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Posted 10/28/2002
Contrarian Chronicles
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Contrarian Chronicles
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Faceless money managers put all of us at risk
I don't think the recent rally has legs. The reason: too many money managers are chasing the markets momentum without doing much real thinking. What have they got to lose? Your money.
By Bill Fleckenstein
People who play with other people's money are the luckiest people in the world. From their trading desks, they have the fun of being in a casino, and little of the risk. After all, they are managing other people's money, so risk is somebody else's problem. Their mission, from market open to market close, is never to let company fundamentals get in the way of speculation and motion. Sadly, by virtue of the sheer size of the mutual-fund and hedge-fund industry, they are doing a bang-up job.
In that vein, I'd like to begin this week with some thoughts on the rally. It seems to me that the driving force behind it is just a lot of circuitous rationalization -- more than has been seen in any of the rallies of the last two years. You know, we're going to rally because we're going to rally. I can understand what the rally in July was about, and I can understand the September 2001 rally, but the current rally seems much more about bravado and arm-waving.
To me, that means one of two things: Either I'm dead-wrong about the impetus for the rally and about my view of the economy -- in which case, this rally will last longer and surprise more people -- or the rally will not go as far and will fall apart sooner, catching everyone who's trying to play it.
Woe is me, therefore owe is me
Obviously, I don't know which will occur, but my bias is toward the latter. As if to put a summation sign in front of the psychology behind the rally, a friend recently forwarded an e-mail that I believe sums up the attitude of investors. It contains the following quote from Tom McManus of Banc of America Securities: "We believe investors can now justifiably claim the market 'owes' them a significant gain in return for the losses they have sustained in the past six months." (The italics are mine.)
Well, if that remark wasn't meant to be tongue in cheek, then it's one of the stupidest things I have ever read, though I believe that this theme, or some variation of it, is exactly why people are expecting a rally. Let's make one thing perfectly clear: The market owes nothing to anybody, and anyone who thinks otherwise is just asking for trouble. To repeat, I have understood many of the rallies in the last couple of years. I could at least see how they might develop, and I myself tried to be somewhat clever around them. But in the case of the present rally, I think this kind of thinking is extra dangerous.
Cavity in the gravity theory
On that score, lets explore how people become seduced into wanting to buy stocks when they come down, and avoid them when they go up. Recently, in a fine article in the always-interesting "Welling@Weeden" (see link at left), Kate Welling quoted Phil Erlanger on the first leg of the process: "The human brain has a thing that I call a widget. It makes you feel that things that are closer to the ground, that are low, that are cheap, that have already come down a lot in price, are safe, secure. So it is a lot easier to buy Cisco Systems (CSCO, news, msgs) at $10 than it was at $15. But of course, they thought it was a lot easier to buy Cisco at $15 than it was at $20."
Then, he offered these thoughts on how the process works when the stock is up: "'Oh, this stock is high. I am way off the ground. If I buy here, look at all the money I could lose. It could go right back down.' But the problem is that the human brain makes it easier for you to buy a downtrend than to buy an uptrend, because it makes you feel like you are too late in the game." That's what happens. When stocks are going up, people feel like they've missed it. And short sellers often want to sell them on the way up, only to be run over. Then, on the way down, buyers continue to try to average down, and people tend to be afraid to be short, because they think they've missed it. Anyway, I thought his comment was rather insightful. It makes a lot of sense in terms of explaining why people keep trying to buy stocks that are down from some higher place, and conversely, why they always seem to want to short stocks that are up on spikes.
Speaking of short-selling, I'd like to talk about its contribution to the outsized run in tech that we have seen. Perhaps more people were short than we might have assumed. Maybe the proliferation of hedge funds has created a cadre of wannabe short-sellers who piled onto stocks at bad prices, and now they are taking them back in, due to the run-up. On many occasions, I have stated that the market is just about chasing motion. Obviously, I don't know who's been buying semiconductor, semiconductor-equipment and PC-related stocks. But I do know that these companies are accidents waiting to happen -- and that at some point, which is not yet knowable, the crowd of buyers will finally realize this.
Three-card monte, eleven-rate-cut Al
You might well ask how we've come to this place where the stock market resembles a game of three-card monte, in which volatility has become a staple of the action. I will share with you my pet theory. Obviously, the bubble fomented by Easy Al (a.k.a. Greenspan) gave us the mania of a lifetime. It warped people's views about what stocks would do, causing them to take more risk than they ever thought possible. Both his monetary and bailout policies made everyone believe there was an implied put. (Sorry to break my policy about not talking about the man I said I wouldn't discuss anymore, but in this case, he is germane to the topic.)
In addition, the explosion of employee benefit plans -- either defined-contribution or 401(k) -- during the early 1990s spawned the phenomenon of individuals taking control of their own investment choices. That precipitated a variation of Gresham's Law, in my opinion, which saw bad money-management strategies driving out good ones. What happened in the mania was that money tended to flow to whoever could boast the biggest numbers. This bred the following view among mutual-fund managers, and perhaps hedge-fund operators:
We can only be fired if we don't maximize the upside, and, if the market goes down, we'll all go down together. So that's OK -- we can't be blamed for this. (The "consultants" who advise giant pools of capital have also exacerbated this mindless approach to investing, but that is a topic unto itself.)
I would just pause here to say that the explosion of mutual funds on the back of the defined-contribution/401(k) phenomenon is one of the reasons I left the money-management business to set up my short fund in 1996. (When I entered the business, in the dinosaur year of 1982, we always had to meet face-to-face with our clients. That physical proximity promoted a tacit sense of responsibility for managing other people's money, especially when they grilled you from a few feet away.) I felt that all the trends in the industry were wrong, and that this, combined with Easy Al, would lead to big trouble. (I obviously was four years and many thousand points too early, but exactly what I feared happened, only on a much, much greater scale.)
In any case, we have a situation in which people are behaving recklessly with other people's money (OPM). They do things that they might not ever consider doing with their own money, because they sort of feel like they have to. (Ask yourself this question: Where would the market averages trade if everyone managed their own money?) They must be involved, and they must show good numbers if the market goes up. On the other hand, if the market goes down, that's everybody's problem, so it doesn't count.
Swoop-down metronomics
This asymmetrical approach is exactly how Greenspan once described Fed policy. He stated that the Fed wouldn't really interfere if the market was going up, but, if the market was going down, it would move heaven and earth to try to stop it. Both Fed policy and the money-management industry have an asymmetrical bias, to a large degree. So, to repeat, everyone has to pile in on the way up, while on the way down, everyone can just suffer together. And that, ladies and gentlemen, is how I believe we have come to find ourselves in this sorry state -- too many people running too much money anonymously for other people.
So, I believe that is the reason why the tape is so wild. The public has probably learned a lesson about how risky the stock market can be, and it's no longer sending money to Wall Street. But the people who have the money are behaving in the same crazy way as they did in the mania, because that's what they think they're forced to do. Until people's expectations change about what professionals are supposed to do (i.e., focus on return of capital, as well as return on capital), this insane volatility and tape-chasing may be with us. Who knows, I may be all wet, but that's how I feel.
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