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Posted 11/1/2002
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When marketing masquerades as investing
Those who bray loudest about economic recovery typically have something to sell. But remember, they're not gambling with their own money. They're gambling with yours.
By Bill Fleckenstein
The kiddies may have just removed their Halloween masks, but on Wall Street, disguise works year-round. Corporate chieftains are still out there spinning bad news into good news. In tech land, DRAM prices rise because of a manipulation dressed up as increased demand. And under the guise of helping clients, the people who play with other people's money turn trust into losses. Unfortunately, that deception is no illusion.
Buckle up, ladies and gentlemen, there's a lot of stuff to cover this week, beginning with some thoughts on false assumptions about the "recovery." The economic data we've seen over the past two weeks won't win any beauty prizes. Consumer confidence fell to a nine-year low of 79.4, vs. expectations of 90. Durable-goods orders, a notoriously volatile indicator, were a nightmare, down 5.9%, vs. expectations of a 1.6% decline. Nondefense capital-goods orders, ex-aircraft, were down a stunning 6.6%.
Suffice to say, these results are not a sign of economic strength (though as I mentioned, the data are volatile), and that brings me to my concern for people who pay today's prices for securities. Their implicit assumption is that the economy is in the process of getting better. As I have repeatedly stated and tried to cite evidence to back it up, my belief is that the economy is getting weaker. That, coupled with current stock prices, is a recipe for huge trouble all over again.
FOPM (formerly other people's money)
And yet people continue to turn their back on trouble. In tech land, for example, a leading fantasy is that since DRAM prices have been ticking up, tech companies may improve. Ladies and gentlemen, you should investigate the people who manage your money, and if you find any of them buying stocks on the back of this, you should summarily fire them. Demand is not picking up in the DRAM market. The DRAM market is manipulated, as I have written about so many times in the last six years. Manipulation often happens in the middle of Micron Technology's (MU, news, msgs) quarter.
Additionally, Insight Enterprises (NSIT, news, msgs), a reseller of computer gear and a competitor of CDW Computer Centers (CDWC, news, msgs), recently lowered its revenues and its earnings forecast going forward. Most people don't pay attention to this rather smallish company, but again, its news is not exactly a sign of strength. As long as we're on the subject of CDW, I notice that there has recently been pretty chunky insider selling, something I've been waiting to see as confirmation that I'm on the right track with my short. I might add that as a short-seller, I pay attention to insider selling when it happens in a way that seems to corroborate my view (and I really pay attention to insider buying). A lot of times, it's just noise and can't be counted on, but in this particular case, I think it might be meaningful.
Buy low, sell HI
Shifting from tech, for a minute, I would just point out that things have been maniacal in other areas, also, because the people who play with other people's money like to do that in a number of ways. Take Household International (HI, news, msgs), for example. A couple of weeks ago, at the supposed bottom, the stock was trading around $21. Within four days, it traded at $31. Just a little over a week ago, it was $22 and change, after the company sold stock "in the hole" at $19. So it's just another example of mindless chart-chasing.
Household obviously has problems, just as Cigna (CI, news, msgs) has problems. This large insurance company's stock price was crushed recently, when it came close to doing a 2-for-1 split the hard way. For people who don't know, one of Cigna's troubles is that it has written a bunch of insurance policies that are geared to the stock market going higher. This leads us to another source of trouble -- the credit area in general, where I believe that potential problems in credit insurance are another time bomb that's not been talked about in the popular press. A lot of people who own bonds think they are safe because they have credit insurance. I don't believe that the people who issue this credit insurance could handle a lot of things going wrong at once, which could easily happen.
That translates directly to potential problems in money-market funds. A recent story in The Wall Street Journal titled "Money Funds Slash Their Fees to Stay at $1 Net Asset Value" talks about low yields and people cutting costs so they won't have to "break the buck." Also, potential credit problems could find their way into money funds. I myself refuse to own a money-market fund unless it is a government-only fund. I think other people should give up that minuscule yield and do the same. It's not worth taking the chance. I am not saying that anything will go wrong, but for safety's sake, who cares about maximizing yields at these levels?
Please pass the shrimp stock tale
Returning to my rant about Other People's Money (OPM), I'd like to talk about a recent story in The Wall Street Journal titled "Rally Aside, It's a Hard Sell in the Heartland." This shows the lengths to which investment marketers will go to try to keep people in the pool (though mutual-fund manager Peter Zuger, who is profiled in the story, deserves credit for at least taking the trouble of meeting face-to-face with concerned shareholders). The problems they've been having is shown in a comment by one woman who attended a dinner for mutual-fund investors, and I think it sums up the change in attitudes rather nicely: "There's a time when you just don't feel comfortable anymore. It's what all the other investment people are saying -- 'stay the course, keep putting money in because prices are low.' I'm not sure it gives me much assurance."
Well, it shouldn't give people much assurance. Prices may be down a lot, but as I've said repeatedly, there's a big difference between low and down a lot. Low implies a cheaper price relative to some tangible set of fundamentals that indicates you're getting a bargain. That is not the case, though the illusion of it comprises the main reason for people chasing this rally. They think it's the bottom. Stocks have been down so much. They've been down so long. It's a good seasonal period. Any of those arguments sound like things are cheap? If the market weren't dominated by people using other people's money, and people only invested their own money, it's quite obvious to me that prices would be dramatically lower.
In any case, part of what's wrong with the investment-management business is that it's not the investment-management business -- it's largely the investment-marketing business. Things have been set up for marketing. Think about it. The mutual-fund industry has created a million different ways to package a portfolio to prospective clients, and there are too many funds out there trying to sell them. There's small-cap value, large-cap value, small-cap growth, large-cap growth, etc., as well as many other little niches used by marketers. Some of these distinctions matter, but many of them do not. Some, in fact, are just oxymorons. Consider the category "large-cap growth." By the time you get to be a large cap, for the most part, your business is going to be much more cyclical. There are exceptions to that rule, pharmaceuticals being the most obvious.
Try this at home
But when it comes to the investment-management business, genuine concern about losing money takes a back seat to concern about missing the next rally. As a mini-expose, I'd like to share three reader e-mails from my daily column on RealMoney. The first is from a man whose stock market losses have awakened him to the link between marketing and the people who play with other people's money: "It's sometimes frightening how close to home your articles are. I just got done reading your Market Rap from today, and then made the mistake of checking my brokerage-account activity. Wouldn't you know it, my large-cap growth account shows that they bought a bunch of Applied Materials (AMAT, news, msgs) today."
He continues: "I would normally be upset, but it's gotten to the point where I can only laugh. (I'm still reeling from last week's surprise of seeing that my large-cap-value account manager bought a ton of Xerox (XRX, news, msgs)) What's even funnier is that I'm up 4% for the year on the money I'm managing myself. I sometimes wonder why these money managers are getting paid five times my annual salary." Obviously, this e-mail begs the question of why this gentleman has these people managing his money at all.
Lambs to the quarterly slaughter
Next, we'll hear from a pension-fund consultant whose comments are a ringside seat into the world of OPM: "I work for a pension-consulting firm. We consult to large DB (defined-benefit) plans, public plans, and endowments/foundations. At the firm, my job is to perform due diligence on investment managers. All day long, I get to listen to people tell me, 'Well, this benchmark, which for some reason we choose to mimic, lost 30%. We lost 20% this year. However, we stayed true to our style (large-growth, mid-value, blah, blah, blah). Therefore, we've done a good job.'
"It makes my blood boil. For most of these clowns, their true style is losing my clients' money, year after year after year. I think our clients are naive. And for that, I'm eternally grateful. If I were in charge of a large pension fund and somebody came to me with those results, I'd beat them senseless. Nonetheless, our clients buy into this 'style purity' bull that my firm, and my industry, propagates. So long as the managers stay close to the benchmark, they won't get fired. Someday, someone will pull the wool from their eyes and we'll get fired. I hope it happens in my lifetime, but I'm not holding my breath."
He concludes: "They buy Intel (INTC, news, msgs) and KLA-Tencor (KLAC, news, msgs) and Applied Materials because their mandates require exposure to the 'major' sectors of the index. They can't go back to their clients and say, 'Well, friends, the outlook is apocalyptic, but we are prohibited from holding cash and from exiting sectors, so we buy the stocks that we think will take the smallest hit.' In conjunction with that, they concoct a fundamental story to justify their decision. All you can do is laugh. The worst part is that these same people manage money for retail investors, using the same philosophy and process. Too bad we retail investors don't have any way to make amends for being 'underfunded' as a result of lousy performance."
Fluent in effluent
Now on to the last and perhaps most poignant of the e-mails: "A casual friend of mine is a physician who retired five years ago with $2.4 million. He has been calling me over the past six months, slowly revealing a heartbreaking story. He asked me how I have been doing in the market, and I replied that my short sales have been doing wonderfully. After speaking at length, he revealed that his broker at Morgan Stanley Dean Witter has kept him fully invested in aggressive-growth mutual funds and tech. His $2.4 million is now $0.8 million. He has to put his dream home up for sale, and may have to go back into practice at the age of 67."
He continues: "I replied that I thought the actions of his 'personal friends' at MWD bordered on the criminal, for not having fixed AAA fixed-income, or just anything other than what he has. Each time he would go to their office to speak with them about his portfolio performance, they would pull out all their charts and cajole him into hanging on just a while longer with the turn just around the corner. With his comfortable retirement in shambles, he is a nervous wreck. Insomnia and stomach ulcers rule his life."
Feet of clay, miles of misery
Obviously, this unfortunate gentleman is not without some responsibility, as he watched his portfolio melt. But this kind of thing has happened all over America, and for two reasons. First, as I have said, due to the irresponsibility of the money-management industry, and second, because of the man who I don't mention anymore. That said, you'll find his name mentioned a lot in two tremendous articles that everyone should read. In "For Whom the Closing Bell Tolls," (see link at left under Related Sites) Jim Rogers gives his take on the mania, and specifically the pivotal role of the Fed chairman. I always like being in the same camp with Jim Rogers, because he is one very smart fellow.
Similarly, Jeremy Grantham filets the Fed chairman in "Feet of Clay: Alan Greenspan's Contribution to the Great American Equity Bubble" (see link at left under Related Sites). It's now becoming clearer to everyone why I have such contempt for Greenspan, for the damage that has come to so many innocent bystanders, thanks to his being the most irresponsible and incompetent Fed chair in history.
Finally, with the damage from the bubble so painful and pervasive, people are left wondering how they will be able to do well in the market. Along the lines of reform, I think we need to see options that make sense and that aren't driven solely by marketing. Over the next several weeks, I'll write more about a lot of the things that I believe are wrong and disgusting in this industry. At some point, I hope to perhaps come up with a few ideas about what people can do to find someone they can have trust and have confidence in.
William Fleckenstein is the president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column for TheStreet.com's RealMoney. At time of publication, William Fleckenstein owned none of the equities mentioned in this column. He held short positions in Applied Materials, KLA-Tencor, CDW Computer Centers and Intel. Positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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