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Posted 11/15/2004
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A new kind of risk, and it's your fault
To company risk and market risk, add career risk -- the danger that career-minded money managers take too many chances to satisfy the public's unrealistic expectations.
By Bill Fleckenstein
I'd like to share an insight that finally became clear to me last week. (If everyone else has already figured this out, I'm sorry that I am the last one to know.)
I think that what I'm about to discuss explains why the market has behaved in such an increasingly speculative, chaotic manner for about the last 10 years, versus how it behaved in the 1980s (or even the early 1990s, for that matter).
When I started out in the investment business in 1982, most money was run by banks and investment-counseling firms. I was part of the latter community. Back then, I believe that the investment world tried to act pretty responsibly. They really did worry about risk, viewing the money entrusted to them as though it were their own.
Opting out of a reckless environment
One reason I left the investment-counseling business in late 1995 (in addition to my concerns about what Fed chief Alan Greenspan was doing) was that I could see the more reckless contingent was going to get the upper hand. As the public started to take charge of their money and turned it over to mutual funds, I realized that this development would create an environment where my concept of the best way to run money would not be particularly successful. In other words, there was no way I was going to be at the top of the performance sweepstakes, which is what folks demand.
I believe that the behavior of the public helped drive the mutual-fund industry to the sort of gunslinger mentality that prevailed in the late 1990s and early 2000, where all the money flowed to the zaniest money managers who put up the biggest numbers. That mentality is similar in the hedge-fund community, where money has moved over the last few years. (It can be argued, however, that some of these people have actually put some of their own money at risk. So, they behave in a somewhat saner fashion.)
Career risk vs. portfolio risk
The bottom line is that we have bred a much more speculative, trading-oriented investment community. Instead of worrying about losing money, the overwhelming majority worries that they won't perform well enough on the upside. The fear of getting fired for not having made enough is the driving factor.
Related news and resources
In a recent article, respected investment strategist Jeremy Grantham, chairman of Grantham, Mayo, Van Otterloo & Co., described this brilliantly:In markets where investors hand over their money to professionals, the major inefficiency becomes career risk. Everyone's ultimate job description becomes 'keep your job.' Career risk-reduction takes precedence over maximizing the client's return. Efficient career-risk management means never being wrong on your own, so herding, perhaps for different reasons, also characterizes professional investing. Herding produces momentum in prices, pushing them further away from fair value as people buy because others are buying. That, ladies and gentlemen, is a perfect description of what the professional money-management business has become.
Grantham went on to make a couple of insightful points: Refusing, on value principle, to buy in a bubble will, in contrast, look dangerously eccentric. And when your timing is wrong, which is inevitable sooner or later, you will, in Keynes' words, 'not receive much mercy.'" He summed up what that means to the folks who try not to go with the herd and do the right thing: Today the challenge is not getting the big bets right. It's arriving back at trend with the same clients you left with. . . .
Dislocation before a new/old way of doing business
I myself continue to expect the investment business to revert to the saner style that I grew up with. This is not to say that the market then didn't do weird things, confound people or get out of whack. It did. It just wasn't anywhere near as maniacal as it has become. To repeat, I fully believe that we will eventually revert to a more conservative environment. But I think the only way that can happen is through some sort of a market dislocation, as I have been discussing for at least the last six months. Though it has not yet occurred, I still think it will at some point. I just don't see how the structure presently in place can unwind in anything but a violent manner that involves some dislocation.
I think that if one approaches their own problems or disputes with the market by first knowing the personality of the enemy, as it were, they will be more successful. I know that in my own short-selling, when I act as though the guys I'm fighting against will behave in the manner I've described, I often do better. For example, I sometimes get out of the way because we're in the no-news period and I expect them to take stocks up, even though it doesn't make sense that they should. Oftentimes that tactic works better than sticking with my shorts, as I have done recently, with the view that the dire macro problems will matter.
Of dilettantes and their wants
I believe that the demands of individuals, consultants and committees that run employee-benefit plans -- people who are not really investment professionals and tend to want to buy high and sell low -- are partially responsible for the behavior of the professional investment community. Whether it's Joe and Jane Six-Pack deciding for themselves, or the committee that runs Joe and Jane Six-Pack's money, these tend not to be sophisticated investors.
They think they've been around the investment markets, but most have really only grown up in a bull market. These are the folks who are not particularly good at risk management, and who are setting the incentives, as described by Jeremy Grantham, that have produced the market environment we are now in. Hopefully, that long-winded discussion will help folks deal with this environment.
Toppling technical analysis from Mount Olympus
Lastly, because of the moment-to-moment performance demands that people now perceive, and the advent of PCs, I believe technical analysis has become the vehicle of choice for doing analysis. That everybody has all the technical bells and whistles at their fingertips has made people believe too strongly in the merits of technical analysis. Example: A lot of people believe that the recent breakout in the S&P means the market must trade higher at the end of the year. And nothing else matters.
Maybe they will get that right. But I think that, at some point, technical analysis will be the big hook in the market that will trap people. Technical analysis is a tool, like bottoms-up fundamental analysis or looking at the macro environment. It's just one tool -- not the be-all and end-all that folks seem to think. It's not surprising, given the environment that I have described, that technical analysis has been elevated to such high status. But folks who only believe in charts will ultimately come to learn that there's a lot more to it than that.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. His investment 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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