THE MERITS OF SPECULATION

IN the twilight of his long and laudable career, Bernard Baruch was invariably characterized as an adviser to Presidents or a park-bench philosopher who doled out wisdom from a seat in Central Park or Lafayette Square. Admirers tended to forget--Baruch never did--that in the forenoon of that career, he had also been one of Wall Street's craftiest speculators. Baruch could be bearish or bullish. He once sold Amalgamated Copper short and realized $700,000 when Amalgamated reduced a dividend, causing its overpriced stock to tumble. Another time, alerted by a newspaperman that Commodore Schley had beaten the Spanish at Santiago, virtually ending the Spanish-American War, Baruch spent July 4, 1898, on the cable buying U.S. stocks in the London market. Next day he made a neat profit when the New York Stock Exchange reopened following the holiday and prices shot upwards on word of the victory. Baruch was proud to have been a speculator, but he cringed at the implications the term came to carry. "Modern usage," he noted in a 1957 autobiography, "has made the term 'speculator' a synonym for gambler and plunger. Actually the word comes from the Latin speculari, which means to spy out and observe. I have defined a speculator as a man who observes the future and acts before it occurs."

The trouble with that definition and the reason why the word has fallen into even deeper disrepute was noted as far back as 1905. Handing down the opinion in the case of Chicago Board of Trade v. Christie Grain, in which the court ruled that commodities trading and the Board of Trade served a legitimate purpose, Justice Oliver Wendell Holmes sagely commented that when competent men engage in speculation, it is "the self-adjustment of society to the probable." But he added that its pervasive peril surfaces when "the success of the strong induces imitation by the weak, and incompetent persons bring themselves to ruin." Incompetent speculators lack, somehow, the sang-froid of an emotionless Baruch or the attributes of another successful pre-Depression speculator, Joseph P. Kennedy. Old Joe succeeded in the Great Bull Market of the '20s and magnificently survived the crash, suggested a friend, because he possessed "a passion for facts, a complete lack of sentiment and a marvelous sense of timing."

Broadway as Well as Wall Street

At present, lacking these qualifications, many an incompetent has more opportunity than ever to achieve ruin. Speculation in the prospering U.S. has become not merely an easy but an enviable thing to do. For little money down and years to pay the balance, an Iowa farmer or Rhode Island schoolteacher can acquire without seeing it a small strip of Florida that is bound to quadruple in value--or so the salesmen hint, using a Will Rogers slogan, "Buy land, they're not makin' it any more." Art has become as much of a speculative exercise as an esthetic experience; collectors have bought millions of dollars worth of art works, often in hope that the purchase will increase in value as the artist becomes better known. Amateurs can also dabble in oil-well exploration, beef cattle, race horses, Broadway plays, foreign exchange, gold and silver and precious gems on the chance that Oliver Wendell Holmes's probable will occur.

Lately, under the twin spurs of threatened inflation and easy credit, speculators have been especially active in two most traditional fields: the stock market and the commodities exchanges. "October, this is one of the peculiarly dangerous months to speculate in stocks," said Mark Twain. "The others are: July, January, September, April, November, May, March, June, December, August and February." His caution is widely ignored. No fewer than 22 million people own common stocks, far more than ever before, and few among them do not have some sort of speculative ambition. Daily trading on the New York Stock

Exchange has reached 9,800,000 shares--a level that former Exchange President Keith Funston had not expected until 1975. Some of the records being set are disturbing. Margin requirements are presently 70% for most stocks; yet loans from brokers to cover that remaining 30% have now reached a record $5,580 billion, and shrewder speculators can still get loans for as much as 100% of their purchase price from unregulated lenders.

In the commodity pits, where the action is faster, the risks greater and the rewards fatter, records have piled up also. Helped by the lower margin requirements--5% to 15% v. the stock market's 70%--speculators are busily buying or selling 37 kinds of commodities ranging from wheat and sugar to orange juice and torn turkeys. Last year a record 10,460,000 contracts were bought and sold; the rate this year is almost the same. Traders lured by the idea of making $10,000 out of pork bellies on a $700 investment constitute a surprising cross section of America. A survey of corn futures not long ago showed that, along with the professional speculators, contracts were also held by lawyers (178), clerks and stenographers (122), housewives (339) and students (66). Unfortunately, in a fast-moving market like commodities, most of the amateurs hesitate too long about closing out losing contracts. Another survey, this one of 418,000 commodities transactions, turned up the fact that 75% ended in losses. So strong is the possibility of loss that brokers do not want to do business with women speculators because they "cry about it." In this specialized market, says University of Illinois Professor of Agricultural Economics T. A. Hieronymus, "speculation is a zero sum game in which speculators vie with each other for profits that they, in the aggregate, cannot achieve."

Supply, Demand and Human Nature

Cynics argue that the speculative trend is inevitable until the law of supply and demand is repealed and human nature changes. But responsible men have begun to worry. Both Funston and American Exchange President Ralph Saul have warned their member brokers not to abet ill-advised speculation; in some cases the exchanges have stopped trading in risky stocks temporarily or require 100% margin. Giant Merrill Lynch, Pierce, Fenner & Smith recently dusted off an advertisement that reminds investors that Wall Street runs two ways. Securities & Exchange Commission Chairman Manuel F. Cohen has his investigators scrutinizing for possible fraud 45 companies whose stock is actively traded; previously the Government had secured indictments against 22 brokers, bankers, lawyers and businessmen for allegedly rigging the stock of two small companies traded on the American Exchange. Alex C. Caldwell, administrator of the Agriculture Department's Commodity Exchange Authority, which supervises commodity trading, has asked Congress for stricter powers. And no less an overseer than Federal Reserve Chairman William McChesney Martin chose the 175th anniversary celebration of the New York Stock Exchange to warn against suspiciously speculative activity among professional traders, which Martin finds "disquieting." Last week, as market averages reached new highs, Martin sent up another warning rocket, telling the House Ways and Means Committee that there is "an unwarranted spree in stock prices and a lot of people chasing a fast buck."

The warnings were newsworthy but the game that prompted them is hardly new. Commodities traders wryly note, for instance, that the Old Testament's Joseph was the first man to corner the grain market. After all, when the seven fat years ended in Egypt and the seven lean years began, wasn't Joseph the only man with grain stacked in his barns? Seventeenth century Holland experienced one of the first of the futures markets. Dutchmen became so infatuated with tulips from Asia Minor that they stopped planting and began trading them. Prices rose to the point where one merchant paid $1,400 for a Semper Augustus bulb, which was eaten by an employee who mistook it for an onion.

It remained for the U.S. to hone speculation to its finest edge, and not surprisingly. "Of all the peoples in history," observed Economist J. Edward Meeker in 1930, "the American people can least afford to condemn speculation. The discovery of America was made possible by a loan based on the collateral of Queen Isabella's crown jewels, and at interest beside which even call-loan interest rates look coy and bashful. Financing an unknown foreigner to sail the unknown deep in three cockleshell boats in the hope of discovering a mythical Zipangu cannot, by the widest exercise of language, be called 'a conservative investment.' "

Columbus' Zipangu, unlike Marco Polo's, thereafter grew swiftly on both economic and personal speculation. Pioneers speculated that living was better west of the Alleghenies and pushed constantly westward; transportation speculatively followed. Railroads were built--and speculated on. Before long, New York's young exchanges were the seats of speculation, and the bulls and bears rampaged with home-grown capital instead of European imports. The ticker tape, in 1867, followed by the telephone in 1878 on Wall Street, made it possible to speculate far from the floor of the exchanges. Jesse Livermore, operating from a hideaway with 30 telephones, became "king of the speculators" by being bullish or bearish as the tape seemed to indicate. Arthur W. Cutten made $25 million in commodities, came east from Chicago to double that in Wall Street.

Ordinarily such big speculators played a lone hand, but they could manipulate together when there were enough small investors to be skinned. In 1929 alone, 105 pools were organized; the insiders in a pool quietly bought up a large block of some corporation's stock, drove prices up by churning sales among themselves, paid radio broadcasters and financial writers to tout the stock. When the price was high enough and the public panted to get in, the pool sold out. Cutten and his partners cleaned up $13 million on one such pool in Sinclair Oil. Tuesday, Oct. 29, 1929, changed all that. In the aftermath, Ferdinand Pecora, counsel for a Senate banking subcommittee investigating securities practices, sternly described the stock market as "neither more nor less than a glorified gambling casino where the odds were heavily weighted against the eager outsiders." Between the SEC and the Conway Report of 1938, which led to complete reorganization of the New York Stock Exchange, speculative frenzies subsided and Wall Street became less a rich man's club and more an everyman's emporium.

The Gun Slingers

The exchanges today are vigorously ethical. The Big Board and the American Exchange constantly patrol members--lately by computer checks--and the respectable brokerage houses in turn refuse suspicious business and use "compliance men" to keep their customers' men honest. As much as he can be, the individual public investor is being protected--against dishonesty and against greed.

In the stock markets, at least, the latest wave of speculation is hardly the work of the individual investor. The market, first private club, later part of Main Street, seems now to be entering a third phase in which institutional investors--banks, insurance companies, pension funds and especially mutual funds--dominate it more and more. Since 1961, the number of New York Stock Exchange shares held by institutions have increased 17%, and institutional trading now accounts for a third of all Big Board transactions. Armed with increasing coffers of cash from small investors, the mutuals have invested $43 billion in the market. Because of their activity, the number of block transactions, or 10,000 share trades, has almost doubled in the past year. Not surprisingly, institutions as a group own as much as 20% of 24 major companies at present. In the case of Northwest Airlines, institutions at one point had 41.5% of all the stock available.

What alarms such financial policemen as William McC. Martin is not the massive size of institutional investing; rather it is a new look among the mutual funds. Because of the Depression, Wall Street suffers from a curious age gap; its brokers and bankers and analysts are either conservative older men or bright young business-school graduates; the 40-to 55-year group is largely lacking because there was scant opportunity in the market when it emerged from college. Discontented with conservatism, the young men--gun slingers is one term for them on the Street--use computers to plot the market and spot promising growth stocks quickly, move in and out of likely companies on a short-term basis that appalls their elders. The combined turnover rate of the mutual funds is now 36%, and a dozen of the fastest gun slingers have a 100% annual turnover. When they turn over a stock in unison, especially one in which funds hold a major position, the result can be devastating.

Xerox, a former favorite among these go-go funds, dropped 30 points in three days when second-quarter earnings this year were lower than expected and some performance funds sold out. Fairchild Camera fell from 123 3/8 to 82 1/8 after a similar fall from go-go grace, and KLM airlines declined from 117 5/8 to 77 7/8 for the same reason. After the Chicago & Northwestern Railroad, with one-third of its stock held by funds, announced that a planned merger had been called off, the funds dropped out and C.N.W. stock dropped from 175 to 115. One day in 1966, Motorola Chairman Robert W. Galvin told New York security analysts that earnings would be good but lower than anticipated. In the ensuing scramble by the performance funds to unload Motorola, the stock fell nearly 20 points and the paper loss reached $114 million.

There is nothing illegal, as far as can be determined, in the way the performance funds perform. "The SEC," says one broker, "is trying to catch them using insider information, and the SEC is right. But we all do that. When you have a man on the board, that's what he's for." Moreover, the go-gos constantly outperform everyone else. According to Arthur Wiesenberger & Co., which keeps track of mutual-fund assets and earnings, the performance funds jointly showed a 35.1% gain during the first half of 1967 compared with 9.5% for the Dow-Jones industrials and 15% for all 1,260 stocks on the New York Stock Exchange Index. The principal complaint is rather that, whatever their intent, the go-go funds are having almost the same effect as the outlawed pools of the '20s. Smaller speculators try to follow their moves by watching the market's most active list (since block transactions make for most active stocks) but with little more information than that the hangers-on more often than not take a beating when the funds suddenly sell out. Corporate executives who once were flattered by mutual-fund purchases in their company are now alarmed at the thought of having half their capitalization turned over on the market within a week.

2+2= 4

Wall Street, from long association with speculation, has a maxim about speculators who overreach themselves: "Bulls make money, bears make money, but pigs never do." But there is no maxim or method for determining how much speculation is too much. Some is necessary and desirable. With farm surpluses dropping, Government subsidies are becoming a smaller factor and speculation a larger one in maintaining prices for farmer and housewife. And stock market speculators willing to risk venture capital are the means by which many a U.S. corporation got its start, in electronics today or in airplanes a generation ago. Speculators, moreover, help maintain the market liquidity which guarantees that an ordinary investor can always cash in his chips when he wants to.

In markets that have always preferred to regulate themselves voluntarily, "too much" is probably the point at which federal regulators wielding laws or threats of laws move in. Speculation is broader than ever and, while hardly anyone concerned believes that it is at the danger point, Congress, as well as the SEC, is asking pointed questions about the performance funds in particular. All of which suggests that it is time for speculators to refresh their memories that two and two add up to four, not eight or ten.

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