Pop Finance: Investment Clubs and the New Investor Populism [NOOK Book]

"Irrational Exuberance"

Much that can be said about the spirit of the 1990s in America can be encapsulated in the publication of three books in rapid succession between May and September 1999: Dow 36,000; Dow 40,000; and Dow 100,000. Issued by three different publishers, and written by three different sets of authors, each book vied to be the most optimistic about the upward trajectory of U.S. stocks. Though we might now wish to shelve these books in the science fiction section of the library, at the time their ideas were treated quite seriously and discussed earnestly in almost every public news forum you could name. In 1999, everyone agreed that the sky was the limit for the American stock market: the only question worth asking was, how high is the sky?

However implausible their optimism might seem in the morning-after light of the early twenty-first century, these books simply reflected the astonishing events occurring immediately before and after their publication. On March 29, 1999, the Dow Jones Industrial Average-a group of stocks issued by thirty industrial firms, which have long been used by the Dow Jones Corporation as a barometer of the U.S. stock market as a whole- closed above10,000 for the first time in its history, having doubled its value since 1995. During the five weeks that followed this benchmark, the Dow climbed another 1,000 points-the fastest run-up in its history-and closed over 11,000 on May 3. This orgy of economic optimism culminated on January 14, 2000, when the Dow closed at what was then an all-time high of 11,722.98, followed by a descent almost as swift as its rise, with the index dropping almost 3,000 points in a few months. Despite the dramatic changes in the numbers, some aspects of the market boom of the late 1990s are still very much with us.

Among the most notable legacies of this extraordinary period is the shift in what could be called the "investor class." Once limited to a tiny elite among America's wealthiest families-the 1 percent of adults who owned stocks in 1900, which by 1952 had risen to just 4 percent-investing in stocks became a mass activity, involving over half the U.S. adult population by the end of the twentieth century. Much of this growth in "market populism" occurred during the 1990s. For example, at the beginning of that decade, about 21 percent of American adults owned stocks; seven years later, the percentage had more than doubled, rising to 43 percent; by 1999, the figure was 53 percent. The last time the number of investors doubled in America, the change took twenty-five years: from 10 percent in 1965 to 21 percent in 1990.

This shift in the composition of the "investor class" brought with it substantial demographic and political changes. For example, while women made up a little less than a third of American investors in 1990, they constituted fully half of the "investor class" by 1999. In addition, by 1998 the majority of the nation's registered voters were also investors, spurring declarations of a major political shift in America, with the New York Times announcing the birth of "shareholder democracy." The views of the nation's newspaper of record on this subject capture the expansive spirit of the era: "This may be the least appreciated economic, cultural and political development in recent years ... we have developed a mass culture of investing, the first to exist anywhere in the world. American democratic capitalism has brought about the democratization of capitalism."

Americans flocked to the stock market as they once flocked to lands of opportunity. And despite the market downturn, this "new investor class" appears to have continued investing, unlike the generation that followed the crash of 1929. How did this change occur, and what does it mean socially and economically?

It is significant that the initial research for this book took the form of an ethnography conducted in the Silicon Valley. Like the populist expansion of the nineteenth century, the stock market boom turned Americans' attention westward, toward the 1,500-square-mile area bounded by San Mateo to the north, Gilroy to the south, Fremont to the east, and the Pacific coast on the western edge. An area formerly known as the plum-and apricotgrowing capital of California, the Silicon Valley was so entirely transformed by the mid-1990s that it surpassed Detroit as the nation's leading export region. The transition was swift and dramatic. Between 1994 and 1998, thousands of people moved to the area every month to work in high-tech jobs, creating the kind of traffic jams that northern Californians had previously associated with Los Angeles. These material changes were accompanied by hyperbolic rhetoric that proclaimed, the end of the old world- economically and even socially-and rise of an entirely new regime in which none of the conventional wisdom applied and the rules would be made by smart young men and their machines. Among the first casualties of this revolution were the metrics used to value companies. In the new order, anything that smacked of "bricks and mortar" was deemed useless: what counted was ideas. That meant that companies' value would no longer be assessed by whether they made a profit, or even made a product; anything with dot.com after the company name was held to be a good bet. A best-selling book of the time proclaimed, "The old rules are broken ... Forget supply and demand ... Old business know-how means nothing."

Anyone who paid attention at that time recalls the strangely manic tenor of public dialogue about economic conditions. It resembled nothing so much as a very long infomercial, complete with hagiographic rags-to-riches stories featuring leading entrepreneurs, such as Steve Jobs and Steve Wozniak of Apple Computer. Economist Paul Krugman described the rhetoric of the "new economy" as "a rapid-fire blur of neologisms and breathless declarations that all the rules have changed, that there are limitless opportunities for those who have the courage to let go of old assumptions." At the same time, skepticism about the "new economy" was so marginalized that it could scarcely bear public discussion, except under the guise of humor-the traditional method for treating many taboo subjects. For instance, in July 1997, the Wall Street Journal ran a front-page story quoting an investor who said that the notoriously bearish investment newsletter Grant's Interest Rate Observer was now worth reading only for entertainment value: "It's like [reading] the Marquis de Sade; it's interesting as long as you don't try to do it."

To study investor behavior at this time and place was a bit like studying government in 1789 Paris. Investing was exciting, confusing, and tumultuous-and the only game worth playing. People who at another point in history might have joined a temperance league or a fraternal organization instead joined investment clubs, drawn by the recognition that the economy was where the action was, historically and culturally. Though some of these individuals seemingly had little economic need to invest, the president of one group spoke for many people in my study by explaining that she had joined an investment club because she was "caught up in the euphoria of the bull market." Of course, investing is driven by the profit motive, as will be discussed at greater length in subsequent chapters. But investing together during the 1990s also meant participating in a form of social organization that was both historically specific and status-relevant: in other words, fashionable.

At the height of the bull market, between late 1997 and early 1999, I studied seven Silicon Valley investment clubs, attending their monthly meetings over the course of a year and supplementing my observations of their decision-making behavior with in-depth interviews. (See this chapter's appendix for further details on sample selection and methodology.) Investment clubs, often characterized as "do-it-yourself mutual funds," are voluntary associations of ten to fifteen people who pool their money to invest in the stock market. Based on what I learned from my observations and interviews, I gathered survey data from 1,245 investment clubs and over 11,000 individuals nationally, with results I report in subsequent chapters.

Although investment clubs have existed in the United States for at least a century, they did not become extremely popular until the 1990s, when they constituted the major vehicle of the "popular finance" movement that has attracted so much attention from the media and policy makers. Through the clubs, an estimated 11 percent of the U.S. population collectively poured hundreds of millions of dollars into the stock market. In addition, investment club participants during that period captured a broadly representative slice of the U.S. population, particularly groups that have previously been underrepresented in studies of investor behavior, including the very young, the elderly, and women. Approximately 60 percent of investment club members are women, and there is wide variation in age and occupational status, with members ranging from teenagers to octogenarians, and from executives to farmworkers. Thus, what started as an investigation of the social underpinnings of investor behavior turned into something larger: a snapshot of historical and social transition, as millions of people were caught up in what Federal Reserve chairman Alan Greenspan called "irrational exuberance."

A Brief History of the Investment Club Phenomenon

Investment clubs make such useful research settings for studying real-life investor behavior that it is surprising that they were virtually ignored until this research was conducted in the late 1990s. The first U.S. investment club was founded in Texas in 1898, based on a European model going back several generations. But the clubs were little more than an obscure hobbyist movement until the closing years of the twentieth century, when the stock market began its record-breaking upward surge and ordinary Americans rushed to participate in the boom.

Investment clubs were at the epicenter of this economic and social transformation. With each market surge, NAIC enrollments swelled- peaking in 1998 at 37,129 member clubs-as did the involvement of women. As a benchmark, NAIC's 1986 membership data show that all-women's clubs made up 38 percent of NAIC enrollments, followed by 35 percent mixed clubs and 27 percent all-men's clubs. Ten years later, mixed clubs made up 47 percent of NAIC membership, followed by 41 percent all-women's clubs; meanwhile, all-male clubs had fallen to a mere 12 percent of enrollments. Five years later, the trend had continued further in the same direction, with all-women's clubs representing 54 percent of the total NAIC enrollments, mixed clubs 38 percent, and all-men's clubs only 8 percent. Overall, the balance shifted through the massive entry of women into investing; once a minority, women comprised 62 percent of NAIC membership by 2001.

Fluctuation in investment club participation has been influenced not only by economic imperatives but also by cultural and historical conditions. For example, the 1950s witnessed a push to woo back to the stock market a generation scared away from investing by the 1929 crash. Corporations, stock exchanges, and brokerage firms urged Americans to purchase stock though a joint education/public relations campaign titled "People's Capitalism." Charles Merrill, founder of Merrill-Lynch, made his fortune by advertising extensively to individual investors and by publishing newsletters encouraging Americans to get involved in the stock market. Another pioneer of market democratization-George Funston, who become president of the New York Stock Exchange in 1951-leveraged the anticommunist sentiment of the time to claim that buying common stock was a vote for democracy and the American way. The perennial appeal of the "investor as patriot" metaphor was reaffirmed fifty years later by the numerous e-mails that crisscrossed the nation following the September 11 attacks, urging Americans to buy stocks to prop up the faltering economy and signal defiant confidence in the face of the terrorism that had targeted the nation's financial center.

For investment clubs, this link between investing and American identity is captured by NAIC's slogan: "Own Your Share of America." This demotic strain in the U.S. stock market is more than a marketing ploy: there seems to be a genuine sense of Manifest Destiny among American investors, characterized by belief in limitless possibilities for expansion, and the average citizen's entitlement to a piece of the economic pie. It is remarkable how readily this set of beliefs translated from the landgrabs of the 1840s to the stock market of the 1990s. As one historian put it, "the essence of speculation remains a Utopian yearning for freedom and equality which counterbalances the drab rationalistic materialism of the modern economic system." Since investment clubs have served as the primary point of entry for new investors into the stock market, it is not surprising that club enrollments have risen and fallen with waves of confidence in the market. Figure 1.1 compares NAIC's club enrollments with the Dow Jones Industrial Average since NAIC began keeping records in 1952. The trend lines match very closely, although most changes in club enrollments lag major market swings by several years. For example, investment club participation peaked first in 1962, with just over 106,000 members, following the nearly 20 percent surge in the Dow Jones Industrial Average between 1959 and 1960. The second peak in investment club participation occurred in 1970, with 169,000 members enrolled, about four years after a record high in the stock market. The decline in club enrollments began in the early 1970s as Vietnam, Watergate, and the energy crisis erased fifteen years' worth of gains in the Dow. However, the lowest enrollment levels (44,000 individual members-fewer than the 1958 membership numbers) occurred in 1980, five years after the Dow hit its lowest point.

The Dow had regained all its lost ground by 1983, but investment club enrollments did not return to 1970 levels until 1994, when membership began soaring with the onset of the bull market; enrollment reached a peak of over 600,000 individual members between 1998 and 1999. The pattern breaks down somewhat during the period from 1999 to 2001, when there was a steep plunge in investment club participation; this may have been occasioned by the decline of the high-technology boom. Although the Dow has certainly represented a large segment of the American investment market historically, the late 1990s were dominated by the high-technology stocks listed on the NASDAQ exchange. As the high-technology boom wound down in 2001, investment club enrollments began to track the Dow more closely.

From the highs of "irrational exuberance"-marked by peaks in the early 1970s and mid-1990s-to the long period of aversion to the stock market in the intervening twenty-five years, the history of investment club enrollments echoes recent findings that individual investors do not just react to market conditions-they overreact, often wildly.

Economic, Legal, and Technological Factors

The investment club "renaissance" of the 1990s was not due just to the upswing in the stock market during that period. More importantly, as noted in the previous chapter, new kinds of investors entered the stock market. Women and people of color, after years of being the tiniest of minorities in investing, joined the "investor class" en masse. Thus, investment clubs rose from the ashes of stagflation with a push from new kinds of investors forming new clubs, rather than building on old ones. This was part of a larger trend toward broadening the demographic composition of the investor population.

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Excerpted from Pop Finance by Brooke Harrington
Copyright © 2008 by Princeton University Press . Excerpted by permission.
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