Capital Ideas. Bernstein Peter L.

publication was the best and to subscribe to just that one. In 1928, he started to keep track records on the twenty-four most widely circulated services and continued to do so for four years. That period ran from the height of the great bull market of the 1920s, to the crash of 1929, to the cascading bear market of 1931–32. As the appalling drama unfolded, it seemed to come as a total surprise to the services Cowles was subscribing to. He decided to find out whether the failure was something endemic to the advisory business or just a reflection of the shortcomings of those services.

      Ironically, a neighbor of Cowles in Colorado Springs, Robert Rhea, was in the process of reaching exactly the opposite conclusion from Cowles. Rhea, who had been permanently disabled while serving in the aviation branch of the Signal Corps during World War I, was later to emerge as the most famous exponent of Dow Theory. A diligent student of Hamilton’s writings, he launched a market letter called “Dow Theory Comment” in mid-1932. The letter put Dow Theory on the map and became so popular that its subscription list reached 6,000, a large number in those days, particularly in view of the depressed state of the stock market and the economy.

      Although Rhea made few original contributions to Dow Theory, he is generally credited with having transformed Hamilton’s scattered observations into a structured set of ideas. He also traded successfully enough in the market to cover the large medical bills that had accrued during his many years of disability.

      Rhea never pretended that market forecasting was simple. He wrote in 1935:

      Those who try to profit from the advance and decline of security prices are perplexed perhaps 90 % of the time. And it seems that perplexity increases with experience… [U]nvarying cocksureness on the part of traders or investors is a badge of incompetence. There is, nevertheless, a time and place for certainty where the market is concerned, but such times and places are few and far between.42

      Rhea identified two “times and places for certainty.” He called the bottom of the great bear market on the exact day it hit its low, on July 8, 1932, and then predicted the top of the market in 1937. We do not know whether his uncanny forecasting abilities would have continued into the future, because he died in Kansas City in 1939.

      Meanwhile, in 1931, Alfred Cowles had set out on his own quest to determine whether stock prices are predictable. His achievements were noteworthy in his own time, and few scholars of any era have been as thorough, as creative, and as helpful to others. The amateur converted himself into a distinguished professional.

      Cowles knew what he wanted to do but was uncertain about how to go about it. He consulted his friend Charles Boissevain, a Dutch biochemist with mathematical training who was chief of research at the Colorado Foundation for Research in Tuberculosis, where Cowles was a director and treasurer as well as a patient. Boissevain must have been a colorful and stimulating companion. At one time the champion sculler of Holland, he suffered from both tuberculosis and asthma and had come to Colorado for relief. A contemporary described Boissevain in these words: “He had a brilliant mind and knew what research was all about. Just one caveat though: Webb [the head of the foundation] would have to take care to keep Boissevain on the track. He had so many ideas, so much scientific curiosity, that he might be prone to start up too many hares and not all of them in the tuberculosis field.”43

      Boissevain referred Cowles to Harold Davis, a professor of mathematics at Indiana University who shared Cowles interest in economics and statistics.

      Cowles asked Davis whether it would be possible to compute a mathematical procedure called linear regression with twenty-four variables, an unusually large number. Davis replied that he could not imagine why anyone would want to perform a regression with that many variables, but he helped Cowles acquire a Hollerith machine, IBM’s most advanced punch-card computer in the early 1930s. Despite Davis’s skepticism, he helped Cowles to perform the necessary calculations.

      Davis also urged Cowles to get in touch with the Econometric Society, an organization established two years earlier to encourage scholars interested in combining the science of mathematical statistics with economics. Davis was confident that Cowles would find the guidance he was seeking from among the society’s membership of about a hundred distinguished economists and mathematicians. With Cowles’s still ample fortune in mind, Davis mentioned that the society was short of funds and could afford only occasional small meetings and that the members were eager to publish a journal that would bring their work to the attention of other scholars in their own and related fields.

      Cowles immediately wrote to Professor Irving Fisher of Yale, President of the Econometric Society and an old friend of Cowles’s father from their undergraduate days at Yale. Like Cowles, Fisher had suffered from tuberculosis in his youth and managed to survive a long stay in a sanitarium. He emerged as a health fanatic and, in particular, as a passionate crusader against alcohol and tobacco.

      Fisher had won worldwide reputation as a theoretician for his work on interest rates and statistical innovations. Despite his well-justified fame, his attempts to forecast the stock market had given him a different kind of reputation. On October 15, 1929, just a few days before the Great Crash, he made what John Kenneth Galbraith refers to as his “immortal estimate” that “Stock prices have reached what looks like a permanently higher plateau.” That was not bad enough. Fisher went on to say, “I expect to see the stock market a good deal higher than it is today within a few months.” On October 21, the day Hamilton published “The Turn in the Tide,” Fisher welcomed the ominously weakening market, describing it as “a shaking out of the lunatic fringe.”44 Fisher subsequently lost his substantial fortune, which had been acquired partly from a wealthy wife and partly from an innovative filing system he had developed and marketed.

      1

      Some, but by no means all, of this money has come back into the stock market through individual purchases of mutual funds. Distaste for the difficulties individual investors encounter when they try to manage direct holdings of common stocks explains the dramatic growth of the mutual fund business over the past fifteen years.

      2

      Institutions yield sluggishly to technology. The Hong Kong exchange has a new trading floor filled with rows of people sitting at computing desks. With everything being done by the computer, a “trading floor” is no longer needed. But there always has been a trading floor, so there still is.

      3

      Hansell (1989).

1

Some, but by no means all, of this money has come back into the stock market through individual purchases of mutual funds. Distaste for the difficulties individual investors encounter when they try to manage direct holdings of common stocks explains the dramatic growth of the mutual fund business over the past fifteen years.

2

Institutions yield sluggishly to technology. The Hong Kong exchange has a new trading floor filled

42

Rhea (1935).

43

Clapesattle (1984).

44

All quotes in this paragraph from Galbraith (1972).