Where Mr. Market Goes For Data

Safe As A Bond… With All The Equity Upside

Frank Luke had just popped his last balloon.

With hydrogen flames whooshing in his face, and the canvas wings of his biplane fighter SPAD in tatters, the 21-year-old American ace pilot banked sharply over the French town of Margaux and nosed down for cover.

He’d demolished three German “sausages” – tethered observation balloons – in 15 minutes flat… and now, a squad of Fokker D-7s were on his tail as anti-aircraft shells exploded around him. 

He made the tree line past Margaux... just.

Luke – known as the “Arizona Balloon Buster” – held the American record for the most popped balloons (14 downed in just 17 days). A surly young lieutenant with a chip on his shoulder, he’d defy orders to take a 42-hour breather and hop right back in the cockpit after a successful kill.

Up until this evening in September 1918, his swagger had served him well.

It was the height of World War I, and over a million newly-enlisted American “doughboys” had just hopped off the boat in Europe, eager to help their allies fight the German menace. 

At the heart of that conflict was a heated – and now, largely forgotten – battle over balloons.

Balloonomania kicked off in the late 1700s when the Montgolfier brothers sent up a sheep, a duck, and a rooster in a hot-air balloon, and picked up steam over the next century as amateur ballooning societies sprang up all over America and Europe. Observation balloons appeared in the Napoleonic wars and the U.S. Civil War, and by the early 1900s, governments realized that the lighter-than-air fad might have serious surveillance possibilities. 

Enter the Caquots… 90-by-30-foot captive hydrogen balloons, tethered to sturdy winches and floating as high as 4,000 feet in the air. Swinging from the ropes beneath were two-man wicker baskets, equipped with mini field communication offices and connected to the ground by telephone. 

With a good pair of binoculars, the balloonist could see 40 miles into enemy territory. With a portable camera, he could take pictures for creating scale maps. And, with a new-fangled invention called a “parachute” strapped to his back, he could get away quickly if a balloon-buster plane scored a hit. 

In a low-tech world before drones or helicopters, these oblong “sausages” were a game-changer. By 1908, the U.S. Army had launched a full-fledged military aeronautics school to train would-be balloonatics (the saying went, you had to be a lunatic to climb into one of the wicker baskets). In 1918, 26 squadrons of U.S. planes, along with around 30 balloons, unloaded in France, ready to hammer a weak spot in the German lines at Saint-Mihiel.

The Germans were ready with planes and balloons of their own – and Saint-Mihiel quickly exploded into the largest and bloodiest air battle of World War I…

The balloons weren’t as fragile as you might think. Tightly woven from multiple layers of fabric and rubber, they tended to leak slowly, but not pop. However, if a hot shell penetrated the hydrogen-filled chamber, the balloon would explode in a massive fireball, often spelling death for attackers. To sweeten the deal, the Germans allowed their pilots to log one and a half “kills” for every balloon they demolished.

Sometimes, of course, the busters got busted.

Frank Luke’s war ended just beyond the village of Margaux, in a muddy pasture where the Germans swarmed his crippled SPAD. Firing a hand pistol, he refused to surrender, and the krauts shot him, stripped him of everything but his wristwatch, and threw him into a hole. It was the watch that ultimately helped identify his bones and bring him home for a hero’s burial. 

He received a posthumous Medal of Honor, as well he should…

At $7,000 per sausage ($177,000 today), plus the priceless intel they delivered, a burst balloon was a major catastrophe... or a major coup, depending on which side you were on. American fighter pilot Eddie Rickenbacker summed it up: “The safety of thousands of our attacking soldiers depended upon our success in eliminating these all-watching eyes of the enemy.”

To guard their “eyes in the sky,” a complicated infrastructure sprang into place on both sides: lookouts stationed in trees near each balloon, nimble fighter planes patrolling the airspace around the giant windbags, and on the ground, a battery of dedicated antiaircraft artillery called Archies.

The Archies are where math whiz J.B. Lovelace stepped in… 

Kindergarten Math

Hitting a moving target from the ground – as anyone who’s tried skeet shooting knows – is more challenging than it appears. The Archies were deadly – cannons that shot 13-pound “flaming onion” shells – but the problem was targeting the nimble German balloon-buster planes, while not hitting the balloons themselves.

Lovelace, a math nerd who’d enlisted as an officer in 1917, thought trigonometry sines and cosines might have something to do with it... and he was right.  

As he’d later outline in the Army’s Manual Of Anti-Aircraft Artillery, you could calculate a triangle for each hit that looked something like this – and you’d be far more likely to get a kill:

After completing officer-training camp, Lovelace was quickly assigned to a special group designing anti-aircraft artillery, where he perfected a rudimentary computerized gun sight. Lovelace’s mathematical guns got the credit for the very first German plane downed by U.S. forces in France. (He kept a piece of debris from that plane’s fuselage in his basement for the rest of his life. ) 

By the end of the four-day Saint-Mihiel conflict, a lot more Krauts went down in flames. General Mitchell’s 1,500-plane air armada – the largest of World War I – saw 18,500 Germans dead or captured, with only 7,000 losses on the American side of the ledger. The momentum from Saint-Mihiel swept the Allies straight into the Meuse-Argonne Offensive, the final campaign of the war.

Lovelace’s modded Archies continued to do a bang-up job protecting balloons: by the time the Germans surrendered in November 1918, the Allied forces had lost only 89 out of 265 total balloons to aircraft attacks, and, astonishingly, had suffered only one balloonist casualty – Cleo J. Ross, whose parachute caught on fire.

Lovelace – now a captain – headed Stateside, along with his new buddy Ed MacCrone, who he’d met during training camp in the next alphabetically-assigned bunk. 

They set up shop together in Michigan as a brokerage firm called E. E. MacCrone & Co., and for the rest of the Roaring ’20s, as the old song went, life was just a bowl of cherries.

Lovelace holed up and did sums while MacCrone dove into the exciting world of leverage. And toward the end of the decade, Lovelace started to realize that the math didn’t add up: One big bank that he analyzed had a stock market value equal to its total assets – as though the bank didn’t have any liabilities at all.

Citing what he called “kindergarten financial research,” he tried to convince MacCrone that all was not well… Later, he explained:

The bank incident “scared me so much that I did the same simple arithmetic with a lot of other companies. I found that people were climbing all over each other to buy 100 shares or 10,000 shares of those ‘hot’ stocks. But no one in his right mind would buy the whole company at such a high price. That’s what got me out of the market. It was a very simple lesson. Don’t pay more per share for a company’s stock than you’d be willing to pay if you were buying the whole company.”

Even though MacCrone had seen first-hand how well Lovelace’s “kindergarten math” worked during the war (trigonometry is just triangles, after all!), he wasn’t convinced. MacCrone doubled down with more leverage – and, in summer 1929, Lovelace pulled out.

Leaving a small bit of his own capital in the firm so his wartime buddy wouldn’t feel embarrassed, 34-year-old Lovelace moved to cash, hopped on a train, and headed for sunny California, where he’d purchased a date farm with his brothers. And in October 1929, like a well-placed shell hitting a Caquot, the market popped.

McCrone & Co. (now, just MacCrone) had no parachute. By 1930, his firm had dissolved completely.

Lovelace, though – with his chunk of capital and his genius for arithmetic – survived… and thrived. Quickly tiring of the fruit business, he started his own investment firm: first focusing on conservatively managed mutual funds, and then branching out into international investing. Without much fanfare – just crunching unglamorous numbers – his company quietly grew into the world’s largest active fund manager, with over $3 trillion currently under management.

Along the way – in 1968 – Lovelace’s firm developed a first-of-its kind series of equity indexes that today are used to benchmark more $26 trillion in assets. It’s that product – now trading independently as a $44 billion public company – that we are recommending in this issue.

The term benchmark has evolved to refer to the process of comparing performance between competing products or processes. The distinction is the difference between thinking about things in absolute versus relative terms. When something is absolute, it is not debatable. On the other hand, a relative factor is comparative, by definition connected or influenced by other factors. Looking at things in relative terms applies context, something that is important in an increasingly complex world.

For anyone in the investing world, this is a critical distinction. The calendar just flipped to a new year, and it is typical for investors to take a look back and assess performance. Let’s say a stock was up 10% for the year. That’s a nice return. But what if we compared it to the S&P 500 return of 17%? Then all of a sudden that stock doesn’t seem so hot. But what if that stock was much lower risk than the broader market, or paid a much bigger dividend, or any other number of factors that might muddy the waters? Evaluating investments can be much more complicated than simply looking at one number on the page. That’s where benchmarking comes in.

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