What Will Happen To The Market In 2005?
Editor's Note: The following interview was conducted by Dave Goodboy and was published yesterday on Realworldtrading.com.
Hi, my name is Dave Goodboy, I am executive producer at Realworldtrading.com and today I am privileged to be joined by Todd Harrison. Todd is the former president of Cramer Berkowitz, a 400 million dollar hedge fund. He has a reputation of being a true visionary in the world of finance. I am excited about what we will learn during this interview. Let's get started!
Dave: How are you today, Todd?
Todd: I'm fine, thank you.
Dave: Many of our readers know who you are, but for those who do not, please tell us a little bit about your background.
Todd: Sure, I started on the sell side at Morgan Stanley's derivatives desk in 1991. I worked there through 1997 and then moved on to the Galleon Group where I was the managing director of their derivative portfolio. I then moved over to Cramer Berkowitz in the beginning of 2000 where I ran their trading desk as a partner, and I was also President for a few years. Then I left to focus my energies on Minyanville, which is a financial team and community.
Dave: Is Minyanville purely your concept?
Todd: Yes. I had started writing for TheStreet.com in 2000, at which point I found by using characters as metaphorical representations of the market were tremendous vehicles. With the understanding that there is always a bull market or bear market in play and the residual grist is what you read about in the newspaper. What we do at Minyanville through my eyes and through the eyes of twenty columnists, who I greatly respect, is synthesis and filter the information noise in the market place and interpret it in a very engaging platform.
Dave: When you say the market place, do you mean equities, commodities, or something else?
Todd: My background is on the equities side and I have actually learned a tremendous amount from reading the other columnists on Minyanville. We have folks like Brian Reynolds who focuses on corporate bonds and fixed income as well as John Succo on the derivatives side. We have a whole slew of columnists who look at the market through different lenses. May it be commodities, fixed income, equities, or whatever.
Dave: Sounds like it pretty much encompasses the entire financial realm.
Todd: Well, we try to. My background was really in the equity arena. Currently, it's myopic to trade one market without understanding the influences on a macroeconomic basis.
Dave: It's an incredibly unique and innovative concept. Tell me a little more about Minyanville.
Todd: Minyanville started out as a hobby. It was really just a writing platform for me to communicate my thoughts, but it has really become my fulltime focus now. It's important to note that we aren't out there giving advice or telling people what to do. Rather, we are interpreting what we are seeing and communicating that through a real time platform. We have an application called the Buzz and Banter which is an IM sized window that sits on your desktop. It is an animated financial show each day that synthesizes and interprets the information in the market place.
Dave: As far as the marketplace goes right now, do you have an opinion on the stock market at this time?
Todd: No, I think it's impossible to answer that question without a time horizon. From a big picture standpoint, I think we are stuck between a rock and a hard place. I think the Federal Reserve has tried to buy time on the heels of the internet bubble for a legitimate economic recovery. I think, by and large, investors are confusing legitimate growth with debt induced growth. The system right now is flushed with liquidity, and I think the dynamic that we find ourselves in is 'Do we continue our inflation efforts which will buoy asset classes across the board, be it equities or metals?' Therefore, they would devalue the dollar, or does the Fed step aside and stop printing money, for lack of a better word, which would lead to some deflationary effects. Most people within the market, much less outside the market, don't understand that the dollar has been cut by a third since 2002. So even though most equity portfolios have risen since that time, the basis of value has fallen dramatically.
Dave: Exactly. In your opinion, when the dollar falls, is that good or bad for the equity market?
Todd: Well, I don't think it's good or bad, but I believe 54% of our debt is owned by foreigners. My point is that the falling dollar is going to severely impact those holdings. I am looking at the dollar really right now as a proxy of liquidity and as a proxy of isolationism. We are in a very interesting juncture in history.
Dave: I agree. Can you elaborate a little on this juncture in history?
Todd: I look at the stock market now, and, in the near term, there is so much noise. There are so many fund managers standing in a circle shooting each other. It is increasingly difficult to identify a trend. You saw that in January where everyone was leaning long for the rally, and now, in February, you see the mirror image of that. I think investors are confused and they are spinning their wheels.
Dave: What's your opinion of the super low volatility in the equity market? The VIX is on or near historical lows.
Todd: That is somewhat of a quandary. I have been looking at it as a potentially problematic element. Not so much as a causation point, because low volatility is not a cause of a dislocation. What I am seeing in the market is compression, a yearning for yield. Investors are so hungry to lock in returns, where earning less than 30% would have gotten you fired as a money manager, now double digits makes you an all-star. Again, it's not a problem in and of itself, but should a dislocation occur, it can greatly exasperate that volatility.
Dave: Could the low volatility be due to the proliferation of hedge funds? They are basically arbing all well known edges out of the market.
Todd: Yes, I think that is an intelligent assertion. I don't think it is the only reason why, but I do think that the abundance of hedge funds has changed the game. There are crowded situations in every metric. I view the market similar to four primary legs of a table: fundamental, technical, psychological, and structural. In each of those legs, you can make the case that an abundance of hedge funds has crowded the picture. Whenever you have the same technical levels, they are bound to become convoluted, and ultimately, lose their relative edge.
Dave: Let's dig a little deeper into each of these pillars. In this age of computer modeling, the fundamental picture is often ignored. What do you believe is the most important fundamental aspect or aspects for the trader?
Todd: Proper assimilation of the four pillars will often provide an advantageous risk/ reward dynamic. Specifically, in the fundamental picture, this past earning season, on the aggregate, met analysts' expectations. However, multiples are generally optimistic to begin with. Historically, we remain closer to levels associated with market tops than cycle bottoms.
Dave: Ok, is there a common fundamental aspect which most of us, as traders, miss that we really should be paying attention to?
Todd: Yes, when monolithic market rotations occur-as we saw in January, and continue to witness in February-traders often fall prey to the individual fundamentals, forgetting that bigger agendas are in play. Additionally, it is always important to remember, that news is always best at the top and worst at the bottom (as a discounting mechanism). This often sets traps at either end of the cusp.
Dave: Moving onto the technical pillar of analysis. Do you have an opinion on TA, and what indicators do you use when looking at a market or individual instrument to trade.
Todd: I've always viewed technicals as a framework for a thesis rather than a causation of it. I watch the levels, particularly, as they relate to sector rotation, as well as moving averages, congestion zones and stochastics. My antennas always vibe when I see a disconnect, as often, they provide a profitable edge.
Dave: While we are speaking about TA, is there a particular pattern that you have found to be accurate at timing entries, or do you have a favorite TA pattern?
Todd: I've long believed technical analysis to be a self-fulfilling prophecy. It works because people follow it, rather than the other way around. Not surprisingly, as 8000 hedge funds stare at the same charts, they lose some of their predictive value. It's crowded out there!
Dave: What does the technical picture of the U.S. equity market foretell currently?
Todd: The trade through S&P 1200-1205 was a big step for the bulls, although NDX 1550 should offer some resistance. Additionally, the S&P stochastics are getting a tad toppy.
Dave: What exactly do you mean when you say the "psychological" pillar.
Todd: Perception is reality in the marketplace, and it is the most subjective of the trading metrics. We all see the decade low volatilities; the sentiment skew has many insisting that we're in a new paradigm. This isn't a causation of a problem, but will certainly exacerbate a disconnect, in the event it occurs. Think January-without the bail out rally.
Dave: How does a trader determine the psychological mood of the market?
Todd: The Put/Call ratio, Investors Intelligence, VXO, and, for the trained eye, the price action.
Dave: What is your opinion of the psychological market climate right now?
Todd: I believe that of all bubbles in the marketplace, and there are many, such as, debt, derivatives, and hedge funds, the psychological bubble is by far the biggest. There is no way to game the timing of when it'll pop, but the disconnect between perception and reality is massive.
Dave: Let's move onto the structural pillar. What is it, and how is it used by an analyst or trader?
Todd: Well, there are a couple ways to look at it. You can look at the tightness in corporate bond spreads as being a structural benefit for the market. Bryan Reynolds has been fantastic at identifying this as one of the reasons why money has been flowing in the markets. You can also make the point that the deficit and the debt is a structural impediment. Whether it's corporate America or individuals, I believe total debt is roughly 350% of GDP. To me, this is not sustainable.
Dave: What is your current opinion on the structural pillar relating to the U.S. market?
Todd: The tightness in corporate bonds is telling their equity cousins that it's too early to worry. At the same time, the eye-popping deficits, coupled with the precarious dollar, may be nearing an inflection point. I think the Fed is caught between a rock (stagflation) and a hard place (deflation). By the time the market casts its vote, the result will already be in tomorrow's business section.
Dave: When you were on the desk with Cramer-Berkowitz , did you use technical analysis at all?
Todd: Well, I always use technical analysis as a backdrop or framework to apply other metrics. I think technical analysis in itself is inherently flawed if you subscribe to the theory that stocks are better when they are up, and worse when they are down. But I do think that the framework is intelligent and it gives you a basis of comparison. I think TA factors into most any intelligent decision.
Dave: I know, at Minyanville, you are involved in some philanthropy. Can you tell us a little bit about this?
Todd: Sure, Minyanville is the primary sponsor of the Ruby Peck Foundation, which I started in 2001, when my grandfather passed away. We raise money and distribute it to a number of children's educational beneficiaries. Some of my readers, Minyans, as they are known, got together and had a Fender guitar signed by the legends of Wall Street. We had Warren Buffet, George Soros, Peter Lynch, Bill Gross, Paul Tudor Jones, Jim Rogers, the list goes on. We will be mailing an announcement next month to announce when we will be auctioning that off, and we will hosting an event later this year. That is a separate organization from Minyanville, but it is a fabric of how we operate it and the way we try to support each other.
Dave: I know you guys are having a summit somewhere out west. A mini Davos, so to speak.
Todd: Yes, last summer we gathered in Crested Butte, Colorado for what was the first annual "Minyans in the Mountains" financial seminar. We had presentations in the morning from the Minyanville contributors and a roundtable discussion. In the afternoons, we had mountain biking, softball, white-water rafting, and dinner. It was a fantastic networking opportunity. We will be announcing the dates in the next two weeks, most likely in early August, for the next seminar. We have some very big names lined up in the financial community.
Dave: Let's get back to talking about the market. What is your opinion on the U.S. stock market over the next year?
Todd: To give you a little background, I made a name for myself by being extremely bearish in 2000. I maintained that view because of the overcapacity and the relative imbalances in the systems, and I was wrong in 2003. I got caught looking the wrong way, and underestimated the power of a coordinated agenda. With that historical backdrop of my opinion, I think the conditional elements of a downside dislocation are in place, but I also respect the other side of the probability spectrum. We are caught somewhere between stagflation and deflation, and I think the dollar is going to be the determinant of that equation. If the dollar continues to devalue, there is nothing that says the stock market, on a relative basis, can't continue this upward migration. I don't believe that the majority of corporate debt will mature until 2006, or 2007. With that being said, I would bet on the side of caution, rather than the side of a continued rally. More likely than not, there is a fair chance that we will chop around. You have to remember that bear markets by definition cost everybody money. You weeded out the bulls in 2000, and the bears in 2003, and I think you will see a lot of that back and forth continue until overcapacity in the financial industry tapers off.
Dave: Specifically, are you familiar with the new threshold rule? I believe that this, in and of itself, may buoy the bull market for awhile. The rule basically controls and limits short selling.
Todd: I have heard of it, but I am not too familiar with it. But I am a proponent of free markets, and I think whenever you introduce legislation or a type of parameter to limit free market trading, it's a negative.
Dave: Is there anything you would like to leave our members with?
Todd: I would just like to say, if anyone wants to give Minyanville a shot, just contact me, and we can set up a free 2 week trial. I am sure it will leave a good taste in your mouth.
Dave: Great, thank you for joining me today.
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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