Dennis C. Butler, President
of all guest columns written by Dennis C. Butler, CFA
In 1930, investor and author Philip Carret wrote about the need for an "Index of Courage." During times when markets get so carried away that prices are beyond any fundamental justification, held aloft by the availability of money and the "courage" to spend it, this fanciful index could warn investors about an impending decline when other, normally useful indicators have proven unreliable (something investors had just painfully experienced). If only such a measuring tool were available these days! Given the enthusiasm for average earnings yields of 3% (or 1.4% in the case of Microsoft and 0.2% for America Online), while 5% risk-free is available with treasury notes, the courageousness of stock buyers would appear to be off the scale. At the other end of the spectrum, "cowardly" investors certainly aren't helping to prop up stocks: Chief Coward Warren Buffett is holding $14 billion in cash.
It's been more of the same on Wall Street so far this year: stocks continued to rise. That is, some did. The popular capitalization-weighted indexes rose, but they currently gauge the action in remarkably few stocks. Not reflected were the declines registered by most securities, especially those of smaller issuers, that have been taking place for a year now. Continued strength in the averages is all the more notable given weak corporate earnings, somewhat higher interest rates and economic crises abroad, not to mention open warfare in Europe. Nevertheless, the good cheer continued. Corporations raised capital in record-breaking bond offerings. Managers of huge pools of venture capital dug into every nook and cranny to find ways to put funds to work. Wise old-timers wagged their fingers at some of the excesses, but who needs wisdom when you can buy Internet stocks that triple in price on their first day of trading?
An "Index of Wisdom"
In recent months our leading financial journal has profiled several members of the new breed of rapid-fire stock traders who sit at their computers, getting their information from the Internet and doing their buying and selling through on-line brokers. Not surprisingly, their interest is focused on the very technology companies that have made such forms of communications and transactions possible. Although the impressive technology and bold attitude of these stock jockeys lend it an all-American frontiersman aura, we find certain aspects of this trend to be a regrettable throw-back to an earlier, unsavory period of our financial history.
Readers of our commentaries know well of our low regard for Wall Street. At its rarest best, it is a good source of information and ideas; the common worst is a world of conflicts of interest, rumors and misinformation. In the old days, before the securities laws of the 1930s, it was even worse. Stocks were subject to blatant manipulation by anonymous pools, "bucket shops" ripped-off "suckers" on a regular basis, financial accounting was irregular, and so on. The securities laws and new regulations did away with (or at least made illegal) the most egregious practices, and greatly improved the quantity and quality of corporate information available to investors. Over the intervening decades, government regulation and policing has served the useful purpose of strengthening the markets and the public's faith in their fairness. Nevertheless, we still think it wise for investors to keep a healthy distance -- physical, mental and emotional -- from the noise and commotion on Wall Street; our lonely outpost in Cambridge certainly helps us maintain an independence of judgement and a rational perspective on what is important.
The rise of on-line trading short-circuits the advantages of distance and undermines the investor protections written into law by people who learned their lessons the hard way. The Internet, it is claimed, brings a wealth of information, formerly accessible only to professionals, right to the desk-top, permitting individuals to make their own investment decisions more easily than ever before. Whether the decisions are good ones or whether the process should be easier goes unquestioned. More importantly, the problem with some of this so-called "information" is that it is unfiltered, or filtered by parties with their own agendas, making it unreliable. In either case it cannot be compared with professionally-edited articles and analyses found in reputable publications, or even brokerage reports. With the exception of corporate regulatory filings, we have found even seemingly innocuous statistical data on the Internet to be untrustworthy. So, ironically, the Internet brings home misinformation and gossip to users who are often ill-equipped to judge their veracity.
Any knowledgeable person who has visited an Internet "chat room" will immediately recognize the risks of taking anything found there seriously. The first question that comes to mind is "Who are these people?" Most messages evidence no particular level of sophistication; others obviously hype the stocks owned by the authors. Rumors bounce around among participants. Nevertheless, on-line traders use chat rooms as a source of trading ideas and information. Tellingly, the Securities and Exchange Commission has begun to monitor this activity after discovering fraudulent schemes involving Internet stock tipsters.
It is not our intention to condemn the idea of managing one's own funds. It is an attractive option for some people who possess the necessary temperament, and who have the time and inclination to engage in serious study. These are attributes that don't seem to apply to on-line day traders. It's not always as easy as it looks during bull market periods, when almost any "system" -- even astrology -- seems to work well. Successful investing over a long period requires experience, maturity of judgement, and knowledge of the language of business, and for those lacking these requisites, relying on the Internet or any simplistic methodology is likely to be costly.
For these reasons most investors who make their own decisions still rely on the help of brokers, or "financial advisors," to use the preferred term. Despite our doubts about the brokerage industry and its conflicts, its professionals are required to pass examinations giving evidence of at least a minimum amount of knowledge of the investment business. Good judgement may be another matter, but at the very least a broker represents one more potential barrier between a fool and the loss of his or her money. On-line trading lacks even these relationships and minimal protections and the investor is on his or her own.
The financial journal profiles mentioned above included the story of a young man (most on-line traders seem to be young men) who spent his days surfing the net looking for the latest "hot" Internet-related stocks, which he would then trade in and out of frequently. When asked what he would do if such stocks suddenly took a dive when he was exposed, he replied: "I'm in it for the long term." Whether he meant he would be trading for a long time or that he would bravely hold onto stocks dropping like a stone was not clear. What was clear, however, was that he was absolutely clueless about appreciating the personal risks incurred through his breath-taking trading schemes. In addition, there are broader, societal risks from this activity, especially if it were to become more widespread. Many traders have funded their accounts with credit card debt and life savings. Since this is essentially gambling, sooner or later it will entail heavy losses, potentially burdening already taxed retirement funding. On a different level, such trading blurs the distinction between investment and speculation, which has had deleterious effects in the past. The fallout from previous bouts of speculation (the 1920s and early 1970s, for example) led many people away from stock investing altogether. This had a negative effect on the cost of capital for American business for long periods.
The Index of Courage would warn investors that an excess of financial derring-do puts their wealth at risk. Continuing in the same spirit as Carret, we recommend an additional index: an "Index of Wisdom" that alerts investors to the presence of attractive opportunities (and could be applied to individual stocks or the market as a whole). The necessity for such a measure is obvious, since the usual economic indicators are typically not encouraging during those times when wise investors are afoot and market operators, along with their Wall Street abettors, have long since left the scene. The construction of such an index will have to await the efforts of those more knowledgeable in such matters than we are, but we can imagine that a ratio of grey hairs to dark on Wall Street might be one variable. A "crash and burn" indicator tracking the fate of on-line stock traders could well be another.
Dennis C. Butler, CFA, is president of Centre Street Cambridge Corporation, investment counsel. He has been a practitioner in the investment field for over 23 years and has been published in Barron's. He holds an MBA from Wharton and a BA in History from Brown University. His quarterly newsletter can be found at www.businessforum.com/cscc.html.
"Current low valuations reward the long-term view", an article by Dennis Butler, appears in the May 7, 2009 issue of the Financial Times (page 28). "Intelligent Individual Investor", an article by Dennis Butler, appears in the December 2, 2008 issue of NYSSA News, a magazine published by the New Yorks Society of Security Analsysts, Inc. "Benjamin Graham in Perspective", an article by Dennis Butler, appears in the Summer 2006 issue of Financial History, a magazine published by the Museum of American Finance in New York City. To correspond with him directly and /or to obtain a reprint of his featured articles, "Gold Coffin?" in Barron's (March 23, 1998, Volume LXXVIII, No. 12, page 62) or "What Speculation?" in Barron's (September 15, 1997, Volume LXXVII, No. 37, page 58), he may be contacted at:
Dennis C. Butler
Centre Street Cambridge Corporation
Post Office Box 390085
Cambridge, Massachusetts 02139
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© Copyright 1999 Dennis C. Butler, All Rights Reserved
Revised: April 9, 1999 TAF
© Copyright 1999 Dennis C. Butler, All Rights Reserved