only 25 years later (no enthusiasm for stocks at all and difficult to understand why people were so crazy for stocks in the prior decade).
  5. 1949 – 1968: Greatest bull market in history with two short dips in 1957 and 1962 – (2000 and 2008 ring a bell?); 6 fold advance in 17 years -11% per year.
  6. 1971: Graham’s comment: “Few people have been bothered by the thought that the very extent of the rise might indicate it had been overdone” (the bull market).

Apart from the most interesting stock price movements, Graham urges us to study corporate earnings with even more importance.

Figure 2: Graham’s 10-year average numbers from 1871 to 1971. Source: The Intelligent Investor.

The message from above is this:

  • Stocks will deliver growth over time.
  • Only 2 out of 9 decades have seen a decline in earnings.
  • PE ratios went from 6.3 in 1949 to 22.9 in 1961 – dividends fell from 7% to 3% even though bond yields went from 2.5% to 4.5% – Graham describes the most remarkable turnaround in the public’s attitude in all-stock market history.

The Stock Market Level In 1972

Graham says “old standards of valuation appear inapplicable while new haven’t yet been tested by time.”

The S&P 500 was at 100 points and what Graham focused on is that bonds yielded twice as much as stocks. It was the opposite in 1949, when it was the best time to buy stocks. Further, Graham warned investors that they should be prepared for difficult times ahead.

Was Graham Right?

You bet. He got it correctly that stocks were dangerous and to showed how prescient he was it took the S&P 500 10 years to surpass the previous level and a 47% drop in between.

Figure 3: S&P 500 from 1972 to 1982. Source: Marcrotrends.

Before applying Graham’s insight to the current stock market, let’s see what happened in 1982.

Figure 4: The S&P 500 went up 25 times from 1982 onward. Source: Marcrotrends.

Stock performance resembles that from the 1949 to 1972 bull market where there was huge growth, some short term dips here and there, and extremely high valuations at the end of the run. 1982 resembles 1949 because PE ratios were in the single digits which always represented a great buying opportunity in the past.

What To Expect In The Future?

Well, according to current valuations, we could quote Graham and say that the investor should be prepared for difficult times ahead. Further, there is something else that doesn’t work in favor of the investor, economics, which is another topic for another day.


The first takeaway is that stock market returns in the long run are dictated by earnings, and the PE ratio is your best friend. The CAPE ratio even better.

The second takeaway is that there are periods when no one wants to touch stocks with a 10-foot pole (think 1932, 1949, 1974, 1982), and periods when we are all investors. The intelligent investor should think that he or she will probably live through such public states of mind at least twice in their lifetime where the psychology of others has to be taken advantage of by rebalancing between risky assets, hedges, safety nets, asset allocation, debt repayment, and all the things that will lead you to your financial goals with the highest probability possible.

The third takeaway is that long term stock returns will be around 4% given the current PE ratio of 25 and CAPE ratio of 32. These things always balance out in time, and you might see 20 years of negative returns and then see the 4% return when people are again exuberant about stocks. NOTE: If that happens, take advantage of the 20 years of pessimism as it would be a blessing to your long term returns.

The fourth takeaway is that what happened in the past might not happen in the future. Even if the most likely thing to happen is negative returns over the next decade, stocks might even double from today’s level, you never know.

What 150 years of stock market history shows us is that the majority are mostly wrong and that stocks will surprise us over and over again in the future. If you want to avoid surprises, look at fundamentals and businesses—not stock prices—for direction.