Dennis C. Butler, President
of all guest columns written by Dennis C. Butler, CFA
A remark by Bill Clinton making the media rounds of late would seem to apply as much to the investment industry as it does to politics: "When people are uncertain, they would rather have somebody who is wrong and strong than somebody who is weak and right." Uncertainty is the bugbear of the investment crowd. The question "Where's the market going?" reflects fears that constantly plague denizens of the financial markets (perhaps because so many of them have risked someone's capital — someone else's or their own — because of a more or less educated guess concerning what the immediate future will bring). This may explain why Wall Street has always been full of people who get paid a lot of money for having strong opinions about the direction of securities prices. Although the accuracy of their forecasts usually leaves a lot to be desired, apparently the sense of direction and comfort offered by these personalities is something worth paying for (we have never quite understood the concept). Unfortunately, the uncertainty never really goes away, but most people seem to be unable to accept the "weak," but right, "don't know," for an answer.
This year has been no different for Wall Street's opinion leaders, who back in January 2004 foresaw a good, if not excellent, year for stocks. So far, the popular equity averages are showing a mixed picture, with the S&P 500 up a little, and the Dow Jones Industrial Average and the NASDAQ Composite down a little. But there are still a few months to go and market analysts, predictably, are looking forward to a year-end rally to salvage their reputations. At least one fund manager has taken a creative tack in dealing with the desultory markets. To get around the undue influence that large companies sometimes have on the capitalization-weighted indexes, such as the S&P 500 (an issue we discussed at length during the late 1990s bubble), he has constructed a fund that weights the S&P stocks equally. On this basis the fund is up nicely this year. If you can't beat 'em, change 'em..
Much of the really interesting action this year has been in bonds, where that market's best and brightest have been strong and wrong in the most costly manner. The year began with the almost universal expectation that a cycle of Federal Reserve credit tightening would lead to lower bond prices and higher yields, and bond traders positioned themselves accordingly. The Fed dutifully complied with these wishes and began a series of moves to restrict credit. In response, bond prices rose and yields fell, much to the consternation of unknown numbers of hedge funds and at least one major investment bank, which were forced to unwind their interest rate bets with significant losses. We suspect that the decline in longer term rates is, at least to some extent, an artificial phenomenon — the Japanese and Chinese central banks, and OPEC countries have been unusually big buyers of U.S. securities (something akin to having a store with only a few customers) due to their need to recycle huge inflows of dollars generated by their trade surpluses with the U.S. Nevertheless, at quarter's end the consensus appeared to be shifting to an expectation of continuing interest rate declines — indicating to us once again that Wall Street's mouthpieces mostly let the market do their thinking for them.
Returning to our opening comments for a moment — aside from betraying a rather jaundiced view on the former president's and our parts of the electorate and financial market participants respectively, Clinton's remark raises the question about what we really mean by "strong" and "weak." We'll leave the political issues to others. As for the financial markets, we find that weakness and strength are frequently confused. What passes for strength too often amounts to a gift of gab and a penchant for risk-taking, while "weakness" (a.k.a., "stodgy," "stagnant," "out of date in a changing stock market," as the New Era critique went), far from indicating a dearth of animal spirits, may actually reflect an unwillingness to commit capital on disadvantageous terms (evidence of strongly-held convictions, we would think). In the investment game, being strong — even if wrong — may attract attention (and business), but in the long run, being wrong in this business costs you money. Perhaps another maxim from the political arena is more apt in this context: "Speak softly and carry a big stick." In other words, keep your opinions to yourself and preserve your capital for when it can be most profitably employed. Such an approach may not win you a big following, but it may mean you are more often right than wrong, and that is what counts — at least when it comes to risking other people's money.
It has been said that the beginning of wisdom lies in knowing that one does not know. Over the years, as we gained in experience and knowledge of the investment field, we became increasingly confident in our ability to separate the wheat from the chaff, while maintaining a decent respect for the unknowns and unknowables that characterize the endeavor. Hence, we believe we can lay claim to a modicum of wisdom in investment matters. We had long viewed ourselves as agents for our clients, representing them in the marketplace as an attorney would represent them in legal matters, protecting them from dishonest operators and using our knowledge and experience to see that the investment part of their financial lives was handled properly. All of this is fine and true. But at a recent luncheon, an astute colleague pointed out that what the investment counselor really offers — what our clients look to us for whether or not they would put it in so many words — is, in fact, wisdom.
What is wisdom — "the intelligent application of learning," as Webster's defines it — when applied to the investment field? As we thought through this issue, the following account from one of our readings came to mind. In the old days of Wall Street (mid- to late-nineteenth century), when the business of trading stocks in the U.S. was still mostly local to New York, there was a group of market operators called "panic birds," because they "flocked to the scene of disaster." In the midst of the periodic crises that punctuated the financial markets of that era and caused a collapse of stock prices and the financial ruin of a host of speculators, these gentlemen would emerge from their brownstones, make their way to their brokers' offices, and proceed to buy up all the shares they could at the prevailing depressed prices. They then returned home and when the next cycle of market enthusiasm had lifted prices to unsustainable levels, they put in an appearance in order to sell their holdings and take their profits. This was an interesting strategy, occurring as it did in an era when the market (as reflected in the literature of the period) was dominated by rank speculators and "plungers." Of even greater interest to us is the fact that this bit of market lore embodied the basic principle reflected in investment treatises that appeared much later: buy when the price is demonstrably less than the real value of the security.
The true test of wisdom on Wall Street comes at the extremes — those times when capital is most likely to be subjected to undue risk, or, alternatively, when people are most apt to be discouraged from taking advantage of opportunities. While the good times are rolling, wise investors are the "designated drivers" who protect capital when the champagne is flowing a bit too liberally, shielding us from dangerous maneuvers that can cause costly mistakes. During panics, the wise form a "mighty fortress," immovable against calls for abandoning the field to emotion and forsaking investment principles. Incidentally, it is also during these periods that the wise are subject to the most pressure and ridicule from those lacking sound judgement, when demands for unwise actions are loudest.
On this score, investors would do well to recall what occurred during the last great market party in the late 1990s. Investment professionals possessed of fortitude (especially among the mutual fund group) — those who stuck to their principles and rejected the technology craze — were either fired, or their funds experienced huge withdrawals of assets (one manager, whose fund assets dropped from $6 billion to less than $3 billion, said that he would "rather lose half my shareholders than lose half my shareholders' money."). Renowned investors and funds with outstanding long term records came under fire for being too weak to grasp the significance of the technology revolution — in other words, "stodgy," "stagnant," and "out of date in a changing stock market." Sadly, far too many on Wall Street, and large numbers of the investing public, did not comport themselves wisely at a time when wise decision-making was most needed and valuable.
Owing to our general aloofness from Wall Street, our own experience of the dotcom lunacy amounted to observing it from a distance. In spite of our knowledge of financial history — same play and script, just different actors and props — we admit to having been somewhat taken aback by the power of greed to cloud judgement when money seems easy to make. We were also aware that antidotes to the maladies that afflicted a broad swath of the investment business had long been available (you have to acknowledge the affliction first, we suppose). Even in the early twentieth century, as a serious investment counseling profession was just beginning to take form and investment thinkers (usually practitioners in the field) authored works examining the process, the value of independent thinking, skepticism, and judgement based on experience was recognized. Fittingly, some writers of the period proposed the ancient Greek philosophical school of the Stoics as an appropriate model for investment behavior. Stoicism emphasized fortitude, moderation and wisdom. And, according to the Stoics (quoting again from Webster's), a wise man is one who is "free from passion, equally unperturbed by joy or grief." Clearly, the "panic birds" of old Wall Street were wise men.
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. 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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