Genius is a rising market.

—John Kenneth Galbraith

Stocks go up most of the time. At least they have historically in the United States. Since 1900, the Dow Jones Industrial Average has experienced double‐digit gains in 47% of all years. With the wind often at our back, it's the natural tendency of investors to attribute their gains to skill rather than to favorable market conditions.

Humphrey B. Neill, author of The Art of Contrary Thinking, said it best: “Don't confuse brains with a bull market.” The idea that we confuse our ability to select above‐average stocks in a market that lifts all boats is so pervasive that there's a name for it, attribution bias. “Attribution bias refers to the tendency of people to attribute their successes to their own ability and their failures to external ‘unlucky’ forces.”

A 2013 research paper finds that bull markets lead individual investors to make more trades.¹ The reason we trade more in an environment where we should trade less is because, in a rising market, we constantly receive positive feedback, and we get hooked on the natural stimulants that our bodies produce. To keep this feeling going, we trade more and more, faster and faster. Unfortunately, it's been well documented that turnover and excess returns are negatively correlated. A bull market leaves plenty of margin for error, but when it ends and the tide goes out, we find out who was swimming naked, confusing brains with a bull market.

The Dow Jones Industrial Average peaked in 1929 and the nearly 90% crash that it experienced over the next three years required an 825% increase to get back to even. It took 25 years for the index to traverse that mountain and the industrials eclipsed their previous peak in November 1954, the same year that John Kenneth Galbraith published The Great Crash, the quintessential book about the market event that triggered the Great Depression.

The Dow rose from 200 to 680 in the 1950s, a 13% annual increase. The S&P 500 annualized real return (inflation adjusted), including dividends, was 16.76%, which is the best calendar decade ever. Despite this remarkable advance, the 1950s are one of the least documented decades for the stock market. So few people were writing about the investment scenery in the 1950s because the crash and subsequent depression wiped out a whole generation of investors.

After a 90% decline from 1929 to 1932, a rebound, and then another 50% decline in 1937, it's understandable that investors were done with stocks. Because there was little demand for these risky pieces of paper, they spent nearly 50% of the 1940s trading at single‐digit price‐to‐earnings ratios (the long‐term average is ∼17).

It wasn't just individual investors who wanted little to do with the market, but the financial industry was void of new blood. Between 1930 and 1951, only eight people were hired to work on the New York Stock Exchange trading floor.² In The Money Game, Adam Smith (a pseudonym for Jerry Goodwyn) wrote, “There is a missing generation on Wall Street, because nobody went there from 1929 to 1947…the shadow of deflation hung always over one shoulder; there was always a chance that it might happen again, and this feeling, even unconscious, took a lot of conscious effort to overcome.”³ As Roger Lowenstein put it, “Graham's generation had retired, taking its grim Depression memories with it. Wall Street had reawakened to a younger breed, many of whom had not been alive in 1929, and who were bored with their elders' endless recitations.”⁴

By 1969, just 90% of the people employed in the financial industry were over 45 years old.⁵ Youth was an enormous asset on Wall Street: “The Institutional Investor magazine told of an under‐thirty stock analyst with three years' experience and a salary of $25,000, who decided to better his situation by changing jobs. Within two weeks of making known his availability he had fifteen job offers, including one of $30,000 plus bonus and equity in the firm, one of $30,000 with the virtual promise of $50,000 and a partnership in two or three years, and one of $30,000 plus bonus, profit sharing, and deferred compensation.”

In 1946, there was only $1.3 billion invested in mutual funds. By 1967, that would multiply many times over, to $35 billion,⁶ and money flocked especially to one man, Jerry Tsai. In an era of anonymous money managers, he was the exception.

John Brooks, who wonderfully chronicles the shift from apathy to euphoria in The Go‐Go Years, wrote, “In the 1920s the man to whom the public ascribed almost supernatural power to divine the future prices of stocks had been Jesse L. Livermore. In the middle 1960s, it was Gerald Tsai.”⁷

In 1952, at 24 years old, Jerry Tsai was introduced to Edward Johnson, who ran Fidelity Funds. In 1957, prior to his 30th birthday, Tsai began running the Fidelity Capital Fund. Jerry Tsai was the guy, the first celebrity money manager ever. There wasn't a fund manager on the planet who wasn't watching what he was doing. “A number of fund managers I know describe their job very simply, all in nearly the same way. ‘My job,’ they say, ‘is to beat Fidelity.’”⁸

He was trading large blocks of stocks, in and out, rapid‐fire. If it was going up faster than the market, he bought it. When it slowed down, he moved onto something else. Another go‐go investor, Fred Carr, described this style of trading, “We fall in love with nothing. Every morning everything is for sale – every stock in the portfolio, and my suit and my tie.”⁹ Edward Johnson described Tsai's style, “It was a beautiful thing to watch his reactions…. What grace, what timing – glorious!” His annual portfolio turnover often exceeded 100%, meaning a share traded for every one held. This was not the way Wall Street was used to managing portfolios.¹⁰

Tsai's timing, grace, and most important, his returns, drew people to the Capital Fund like nothing ever seen before. The number of shareholders rose from 6,200 in May 1960 to 36,000 in May 1961.¹¹

Tsai put together an incredible track record with Fidelity. From 1958 to 1965, he returned 296%, compared to a gain of 166% for the average conservative equity fund.¹² But Fidelity was a family‐owned company, and despite Tsai's success, and being named an executive vice president in 1963, he was fully aware that Ned Johnson would succeed his father. So in 1965, Tsai sold his stock back to the company for $2.2 million and left Boston for New York to hang his own shingle, launching the Manhattan Fund.

Hailed as a hero, even by competitors, Tsai was recognized as one of the top fund managers on the scene, and he was giving the industry a good name. What his investors, competitors, and even Tsai himself saw as skill and genius was nothing more than luck.

Tsai's Manhattan Fund first planned to offer 2.5 million shares to the public, but investor appetite for the original high‐frequency trader was 10 times greater than Tsai had anticipated. They issued 27 million shares and raised $247 million in capital, representing what was at the time the biggest offering ever for an investment company.¹³ This extraordinary amount represented nearly 15% of the total cash flow into equity funds that year.¹⁴ Investors were even willing to forfeit 8.5% in the way of a sales load to get access to the most famous money manager of the time. But the bloom would soon come off the rose.

Talking about Jerry Tsai was fashionable, and the Manhattan Fund was a constant topic of conversation. He had a larger‐than‐life presence on Wall Street. It was hard to keep up with Tsai's lightning‐quick moves and what his actual holdings were, but that didn't stop people from making assumptions. Not only did people pay close attention, they both rooted for Tsai and waited for him to get stuck in a position that would send him spiraling downward.¹⁵ And soon, Tsai would quickly go from being on top of the world to buried underneath the scorn of his investors.

In Tsai's go‐go years, high‐flying stocks with positive momentum were all the rage. Polaroid, Xerox, IBM all traded at price‐to‐earnings ratios of more than 50. These expensive stocks were supported by explosively high growth rates. From 1964 to 1968, IBM, Polaroid, and Xerox grew their earnings per share at 88%, 22%, and 171%, respectively. Others like University Computing, Mohawk Data, and Fairchild Camera traded at several‐hundred times their trailing 12‐month earnings. The latter three and many others like them would go on to lose more than 80% in the 1969–1970 bear market.

The Manhattan Fund was up almost 40% in 1967, more than double the Dow. But in 1968, he was down 7% and was ranked 299th out of 305 funds tracked by Arthur Lipper.¹⁶

When the market crash came, the people responsible were entirely unprepared. By 1969, half of the salesmen on Wall Street had only come into the business since 1962¹⁷ and had seen nothing but a rising market. And when stocks turned, the highfliers that went up the fastest also came down the fastest. For example, National Student Marketing, which Tsai bought 122,000 shares for $5 million, crashed from $143 in December 1969 to $3.50 in July 1970.¹⁸ Between September and November 1929, $30 billion worth of stock value vanished; in the1969‐1970 crash, the loss was $300 billion!¹⁹

The gunslingers of the 1960s were thinking only about return and paid little attention to risk. This carefree attitude was a result of the market they were playing in. From 1950 through the end of 1965, the Dow was within 5% of its highs 66% of the time, and within 10% of its highs 87% of the time. There was virtually no turbulence at all. From 1950 to 1965, the only bear market was “The Kennedy Slide,” which chopped 27% off the S&P 500, and recovered in just over a year.

Tsai was playing a game that could not be consistently won. He was the first of a new breed of traders who ditched the slow‐and‐steady to chase immediate profits. Led by Tsai, the Manhattan Fund was a pioneer of this micro‐term strategy – and copycats lined up to mimic their every move. According to Lowenstein, “It was said that a whisper of Tsai's involvement in a stock was sufficient to set off a small stampede.”²⁰

Tsai saw the writing on the wall, and in August 1968, he sold Tsai Management and Research to C.N.A. Financial Corporation, an insurance company, for stock worth around $30 million.

Looking back on his experience, Tsai was not fond of the way he was treated:

Nineteen sixty‐seven was a very good year for the Manhattan Fund; we were up 58 percent, as I recall. I think among the big funds, we were the best. So I must have been feeling pretty good that year. Not the following year. The following year felt lousy. The stocks that did so well in '67 did not do well in '68. Either I overstayed, or I had the wrong stocks. But I think the press has been very unkind, because Fidelity Capital started in 1958, so you might say, from 1958 to 1967 we were always on top. We had one bad year, in 1968, and I've been killed in the press ever since. Like a ballplayer, right? If you have ten good games and one lousy game, you're a bum. I don't think that's fair.²¹

Tsai did have “ten good games,” but the game he was playing was like bowling with bumpers in the gutters. He was throwing the ball as hard as he could, and it was working. But when the bumpers were taken away, in 1968, his investors learned a very hard and important lesson. The Manhattan Fund would lose 90% of its assets over the next few years; by 1974, it had the worst eight‐year performance in mutual fund history to date. A rising market lifts all ships, and Tsai's investors learned a very important lesson: Don't confuse brains with a bull market!