It is so many years ago now that I cannot exactly recall when it was that I started receiving Peter Bernstein’s Economics and Portfolio Strategy newsletter. At some point I guess his wife Barbara must have switched from using a typewriter to a word processor, but the format – four to eight pages or so of elegant prose, a couple of graphs, the distinctive coloured paper – has barely changed.
Now with Peter’s death, at the grand old age of 90, another distinctive voice in the investment world has been silenced. As some of his obituaries have noted, one of the remarkable things about Bernstein was that most of his intellectual output – the newsletter, the Journal of Portfolio Management, his many books on investment themes - only began at an age when most people were already contemplating retirement.
There is an irony in the fact that he should die at a point when financial markets are once again under attack for having failed the societies they are meant to serve, for few people have done more to promote an understanding of the way that financial markets work. His whole career was dedicated to advancing the idea that investment is a professional business to which rigorous thinking and standards could (and should) be applied.
He was a willing and enthusiastic exponent of the many ideas that, for good and ill, have come out of academia to reshape our attitudes to finance. The Journal of Portfolio Management, which he founded in 1974, was created precisely so as to provide a forum in which the new ideas could be presented and challenged.
In his wonderfully readable history of modern financial theory, Capital Ideas, he recalled how in his days working for a family-oriented bank in the 1950s, “clients would come to us and say ‘Here is my capital. Take care of me’. As long as their losses were limited when the market fell, and as long as their portfolios rose as the market was rising, they had few complaints. They came to use and stayed with us because we understood their problems and the myriad kinds of contingent liabilities that all individuals must face”.
“We joked that we were nothing more than social workers to the rich – but skilled social workers to the rich, confident that our performance was being measured in human satisfaction rather than in comparative rates of return. We knew no more about the clients of other investment managers than they knew about ours”. That world, still dominated by the private investor, is far removed from the faster, harsher, more institutionalised world we inhabit today.
And yet of course the changes that the intellectual advances and innovation of the last 35 years have unleashed – in performance measurement, in traded options, in asset allocation, in our understanding of risk and so on – have been far from an unalloyed success. Those who believed in efficient markets and rational expectations have been forced to accept the inexorable evidence that such ideas are badly flawed – and indeed, wrongly applied, have the power to do harm as well as good.
Bernstein never believed however that the course of financial innovation would run smoothly. In Capital Ideas, which appeared son after the 1987 stock market crash and the jailing of Michael Milliken, he was already defending the role of the stock market in capitalism. By making diversification easy and inexpensive, he argued, the stock market increases liquidity and enhances the overall level of risk-taking in society.
And risk-taking, with all its ups and downs, is essential to economic progress.”Institutions that encourage risk-taking are essential if a society is to grow and raise its living standards. Granted, risk-taking involves social costs. But the capitalist nations have no monopoly on pollution, maldistribution of income, inadequate education, poverty, speculation, crime or corruption”.
Nonetheless he ended his book by quoting Harry Markowitz, the father of modern portfolio theory: “Granted that the invisible hand is clumsy, heartless and unfair, it is ever so much more deft and impartial than a central planning committee”. Amidst the wreckage of the shadow banking system, such faith in the power of financial innovation to do good over time is inevitably once again under challenge.
The irony is that, in Bernstein’s view, the greatest contribution that financial theory has made over the last three decades is in providing the tools that allow us to understand and measure risk more accurately. Yet those tools, some of which are embedded in the Basel 2 regulatory regime, for example, have proved wholly inadequate to prevent a banking crisis of unprecedented proportions.
There is plenty of work therefore still to be done in understanding the way that unfettered markets work and the limits that should rightly be placed on them. It is a shame that Bernstein himself will no longer be around to chronicle the next stages of the ongoing financial revolution of which he was both champion and critic. His own view, elegantly expressed in his newsletter on many occasions, was that investment risk is far more complex and multi-faceted than most investors assume.
Read more...
Friday, June 19, 2009
Sunday, June 7, 2009
Normality Returns - Up To A Point (FT Column)
Pinch yourself for a moment and it is possible to convince oneself that the financial markets have returned to normality after the drama of the global financial crisis. Libor, for example, has returned to more traditional levels after last year’s market seizure. Many stock markets are back to somewhere around fair value. The dollar has fallen back to a point where it is trading at around purchasing power parity against sterling and the euro.
Bond yields are rising towards a level that once more incorporates at least some expectation of future inflation. The yield curve is upward sloping. Investment bankers are doing well again, even if it is largely by dint of the fees from organising rescue rights issues for each other. After a year in which it has yo-yoed crazily, from a peak of $145 per barrel down to little over $40 a barrel, the oil price has returned to a level that once more appears to bear some relationship with the fundamental balance of supply and demand. Other commodities are following suit.
But these are still far from normal times, as even the most cursory glance at the news testifies. Although the banking system appears now to have been saved by the concerted efforts of governments and central bankers, the global economy is still going backwards, only at a slower rate than before.
Unemployment continues to rise, and the fallout from the ongoing economic slowdown is causing political turmoil in some of the worst affected countries. The risk of future banking setbacks remains acute as lending losses across a range of sectors, including corporate banking, private equity and commercial property, have still to be realised.
In commercial property, for example, the bill for excessive lending threatens to be impressively large, though it has yet to show up meaningfully in reported accounts. Chris Turner, the long-serving manager of the TR Property Trust, estimated last week that the value of UK commercial property assets has fallen by around 40% from its peak of £800 billion in 2007, and there is probably a further decline in values of 10%-15% to go before the cycle is through.
The debt that supports these £400 billion of UK assets amounts to £300 billion. It is going to take several years for the property business as a whole to work its way back to a healthy capital structure - “a long drawn out and hard refinancing road lasting perhaps five to seven years”, in Mr Turner’s words.
While the recovery in equity markets has been impressive, its resilience also remains suspect. The lopsided nature of the market’s recovery, led as it has been by the most cyclical stocks, many with poor financial characteristics, appears to owe more to kneejerk reactions than to considerations of fundamental value.
Many investors have been caught out by the speed and extent of the recovery from the lows of early March and to avoid being left behind have been buying the highest beta instruments they can find. News that the Coppock Indicator has flashed a buy signal may further excite this trend.
The comments made last week on this subject by Neil Woodford, Invesco Perpetual’s income fund manager, seemed to me to be apt. He sees parallels between today’s market conditions and the two-tier market that prevailed in the immediate aftermath of the 2000 technology bubble, when many high quality companies with solid earnings and healthy balance sheets were priced on yields and p/e ratios which, both then and in retrospect, appear ridiculous, especially when compared to those accorded to much flakier businesses.
“We’re in a similar sort of polarised market” today, Woodford thinks, the irony being that the companies that are best equipped to survive the choppy economic times that lie ahead are the very ones that the market currently refuses to favour.
The cyclical stocks that have done so well in the last three months have risen to astonishing levels, in his view, given that “there’s been no recovery in the economy, there’s been no increase in earnings, [and] there’s been no tangible sign of any improvement in profitability for many months now”. As it will be a long time before the economy begins to experience a sustained renewal of economic growth, he is surely right that it leaves a lot of risk in cyclical sectors, impressive though the current momentum behind that move has been.
Of course some will say that Mr Woodford is only talking his book, as his preference for defensive, higher quality stocks has for now left his funds’ performance trailing that of many of his peers. But that would be a dangerously short-sighted conclusion. The arguments for thinking that equities are now the asset class of choice for the medium term are strong.
One historic trend that has not yet returned to normal is the yield gap between equities and government bonds, which still clearly favours the former. As was noted here last week, making money out of Government bonds over the medium term at today’s yields looks extraordinarily difficult, although there will be opportunities to trade the market’s volatile perceptions of the inflation/deflation outlook. But the value is not necessarily where the market currently chooses to think it is.
Read more...
Bond yields are rising towards a level that once more incorporates at least some expectation of future inflation. The yield curve is upward sloping. Investment bankers are doing well again, even if it is largely by dint of the fees from organising rescue rights issues for each other. After a year in which it has yo-yoed crazily, from a peak of $145 per barrel down to little over $40 a barrel, the oil price has returned to a level that once more appears to bear some relationship with the fundamental balance of supply and demand. Other commodities are following suit.
But these are still far from normal times, as even the most cursory glance at the news testifies. Although the banking system appears now to have been saved by the concerted efforts of governments and central bankers, the global economy is still going backwards, only at a slower rate than before.
Unemployment continues to rise, and the fallout from the ongoing economic slowdown is causing political turmoil in some of the worst affected countries. The risk of future banking setbacks remains acute as lending losses across a range of sectors, including corporate banking, private equity and commercial property, have still to be realised.
In commercial property, for example, the bill for excessive lending threatens to be impressively large, though it has yet to show up meaningfully in reported accounts. Chris Turner, the long-serving manager of the TR Property Trust, estimated last week that the value of UK commercial property assets has fallen by around 40% from its peak of £800 billion in 2007, and there is probably a further decline in values of 10%-15% to go before the cycle is through.
The debt that supports these £400 billion of UK assets amounts to £300 billion. It is going to take several years for the property business as a whole to work its way back to a healthy capital structure - “a long drawn out and hard refinancing road lasting perhaps five to seven years”, in Mr Turner’s words.
While the recovery in equity markets has been impressive, its resilience also remains suspect. The lopsided nature of the market’s recovery, led as it has been by the most cyclical stocks, many with poor financial characteristics, appears to owe more to kneejerk reactions than to considerations of fundamental value.
Many investors have been caught out by the speed and extent of the recovery from the lows of early March and to avoid being left behind have been buying the highest beta instruments they can find. News that the Coppock Indicator has flashed a buy signal may further excite this trend.
The comments made last week on this subject by Neil Woodford, Invesco Perpetual’s income fund manager, seemed to me to be apt. He sees parallels between today’s market conditions and the two-tier market that prevailed in the immediate aftermath of the 2000 technology bubble, when many high quality companies with solid earnings and healthy balance sheets were priced on yields and p/e ratios which, both then and in retrospect, appear ridiculous, especially when compared to those accorded to much flakier businesses.
“We’re in a similar sort of polarised market” today, Woodford thinks, the irony being that the companies that are best equipped to survive the choppy economic times that lie ahead are the very ones that the market currently refuses to favour.
The cyclical stocks that have done so well in the last three months have risen to astonishing levels, in his view, given that “there’s been no recovery in the economy, there’s been no increase in earnings, [and] there’s been no tangible sign of any improvement in profitability for many months now”. As it will be a long time before the economy begins to experience a sustained renewal of economic growth, he is surely right that it leaves a lot of risk in cyclical sectors, impressive though the current momentum behind that move has been.
Of course some will say that Mr Woodford is only talking his book, as his preference for defensive, higher quality stocks has for now left his funds’ performance trailing that of many of his peers. But that would be a dangerously short-sighted conclusion. The arguments for thinking that equities are now the asset class of choice for the medium term are strong.
One historic trend that has not yet returned to normal is the yield gap between equities and government bonds, which still clearly favours the former. As was noted here last week, making money out of Government bonds over the medium term at today’s yields looks extraordinarily difficult, although there will be opportunities to trade the market’s volatile perceptions of the inflation/deflation outlook. But the value is not necessarily where the market currently chooses to think it is.
Read more...
Monday, June 1, 2009
The Argument For Long Bonds (FT Column)
One phrase of Professor Paul Samuleson’s that has stuck in my mind for 20 years was his exhortation that investors should always “work the other side of the street”, the idea being that you are more likely to find value in testing non-consensual views as in accepting conventional thinking at its face value. Given that the remarkable feature of financial markets at present is how quickly consensus thinking seems to switch from one extreme view to another, the mental gymnastics required to do as he suggests have become increasingly demanding.
But the need for such challenge remains, with the inflation-deflation debate the most important current issue. In little more than a year, market prices suggest that we have moved from fear of inflation to fear of savage deflation – and now back again. True, it is not easy to gauge where consensus thinking genuinely now lies on this subject, as short covering by frustrated bears surely accounts for a good deal of the force behind the equity market’s recent strength.
My impression is that the majority of market participants remain unconvinced by the argument that inflation is once again the main enemy. There is no denying however that sentiment to that effect is gaining momentum. Most of the professional investors whose judgement I rate highly are now acting in the belief that the inflation, not deflation, camp is the right place to belong. The belief that deflation has been licked is one of the factors that has been driving equity markets higher.
In such circumstances, the need to stand back and look at the other side of the argument is greater than ever. The bond market is one obvious place to look. Peter Geikie Cobb, who co-manages Thames River Capital’s Global Bond fund (up a handsome 36% last year), gave me a powerful corrective opinion last week. His view is that there is simply no convincing evidence that inflation is rearing its head, or will do so any time soon. So firm is this conviction that his fund’s largest position by far is now in the longest duration UK gilt you can find, namely the 4.25% 2055 issue, currently yielding 4.5%. He and Paul Thursby, his co-manager, have never, it seems, owned such a long duration government bond portfolio as they do today.
The argument for such an apparently high risk stance, in essence, is that even if renewed inflation is eventually on its way, to bet on such an outcome today is distinctly premature. The only way that the US and UK economies can redeem their spiralling debt burden in the short term is through a rapid increase in the savings rate. That is already happening, but many investors may be underestimating how far and fast that process needs to unfold. Past experience suggests it will be dramatic.
In Thames River Capital’s view, with prices still falling, it is likely to be several years before we see reported inflation rising above 0%, which is why they see real yields of 4% or more at the long end of the curve as attractive. While it is evident that quantitative easing will hold down shorter dated yields in the government bond market, there is no doubt that the prices of longer dated issues do look, in general, more appealing. Although TIPs appear better value, real yields on index-linked gilts are too low to generate much current interest.
Given the unprecedented reflationary efforts now under way, some will argue that the 20-year bull market in government bonds must already be approaching its end. The charts still tell a somewhat different story. Measured against their 20-year history, yields for 10-year benchmark gilts, at 3.5%, are still firmly in the middle of the down-trending channel they have followed over the whole of those two decades. If the tipping point is coming, in other words, it has certainly not yet arrived, let alone confirmed.
So while government bonds as a class seem distinctly unattractive to those of us who expect higher inflation, the more you look at it, the case for the long bond play, whether you regard it as a hedge or as a trade, looks not unreasonable. To put it another way, even if you are concerned about inflation, it may be the least worst option available in Government bonds.
Notable too is another of the Thames River Capital team’s current convictions, which is that sterling’s renewed has further to run. Their argument is that the eurozone has still to take the punishment that sterling has had over the past few months and that the pound could well go to $1.65/$1.70 to the dollar and 1.25/$1.30 to the euro before its current bout of strength is done. Even if sterling loses its AAA status, as is certainly possible, most other currencies will be suffering just as much, if not more.
Read more...
But the need for such challenge remains, with the inflation-deflation debate the most important current issue. In little more than a year, market prices suggest that we have moved from fear of inflation to fear of savage deflation – and now back again. True, it is not easy to gauge where consensus thinking genuinely now lies on this subject, as short covering by frustrated bears surely accounts for a good deal of the force behind the equity market’s recent strength.
My impression is that the majority of market participants remain unconvinced by the argument that inflation is once again the main enemy. There is no denying however that sentiment to that effect is gaining momentum. Most of the professional investors whose judgement I rate highly are now acting in the belief that the inflation, not deflation, camp is the right place to belong. The belief that deflation has been licked is one of the factors that has been driving equity markets higher.
In such circumstances, the need to stand back and look at the other side of the argument is greater than ever. The bond market is one obvious place to look. Peter Geikie Cobb, who co-manages Thames River Capital’s Global Bond fund (up a handsome 36% last year), gave me a powerful corrective opinion last week. His view is that there is simply no convincing evidence that inflation is rearing its head, or will do so any time soon. So firm is this conviction that his fund’s largest position by far is now in the longest duration UK gilt you can find, namely the 4.25% 2055 issue, currently yielding 4.5%. He and Paul Thursby, his co-manager, have never, it seems, owned such a long duration government bond portfolio as they do today.
The argument for such an apparently high risk stance, in essence, is that even if renewed inflation is eventually on its way, to bet on such an outcome today is distinctly premature. The only way that the US and UK economies can redeem their spiralling debt burden in the short term is through a rapid increase in the savings rate. That is already happening, but many investors may be underestimating how far and fast that process needs to unfold. Past experience suggests it will be dramatic.
In Thames River Capital’s view, with prices still falling, it is likely to be several years before we see reported inflation rising above 0%, which is why they see real yields of 4% or more at the long end of the curve as attractive. While it is evident that quantitative easing will hold down shorter dated yields in the government bond market, there is no doubt that the prices of longer dated issues do look, in general, more appealing. Although TIPs appear better value, real yields on index-linked gilts are too low to generate much current interest.
Given the unprecedented reflationary efforts now under way, some will argue that the 20-year bull market in government bonds must already be approaching its end. The charts still tell a somewhat different story. Measured against their 20-year history, yields for 10-year benchmark gilts, at 3.5%, are still firmly in the middle of the down-trending channel they have followed over the whole of those two decades. If the tipping point is coming, in other words, it has certainly not yet arrived, let alone confirmed.
So while government bonds as a class seem distinctly unattractive to those of us who expect higher inflation, the more you look at it, the case for the long bond play, whether you regard it as a hedge or as a trade, looks not unreasonable. To put it another way, even if you are concerned about inflation, it may be the least worst option available in Government bonds.
Notable too is another of the Thames River Capital team’s current convictions, which is that sterling’s renewed has further to run. Their argument is that the eurozone has still to take the punishment that sterling has had over the past few months and that the pound could well go to $1.65/$1.70 to the dollar and 1.25/$1.30 to the euro before its current bout of strength is done. Even if sterling loses its AAA status, as is certainly possible, most other currencies will be suffering just as much, if not more.
Read more...
Thursday, May 21, 2009
No Going Back - Guy Monson
The stock market rally since its lows in early March (up 37% as of May 20th) has now exceeded any previous recorded bear market rally in history, says Guy Monson, Chief Investment Officer of Sarasin Investment Partners. The previous best bear market rally was 35% in 1937, according to Ned Davis Research historical data. The implication therefore is that what we are seeing is the real thing, not a false dawn.
Although we are seeing the first genuinely global recession, the current recovery in forward looking financial markets is very much running true to past form. Extreme spikes in volatility, like the one recorded in December 2008, have always marked the low points in asset classes in the past. The same goes for rock bottom consumer confidence. The liquidity injection overseen by Mr Bernanke is unprecedented and must lead to asset price inflation.
The biggest concern from here will be the living with the consequences of the unprecedented expansion of the State as Government step into the breach to offset the effect of the surging savings rate in the US and the UK. Sarasin separately are launching fully hedged versions of their global equity funds so as to allow sterling investors to take advantage of the typical pattern of pound currency shocks – namely, sharp falls in response to external events (eg 1992 andthe ERM), followed by a gradual recovery over the subsequent 2-3 years. The pound has fallen well to the south of its long run trading range, as well as below purchasing power parity, and therefore can be expected to continue appreciating, notwithstanding the risk of the UK losing its AAA credit rating as a result of its ballooning public debt and massive fiscal deficit.
Sarasin are also marketing a global equity income fund to reflect the fact that, following the disappearance of most financial sector dividends, the UK market’s dividend yield has becoming dangerously concentrated on just a handful of stocks (nearly 40% of the market’s dividend flow stems from just six stocks, BP and Shell, Vodafone, HSBC, Glaxo and AstraZeneca). The much bigger global equity market universe meanwhile has never had so many high yielding stocks to choose from. Sarasin’s fund has a current yield of more than 5.5%.
Read more...
Although we are seeing the first genuinely global recession, the current recovery in forward looking financial markets is very much running true to past form. Extreme spikes in volatility, like the one recorded in December 2008, have always marked the low points in asset classes in the past. The same goes for rock bottom consumer confidence. The liquidity injection overseen by Mr Bernanke is unprecedented and must lead to asset price inflation.
The biggest concern from here will be the living with the consequences of the unprecedented expansion of the State as Government step into the breach to offset the effect of the surging savings rate in the US and the UK. Sarasin separately are launching fully hedged versions of their global equity funds so as to allow sterling investors to take advantage of the typical pattern of pound currency shocks – namely, sharp falls in response to external events (eg 1992 andthe ERM), followed by a gradual recovery over the subsequent 2-3 years. The pound has fallen well to the south of its long run trading range, as well as below purchasing power parity, and therefore can be expected to continue appreciating, notwithstanding the risk of the UK losing its AAA credit rating as a result of its ballooning public debt and massive fiscal deficit.
Sarasin are also marketing a global equity income fund to reflect the fact that, following the disappearance of most financial sector dividends, the UK market’s dividend yield has becoming dangerously concentrated on just a handful of stocks (nearly 40% of the market’s dividend flow stems from just six stocks, BP and Shell, Vodafone, HSBC, Glaxo and AstraZeneca). The much bigger global equity market universe meanwhile has never had so many high yielding stocks to choose from. Sarasin’s fund has a current yield of more than 5.5%.
Read more...
An Anomaly In The Long Bond Market?
Long term government bond yields look very attractive, according to the managers of the Thames River Capital Global Bond Fund, Paul Thursby and Peter Geikie-Cobb. The biggest positions in their popular fund, up 34% in last year’s exceptional conditions, are in the longest dated UK gilts and US Treasuries, the former currently yielding 4.5%. This looks very tempting, given that, even if (like me) you are a believer that inflation will eventually return as a result of unprecedented Government and central bank activity, published inflation figures are not going to be positive for a long time yet. The real yield on long-dated government bonds looks a bargain therefore, though nobody in their right minds would voluntarily think of lending money to the UK government at shorter-dated rates.
I find this argument convincing, and have added some of these gilts to my own portfolio. Whether it turns out to be a hedge or a trade remains to be seen. (I will not be around to hold these instruments to maturity, alas). Sterling will also continue to strengthen, the Thames River Capital team thinks, and could well reach $1.70 and 1.30 to the euro before it is done. The euro looks most at risk. The two Thames River bond managers have never held such a long duration government bond portfolio as they do today, despite nearly 20 years investing in the field. They are also fully hedged back into sterling.
Read more...
I find this argument convincing, and have added some of these gilts to my own portfolio. Whether it turns out to be a hedge or a trade remains to be seen. (I will not be around to hold these instruments to maturity, alas). Sterling will also continue to strengthen, the Thames River Capital team thinks, and could well reach $1.70 and 1.30 to the euro before it is done. The euro looks most at risk. The two Thames River bond managers have never held such a long duration government bond portfolio as they do today, despite nearly 20 years investing in the field. They are also fully hedged back into sterling.
Read more...
Wednesday, May 20, 2009
The Odds on Market Recovery (FT Column)
This year’s market action has been a perfect advertisement for the Rip van Winkle school of investing: trade little, go to sleep for a year or two, and come back to find that nothing much has changed (FT Column, published May 11th 2009). At the time of writing, both the S&P 500 and the FTSE 100 index are up around 1% for the year. Yet what a ride it has been for those condemned to follow it day to day since the beginning of the year - from falling knife to what may be a runaway bull market in the space of little over two months.
If the March lows prove to be the lows for this phase of the equity market, as now seems very possible, it will be the third time in a decade for UK investors that the middle of March has proved a decisive turning point in the market. That should provide plenty of ammunition for researchers anxious to uncover a new statistical anomaly. “Change tack in March – and don’t turn back”, or something to that effect.
We don’t know for certain that we won’t see new lows again this year, of course. In his latest quarterly letter, Jeremy Grantham of GMO, one of the few asset allocators who sensibly acknowledges that market calls really are probabilities at best, never certainties, puts the odds of the market finding a new low this year or next at slightly better than evens. In practice, so he told me last week, these odds have been improving by the day, the longer the market recovery continues.
If the US economy picks up later this year, as he thinks it probably will, then the odds on the markets avoiding a new low will rise even further. It is only if the economic reality turns out to be disappointing later this year that the odds will go the other way. He thinks that this year’s market recovery could easily take the S&P 500 as high as 1100 before the recovery is done, although fair value in his view is only around 900. That looks possible to me too.
On the other hand, if that outcome does happen, it will certainly not stop us entering a new period of what Mr Grantham calls “long, drawn out disappointment” in the economy and the stock markets of the developed world. He is surely right that the fallout from the financial crisis cannot be wished away so easily. His view is that this market revival, which he has backed with a big chunk of his clients’ money in two big calls over the past six months, represents a “last hurrah” for the bulls.
If we are now past the markets’ turning point, it looks as if Governments the world over will have not just their massive stimulative efforts to thank for the revival in market sentiment, but also, paradoxically, the hedge fund community that they so love to malign. The smart bets that Odey Asset Management and Lansdowne Partners, among others, placed on UK banking stocks a couple of months back have been the starting gun that has fired bank shares on their current upwards trajectory.
On April 28th the newly bullish Mr Odey, in his quarterly call to investors, declared that shares in Barclays, his biggest call, then at £2, could go as high as £4, or five times what he paid when he made his first move into the banks. Ten days later the shares were already halfway to his target figure, as those who were short or still gloomy about the banks scrambled to cover their positions and catch the big move – the point being that if you have decided that the banks aren’t going to go bust, then it is no longer crazy to start valuing them on their earnings capacity and potentially fat margins. That assumption could still be tested on the GMO worst case scenario.
The last month’s market activity has been a textbook example of how bear markets, when they end, have an enormous capacity to catch out the unprepared and mentally rigid. It is unlikely that whatever they may say in public, Mr Bernanke or Mr Brown will on this occasion begrudge the handful of hedge funds who have profited from the banking sector revival their outsize gains. Although at least half the overgrown hedge fund sector will in due course disappear, the experienced hard core that will survive can at least now point to a genuine example of a periodic useful social function.
The biggest surprise of the market rally so far is not that it has happened, but that it has been that it has been led so aggressively by riskier assets, including emerging markets and midcap stocks. This appears to be proof, if proof were needed, that Warren Buffett was right when he said earlier this year that the world has moved from underpricing to overpricing risk. The fact that none of the four professional investors he selected a couple of years ago as potential successors for his CIO role at Berkshire Hathaway managed to beat the S&P 500 last year also tells its own story – which is never write off a great investor, especially one who still owns such a big chunk of his own investment vehicle.
Read more...
If the March lows prove to be the lows for this phase of the equity market, as now seems very possible, it will be the third time in a decade for UK investors that the middle of March has proved a decisive turning point in the market. That should provide plenty of ammunition for researchers anxious to uncover a new statistical anomaly. “Change tack in March – and don’t turn back”, or something to that effect.
We don’t know for certain that we won’t see new lows again this year, of course. In his latest quarterly letter, Jeremy Grantham of GMO, one of the few asset allocators who sensibly acknowledges that market calls really are probabilities at best, never certainties, puts the odds of the market finding a new low this year or next at slightly better than evens. In practice, so he told me last week, these odds have been improving by the day, the longer the market recovery continues.
If the US economy picks up later this year, as he thinks it probably will, then the odds on the markets avoiding a new low will rise even further. It is only if the economic reality turns out to be disappointing later this year that the odds will go the other way. He thinks that this year’s market recovery could easily take the S&P 500 as high as 1100 before the recovery is done, although fair value in his view is only around 900. That looks possible to me too.
On the other hand, if that outcome does happen, it will certainly not stop us entering a new period of what Mr Grantham calls “long, drawn out disappointment” in the economy and the stock markets of the developed world. He is surely right that the fallout from the financial crisis cannot be wished away so easily. His view is that this market revival, which he has backed with a big chunk of his clients’ money in two big calls over the past six months, represents a “last hurrah” for the bulls.
If we are now past the markets’ turning point, it looks as if Governments the world over will have not just their massive stimulative efforts to thank for the revival in market sentiment, but also, paradoxically, the hedge fund community that they so love to malign. The smart bets that Odey Asset Management and Lansdowne Partners, among others, placed on UK banking stocks a couple of months back have been the starting gun that has fired bank shares on their current upwards trajectory.
On April 28th the newly bullish Mr Odey, in his quarterly call to investors, declared that shares in Barclays, his biggest call, then at £2, could go as high as £4, or five times what he paid when he made his first move into the banks. Ten days later the shares were already halfway to his target figure, as those who were short or still gloomy about the banks scrambled to cover their positions and catch the big move – the point being that if you have decided that the banks aren’t going to go bust, then it is no longer crazy to start valuing them on their earnings capacity and potentially fat margins. That assumption could still be tested on the GMO worst case scenario.
The last month’s market activity has been a textbook example of how bear markets, when they end, have an enormous capacity to catch out the unprepared and mentally rigid. It is unlikely that whatever they may say in public, Mr Bernanke or Mr Brown will on this occasion begrudge the handful of hedge funds who have profited from the banking sector revival their outsize gains. Although at least half the overgrown hedge fund sector will in due course disappear, the experienced hard core that will survive can at least now point to a genuine example of a periodic useful social function.
The biggest surprise of the market rally so far is not that it has happened, but that it has been that it has been led so aggressively by riskier assets, including emerging markets and midcap stocks. This appears to be proof, if proof were needed, that Warren Buffett was right when he said earlier this year that the world has moved from underpricing to overpricing risk. The fact that none of the four professional investors he selected a couple of years ago as potential successors for his CIO role at Berkshire Hathaway managed to beat the S&P 500 last year also tells its own story – which is never write off a great investor, especially one who still owns such a big chunk of his own investment vehicle.
Read more...
Friday, April 24, 2009
Grounds For Optimism (FT Column)
This is the original version of my latest FT column, and is I suppose the nearest I have been to a unqualified market call for some time (I always bear in mind Galbraith's famous comment that economists forecast "not because they are know, but because they are asked"). My friend Jim Rogers, I see, talks in the latest issue of Barron's about this probably being "a bottom, but not necessarily the bottom", which is about where I come out too. It is far too risky, in any event, to be out of equities at this point.
The view expressed by this column at the start of 2007 was that it would be a good year for professional investors to study how bull markets end and to start preparing for that outcome. That turned out to be not a bad call, even though in the event it was not until the last quarter of the year that the market averages finally peaked and the financial crisis, in all its fury, started to spill over into the real economy.
The challenge for investors now is clearly to try and understand what lessons can be learnt from the way that bear markets bottom out and to prepare for that eventuality instead. After a traumatic first two months of the year, the markets have since caught a new mood of optimism – and there are, increasingly, some solid reasons to believe that this time they may be right to display that optimism.
Most bear markets, intriguingly, seem to display a number of common features. For example, they start out declining at a relatively slow pace and then accelerate. A typical pattern is for two thirds of the overall decline to be concentrated into the final third of the bear market’s duration.
While there have been bear markets that last more than 18 months, it is usually unwise – and increasingly risky – to act on the assumption that they will last much longer than that.
The reason is that the risks of missing out on what is often a rapid recovery in the first stages of a new bull market soon begins to outweigh the risk of further falls in the ageing bear market that preceded it. The scramble by underinvested professional investors to get back into stocks is one of the engines that typically then drives the equity markets back up to a higher level.
If you believe in these two simple metrics, the current bear market is acting true to form. The S&P 500 index, for example, peaked precisely 18 months ago, at 1565. Eleven and a half months later, in late August 2008, it had fallen to around 1200, a decline of just over 20%. From then until its recent low, at 676, it has fallen a further 44%. The Dow Jones index peaked a month later than the S&P index, but has followed a broadly similar pattern since, as has the MSCI World index.
From peak to trough, the US money manager Ken Fisher points out, it is unusual for the monthly rate of decline in the market averages during a bear market to exceed 2.5% to 3%. At the time of the lows in early March, the S&P 500 index had fallen at a rate of more than 3.5% since its peak in the autumn of 2007. This seems to imply that the risk of the market falling through its March lows any time soon is now relatively slim. It is certainly consistent
with the view that equity markets were horribly oversold at the end of February.
Of course historical precedents are made to be broken, and there are big differences in the regulatory, political and corporate environment compared to that which prevailed during the great bear markets of the past. Nevertheless the historical experience cannot be ignored. Russell Napier’s in-depth study of the four most extreme bear market bottoms in 20th century history (1921, 1932, 1949 and 1982) throws up further interesting pointers to what might be happening today.
His thesis is that the engine which drives bear markets to extreme lows is the fear of deflation. Once that threat recedes, or at least is no longer perceived to be real, it creates the conditions in which equity markets can recover. They typically won’t do so until (or unless) corporate bonds and commodity prices also improve. In the modern era, it is logical also to expect that the receding threat of deflation will be reflected in the price of index-linked Government bonds and
other measures of inflationary expectations.
In recent weeks all three of these market indicators have started to move in the right direction. While that does not prove that the bear market has ended, it is certainly not inconsistent with such an outcome. It provides the clearest of warning signs to the professional community that being out of the market is indeed becoming a significant risk for those willing to assume equity risk.
It is worth emphasising that the bear markets under discussion are medium rather than long term cycles. Mr Napier, for example, does not believe that we have seen an end to the long term bear market in equities that began in 2000. He does not expect the current generation’s equivalent of the four great market bottoms of the 20th century to hit for another five years or so, when the great bull market in bonds that began in 1981 finally runs its course and the dollar is abandoned as the world’s reserve currency.
If you thought what has happened so far is bad, in other words, there may well be worse to come. Today’s equity market valuations are still not as low as they typically fall to at the bottom of history’s worst bear market experiences. The issue however is whether there is money to be safely made from equities over the next 18-24 months and on that point, even without a crystal ball, and notwithstanding the huge uncertainties surrounding the real economy, the omens look much more positive than before.
jd@independent-investor.com
Read more...
The view expressed by this column at the start of 2007 was that it would be a good year for professional investors to study how bull markets end and to start preparing for that outcome. That turned out to be not a bad call, even though in the event it was not until the last quarter of the year that the market averages finally peaked and the financial crisis, in all its fury, started to spill over into the real economy.
The challenge for investors now is clearly to try and understand what lessons can be learnt from the way that bear markets bottom out and to prepare for that eventuality instead. After a traumatic first two months of the year, the markets have since caught a new mood of optimism – and there are, increasingly, some solid reasons to believe that this time they may be right to display that optimism.
Most bear markets, intriguingly, seem to display a number of common features. For example, they start out declining at a relatively slow pace and then accelerate. A typical pattern is for two thirds of the overall decline to be concentrated into the final third of the bear market’s duration.
While there have been bear markets that last more than 18 months, it is usually unwise – and increasingly risky – to act on the assumption that they will last much longer than that.
The reason is that the risks of missing out on what is often a rapid recovery in the first stages of a new bull market soon begins to outweigh the risk of further falls in the ageing bear market that preceded it. The scramble by underinvested professional investors to get back into stocks is one of the engines that typically then drives the equity markets back up to a higher level.
If you believe in these two simple metrics, the current bear market is acting true to form. The S&P 500 index, for example, peaked precisely 18 months ago, at 1565. Eleven and a half months later, in late August 2008, it had fallen to around 1200, a decline of just over 20%. From then until its recent low, at 676, it has fallen a further 44%. The Dow Jones index peaked a month later than the S&P index, but has followed a broadly similar pattern since, as has the MSCI World index.
From peak to trough, the US money manager Ken Fisher points out, it is unusual for the monthly rate of decline in the market averages during a bear market to exceed 2.5% to 3%. At the time of the lows in early March, the S&P 500 index had fallen at a rate of more than 3.5% since its peak in the autumn of 2007. This seems to imply that the risk of the market falling through its March lows any time soon is now relatively slim. It is certainly consistent
with the view that equity markets were horribly oversold at the end of February.
Of course historical precedents are made to be broken, and there are big differences in the regulatory, political and corporate environment compared to that which prevailed during the great bear markets of the past. Nevertheless the historical experience cannot be ignored. Russell Napier’s in-depth study of the four most extreme bear market bottoms in 20th century history (1921, 1932, 1949 and 1982) throws up further interesting pointers to what might be happening today.
His thesis is that the engine which drives bear markets to extreme lows is the fear of deflation. Once that threat recedes, or at least is no longer perceived to be real, it creates the conditions in which equity markets can recover. They typically won’t do so until (or unless) corporate bonds and commodity prices also improve. In the modern era, it is logical also to expect that the receding threat of deflation will be reflected in the price of index-linked Government bonds and
other measures of inflationary expectations.
In recent weeks all three of these market indicators have started to move in the right direction. While that does not prove that the bear market has ended, it is certainly not inconsistent with such an outcome. It provides the clearest of warning signs to the professional community that being out of the market is indeed becoming a significant risk for those willing to assume equity risk.
It is worth emphasising that the bear markets under discussion are medium rather than long term cycles. Mr Napier, for example, does not believe that we have seen an end to the long term bear market in equities that began in 2000. He does not expect the current generation’s equivalent of the four great market bottoms of the 20th century to hit for another five years or so, when the great bull market in bonds that began in 1981 finally runs its course and the dollar is abandoned as the world’s reserve currency.
If you thought what has happened so far is bad, in other words, there may well be worse to come. Today’s equity market valuations are still not as low as they typically fall to at the bottom of history’s worst bear market experiences. The issue however is whether there is money to be safely made from equities over the next 18-24 months and on that point, even without a crystal ball, and notwithstanding the huge uncertainties surrounding the real economy, the omens look much more positive than before.
jd@independent-investor.com
Read more...
Sunday, April 5, 2009
What Agency Law Has To Say
This is the Court of Appeal judgment I referred to in my Financial Times column today. As a restatement of law nothing could be clearer, nor, I would argue, more pertinent to the debate about the past and future behaviour of the financial services industry.
Does everybody in the financial services industry fully understand the concept of agency law and how it might affect the way they conduct their business and earn their money? The issue could surely not be more pertinent than today, when even the most hardened supporters of capitalism (of which in general I count myself one) have been badly shaken by the unfolding revelations of how the financial world lent and traded its way into the current global mess.
Having confessed to feeling outraged by the recent behaviour of many banks, a prominent barrister of my acquaintance recently sent me a judgment from the Court of Appeal that lays out, with splendid clarity, the principles that the law applies to anyone who acts as – and is paid to be - an agent of another person. The implications should not, one hopes, be lost on anyone who acts for clients in financial services.
The law sets out clear standards by which an agent’s behaviour and remuneration should be judged, and has done so consistently, as this recent judgment makes clear, since as far back as the 19th century. In an ideal world every agent would uphold these principles by choice, not just as a matter of professional and fiduciary duty, let alone because some regulator had told them to do so, but for reasons of personal integrity and observance of the law.
The case in question, on which judgment was handed down last month, concerns the case of a footballer, Trinidad and Tobago’s international goalkeeper at the time, who fell into dispute with his agent after agreeing a move to Dundee United. The world of football agents is one of the murkier areas of modern commercial life, but some might feel that drawing comparisons with the recent behaviour of, say, sub-prime lenders and brokers is no longer as far-fetched as might once have been thought the case.
The agent negotiated a move to Dundee United in return for a 10% cut of the footballer’s salary, but then subsequently agreed a separate, undisclosed, deal with the football club that enabled him also to be paid for arranging a work permit for the player. This second deal was worth £3,000, around £200 less than a full year’s commission on the player’s salary, and several times to true value of work involved in the work permit application.
When the player found out about the agent’s separate deal with the club, he stopped paying the agent his 10% cut and took the matter to law, claiming both the agency fees he had paid and the £3,000 work permit fee as well. (Quite how a dispute involving such small sums managed to travel all the way to the Court of Appeal is an interesting question. As a taxpayer, one has to assume that the courts felt moved to justify the expense by the need, once more, to restate the principles of agency law to a wider audience).
The three judges sitting on the case decided unanimously to find against the agent, and declared that he was not entitled to any of the money that he had earned from either transaction. Their judgment is a brilliant summary of the law’s findings on agency law down the years, starting with the landmark case of Boston Deep Sea Fishing v Ansell (1888) and three further important cases in 1903, 1923 and 1925. Of these, perhaps to nobody’s surprise, two involved estate agents and the third revolved around the sale of mineral rights in the Forest of Dean.
In the latter case, one of several magisterial precedents on which the Court of Appeal relied for its recent judgment, Lord Justice Scrutton laid down the law as follows: “An agent must not take remuneration from the other side without both disclosure to and consent from his principal. If he does take such remuneration he acts so adversely to this employer that he forfeits all remuneration from the employer, although the employer takes the benefit and has not suffered a loss by it”. In another case Lord Atkin, better known for a famous judgment on negiligence, said the courts always maintained “a very high standard of conduct on the part of agents”, and did so in part because the standards were often broken, “not by honourable men in commerce, but by a great many men engaged in mercantile transactions”.
Lord Justice Jacob, in the most recent case, pronounced as follows: “The law imposes on agents high standards....If you undertake to act for a man, you must act 100% body and soul for him. You must act as if you were him. Your must not allow your own interest to get in the way without telling him. An undisclosed but realistic possibility of a conflict of interest is a breach of your duty of good faith to your client”.
If the principles of agency law are not today well known today in the financial world, it is probably time that they were. The one common theme that runs through the successive judgments cited by the Court of Appeal is that the principles of an agent’s duty cannot be repeated too often. As Lord Justice Scrutton concluded in the 1923 mineral rights case: “I hope it [agency law] is thoroughly understood in London; and if it is not thoroughly understood in the Forest of Dean, then the sooner it is understood there the better”. Today he might, alas, feel moved to reverse the geography, but not the sentiment.
Read more...
Does everybody in the financial services industry fully understand the concept of agency law and how it might affect the way they conduct their business and earn their money? The issue could surely not be more pertinent than today, when even the most hardened supporters of capitalism (of which in general I count myself one) have been badly shaken by the unfolding revelations of how the financial world lent and traded its way into the current global mess.
Having confessed to feeling outraged by the recent behaviour of many banks, a prominent barrister of my acquaintance recently sent me a judgment from the Court of Appeal that lays out, with splendid clarity, the principles that the law applies to anyone who acts as – and is paid to be - an agent of another person. The implications should not, one hopes, be lost on anyone who acts for clients in financial services.
The law sets out clear standards by which an agent’s behaviour and remuneration should be judged, and has done so consistently, as this recent judgment makes clear, since as far back as the 19th century. In an ideal world every agent would uphold these principles by choice, not just as a matter of professional and fiduciary duty, let alone because some regulator had told them to do so, but for reasons of personal integrity and observance of the law.
The case in question, on which judgment was handed down last month, concerns the case of a footballer, Trinidad and Tobago’s international goalkeeper at the time, who fell into dispute with his agent after agreeing a move to Dundee United. The world of football agents is one of the murkier areas of modern commercial life, but some might feel that drawing comparisons with the recent behaviour of, say, sub-prime lenders and brokers is no longer as far-fetched as might once have been thought the case.
The agent negotiated a move to Dundee United in return for a 10% cut of the footballer’s salary, but then subsequently agreed a separate, undisclosed, deal with the football club that enabled him also to be paid for arranging a work permit for the player. This second deal was worth £3,000, around £200 less than a full year’s commission on the player’s salary, and several times to true value of work involved in the work permit application.
When the player found out about the agent’s separate deal with the club, he stopped paying the agent his 10% cut and took the matter to law, claiming both the agency fees he had paid and the £3,000 work permit fee as well. (Quite how a dispute involving such small sums managed to travel all the way to the Court of Appeal is an interesting question. As a taxpayer, one has to assume that the courts felt moved to justify the expense by the need, once more, to restate the principles of agency law to a wider audience).
The three judges sitting on the case decided unanimously to find against the agent, and declared that he was not entitled to any of the money that he had earned from either transaction. Their judgment is a brilliant summary of the law’s findings on agency law down the years, starting with the landmark case of Boston Deep Sea Fishing v Ansell (1888) and three further important cases in 1903, 1923 and 1925. Of these, perhaps to nobody’s surprise, two involved estate agents and the third revolved around the sale of mineral rights in the Forest of Dean.
In the latter case, one of several magisterial precedents on which the Court of Appeal relied for its recent judgment, Lord Justice Scrutton laid down the law as follows: “An agent must not take remuneration from the other side without both disclosure to and consent from his principal. If he does take such remuneration he acts so adversely to this employer that he forfeits all remuneration from the employer, although the employer takes the benefit and has not suffered a loss by it”. In another case Lord Atkin, better known for a famous judgment on negiligence, said the courts always maintained “a very high standard of conduct on the part of agents”, and did so in part because the standards were often broken, “not by honourable men in commerce, but by a great many men engaged in mercantile transactions”.
Lord Justice Jacob, in the most recent case, pronounced as follows: “The law imposes on agents high standards....If you undertake to act for a man, you must act 100% body and soul for him. You must act as if you were him. Your must not allow your own interest to get in the way without telling him. An undisclosed but realistic possibility of a conflict of interest is a breach of your duty of good faith to your client”.
If the principles of agency law are not today well known today in the financial world, it is probably time that they were. The one common theme that runs through the successive judgments cited by the Court of Appeal is that the principles of an agent’s duty cannot be repeated too often. As Lord Justice Scrutton concluded in the 1923 mineral rights case: “I hope it [agency law] is thoroughly understood in London; and if it is not thoroughly understood in the Forest of Dean, then the sooner it is understood there the better”. Today he might, alas, feel moved to reverse the geography, but not the sentiment.
Read more...
Tuesday, March 31, 2009
Praise for the Commentariat
The global financial crisis is throwing up some wonderful material from what I like to call the market commentariat - those whose job is to pronounce on the market's movements and advise on what investors should do about it. We are living through a quite remarkable period in financial history, and it is good to see that some commentators are up to the enormity of the issues involved.
Here are three examples that have caught my eye in the last few days.
First up is Don Coxe, now thankfully back in action after a short interregnum with his monthly commentary Basic Points (always required reading). He quotes Robert Reich, Clinton’s Labour Secretary, "one of the nation’s smartest liberals", who described President Obama's stimulus plan with characteristic clarity: “Obama has repealed the Reagan Revolution”. And then added this tart comment: "Problem: the Reagan Revolution was the best thing that has happened to equity investors since World War II”.
"The long Reagan boom that came after the last Mama Bear market so energised the markets and the economy that the S&P trebled in five years, and laid the foundations for 900% returns over fifteen years. We shall not see its like again. The entrepreneurial spirit that Reagan praised and unleashed with tax cuts and deregulation is now the object of Obama's obloquy and Obama's program of huge tax boosts, denial of secret ballots in union organisational efforts and massive costs to fight global warming argue for, not a Thatcherite, but at best a Belgian economic recovery".
Don's current investment conclusions can be summed up like this:
Someone also passed on to me this concise summary, from the same side of the political spectrum, of comments made by the veteran natural resources investor Doug Casey at a recent conference:
"The US is going to default on its debt through inflation. Obama has a really high IQ but is unable to foresee the consequences of his actions. 9 trillion dollars deficit divided by 300 million, that's about $30,000 per person and all that money is directed to the State. Government is the Predator and you are the Prey. Yes, I pay taxes in this country but it is for the same reason that I give my wallet to the average mugger at gunpoint".
Finally I also enjoyed an excoriating attack on Gordon Brown in The Times of London by Matthew Parris, a onetime centrist Tory MP turned pundit. It is impossible to underestimate the extent of the mess to which policymakers and bankers in harness have brought the UK. George Soros says it is possible we may end up in the arms of the IMF once more, as we did in 1976. Exaggerated? Perhaps -but not, I fear, impossible.
Read more...
Here are three examples that have caught my eye in the last few days.
First up is Don Coxe, now thankfully back in action after a short interregnum with his monthly commentary Basic Points (always required reading). He quotes Robert Reich, Clinton’s Labour Secretary, "one of the nation’s smartest liberals", who described President Obama's stimulus plan with characteristic clarity: “Obama has repealed the Reagan Revolution”. And then added this tart comment: "Problem: the Reagan Revolution was the best thing that has happened to equity investors since World War II”.
"The long Reagan boom that came after the last Mama Bear market so energised the markets and the economy that the S&P trebled in five years, and laid the foundations for 900% returns over fifteen years. We shall not see its like again. The entrepreneurial spirit that Reagan praised and unleashed with tax cuts and deregulation is now the object of Obama's obloquy and Obama's program of huge tax boosts, denial of secret ballots in union organisational efforts and massive costs to fight global warming argue for, not a Thatcherite, but at best a Belgian economic recovery".
Don's current investment conclusions can be summed up like this:
- Gold as a core holding;
- Canadian and Australian dollars for choice amongst currencies;
- Fertiliser, seed and farm equipment stocks by mid-year (watch out for the continuing absence of sunspots, a key Coxe theory to justify investing in grains);
- The debt of good companies rather than the equity (at least for now).
Someone also passed on to me this concise summary, from the same side of the political spectrum, of comments made by the veteran natural resources investor Doug Casey at a recent conference:
"The US is going to default on its debt through inflation. Obama has a really high IQ but is unable to foresee the consequences of his actions. 9 trillion dollars deficit divided by 300 million, that's about $30,000 per person and all that money is directed to the State. Government is the Predator and you are the Prey. Yes, I pay taxes in this country but it is for the same reason that I give my wallet to the average mugger at gunpoint".
Finally I also enjoyed an excoriating attack on Gordon Brown in The Times of London by Matthew Parris, a onetime centrist Tory MP turned pundit. It is impossible to underestimate the extent of the mess to which policymakers and bankers in harness have brought the UK. George Soros says it is possible we may end up in the arms of the IMF once more, as we did in 1976. Exaggerated? Perhaps -but not, I fear, impossible.
Read more...
Tuesday, March 24, 2009
Sentiment Can Change So Fast
My apologies for the recent break in transmission, the result of travel and other commitments. The way the equity markets have rallied since the beginning of March, perhaps I should stay away for longer! This is the full text of my latest FT column. It seems a safe bet that we will now see a new wave of bullishness from commentators, arguing (with Anthony Bolton and in today's FT, reasonably persuasively, Tim Bond of Barclays Capital) that the bear market has now bottomed out. I am not prepared to go that far, as the risk of more pain remains significant, but the recent recovery in financial stocks, a necessary pecursor to any new bull market, is certainly encouraging. Sentiment can change very quickly in this game.
Contrition, whether real or simulated, appears to be the new watchword in financial markets, if not in political circles. In the spirit of the times, my confession is to own up to having taken a certain amount of guilty pleasure from reading Cityboy, a coarse and unpleasant book about the workings of the City of London, published last year. By all accounts this terribly written piece of tosh, billed as revealing the “explosive secrets about life in the devious, murky and often corrupt heart” of the Square Mile continues to sell very well.
The reasons are not, in truth, hard to find. Public anger over the attitudes and behaviour of bankers is being whipped up by the media and politicians desperate to divert blame anywhere but onto themselves. Professionals who once thrived on the back of the explosive growth of investment banking, derivatives and hedge funds are suddenly facing lean times. Many banks, City law firms and accountancy practices, one hears, are cutting back on graduate recruitment and some have been forced to move, unprecedentedly, to part-time working.
With unemployment rising and the recession deepening, it is no surprise that popular sentiment about the City should be turning so hostile. Books such as Cityboy are both symptomatic of the trend and responsible for its wider propagation. The reason they sell well is that there is a sufficient amount of truth in the picture they paint of how the financial markets function to confirm the most painful prejudices, just as Caryl Churchill’s memorable play Serious Money did for the Yuppie generation twenty years ago.
Some of the recent histories of investment banks, such as William Cohan’s riveting history of Lazard Freres, or Philip Augar’s excellent series of studies of the modern Square Mile, of which Chasing Alpha is the latest, have painfully exposed how the dysfunctional management processes and ego-driven internal feuding that often characterises such institutions typically results in most of the economic rents obtained by investment bankers accruing to the employees while the owners continue to bear the risks and eventual losses. They are the High Priests of the “return-free risk” that victims of the sub-prime crisis, investors with Madoff and others have discovered they were really being sold.
Geraint Anderson, the author of Cityboy, gives his slant on the same phenomenon by caricaturing what he sees as the unhealthy motivation of research analysts, hedge fund managers and other investment professionals. His fictionalised account of the cynical advice he was given on how to get on as an equity analyst is, however, painfully close to that I recall being given myself when I was offered an analyst’s job by a well-known stockbroking firm shortly after Big Bang.
“The moment you take this job seriously”, runs Point Number Six in his litany of must haves in the analyst’s life, “the moment you give a shit that a share-price movement goes against your recommendation or that a client doesn’t like you, you’re done for. Never forget this job is just about money-grabbing dickheads pointlessly pushing around bits of paper. It ain’t curing cancer – it’s just the best legal means of making vast amounts of cash as quickly as possible”.
In the case of the firm that approached me all those years ago, it was made very clear that more time would be spent drinking with and schmoozing fund managers than engaging in fundamental research of any kind. It was better, so the advice went, to be precisely wrong than roughly right.
At all costs keep the client happy, whatever it takes. And so on. Has the game changed much since then? The answer of course is both yes and no.
The City has always been capable of reinventing itself with astonishing regularity, and will surely do so again. With hindsight, the speed with which the investment banks in the US were able to shrug off the findings of the Spitzer enquiry, for example, was breathtaking. My prediction is that current public hostility to banking excess and indefensible greed will also pass more quickly than many imagine possible.
Some things remain constant. The requirements for successful investment, as opposed to winning the game of short term performance, remain much the same now as they have always been: an enquiring mind, an ability to think for oneself and if necessary act alone, an understanding of the meaning of fiduciary responsibility and a degree of humility in the face of the market’s unchanging capacity to surprise and confound the views of even the smartest participants.
In the last few days, which have seen the S&P 500 index rally by 16% in six trading days, the old witch is clearly playing its tricks again. “Is this rally the real thing? Have we really reached bottom?” asks Albert Edwards, the splendidly bearish strategist at Societe Generale, one of several who meets the criteria mentioned above. He adds: “It would be wrong to say I do not agonise that I might not be missing a turn. I’m riddled with self-doubt”.
So are we all. Although rarely a saleable commodity in equity markets, doubt is the permanent condition of the true market prognosticator. My prediction remains that we will get a big market rally this year, too big to risk missing out on, but that the odds on equities breaking through their recent lows nevertheless remain worryingly high. Gold continues to look an attractive two-way bet, even though so many now profess to think so.
Read more...
Contrition, whether real or simulated, appears to be the new watchword in financial markets, if not in political circles. In the spirit of the times, my confession is to own up to having taken a certain amount of guilty pleasure from reading Cityboy, a coarse and unpleasant book about the workings of the City of London, published last year. By all accounts this terribly written piece of tosh, billed as revealing the “explosive secrets about life in the devious, murky and often corrupt heart” of the Square Mile continues to sell very well.
The reasons are not, in truth, hard to find. Public anger over the attitudes and behaviour of bankers is being whipped up by the media and politicians desperate to divert blame anywhere but onto themselves. Professionals who once thrived on the back of the explosive growth of investment banking, derivatives and hedge funds are suddenly facing lean times. Many banks, City law firms and accountancy practices, one hears, are cutting back on graduate recruitment and some have been forced to move, unprecedentedly, to part-time working.
With unemployment rising and the recession deepening, it is no surprise that popular sentiment about the City should be turning so hostile. Books such as Cityboy are both symptomatic of the trend and responsible for its wider propagation. The reason they sell well is that there is a sufficient amount of truth in the picture they paint of how the financial markets function to confirm the most painful prejudices, just as Caryl Churchill’s memorable play Serious Money did for the Yuppie generation twenty years ago.
Some of the recent histories of investment banks, such as William Cohan’s riveting history of Lazard Freres, or Philip Augar’s excellent series of studies of the modern Square Mile, of which Chasing Alpha is the latest, have painfully exposed how the dysfunctional management processes and ego-driven internal feuding that often characterises such institutions typically results in most of the economic rents obtained by investment bankers accruing to the employees while the owners continue to bear the risks and eventual losses. They are the High Priests of the “return-free risk” that victims of the sub-prime crisis, investors with Madoff and others have discovered they were really being sold.
Geraint Anderson, the author of Cityboy, gives his slant on the same phenomenon by caricaturing what he sees as the unhealthy motivation of research analysts, hedge fund managers and other investment professionals. His fictionalised account of the cynical advice he was given on how to get on as an equity analyst is, however, painfully close to that I recall being given myself when I was offered an analyst’s job by a well-known stockbroking firm shortly after Big Bang.
“The moment you take this job seriously”, runs Point Number Six in his litany of must haves in the analyst’s life, “the moment you give a shit that a share-price movement goes against your recommendation or that a client doesn’t like you, you’re done for. Never forget this job is just about money-grabbing dickheads pointlessly pushing around bits of paper. It ain’t curing cancer – it’s just the best legal means of making vast amounts of cash as quickly as possible”.
In the case of the firm that approached me all those years ago, it was made very clear that more time would be spent drinking with and schmoozing fund managers than engaging in fundamental research of any kind. It was better, so the advice went, to be precisely wrong than roughly right.
At all costs keep the client happy, whatever it takes. And so on. Has the game changed much since then? The answer of course is both yes and no.
The City has always been capable of reinventing itself with astonishing regularity, and will surely do so again. With hindsight, the speed with which the investment banks in the US were able to shrug off the findings of the Spitzer enquiry, for example, was breathtaking. My prediction is that current public hostility to banking excess and indefensible greed will also pass more quickly than many imagine possible.
Some things remain constant. The requirements for successful investment, as opposed to winning the game of short term performance, remain much the same now as they have always been: an enquiring mind, an ability to think for oneself and if necessary act alone, an understanding of the meaning of fiduciary responsibility and a degree of humility in the face of the market’s unchanging capacity to surprise and confound the views of even the smartest participants.
In the last few days, which have seen the S&P 500 index rally by 16% in six trading days, the old witch is clearly playing its tricks again. “Is this rally the real thing? Have we really reached bottom?” asks Albert Edwards, the splendidly bearish strategist at Societe Generale, one of several who meets the criteria mentioned above. He adds: “It would be wrong to say I do not agonise that I might not be missing a turn. I’m riddled with self-doubt”.
So are we all. Although rarely a saleable commodity in equity markets, doubt is the permanent condition of the true market prognosticator. My prediction remains that we will get a big market rally this year, too big to risk missing out on, but that the odds on equities breaking through their recent lows nevertheless remain worryingly high. Gold continues to look an attractive two-way bet, even though so many now profess to think so.
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