Keynote Address From Ojai
Many thanks to everyone at MVHQ for a massive upside surprise
Editor's Note: The following text was taken from Todd Harrison's keynote address at the the second annual Minyans in the Mountains financial seminar on August 20th, 2005.
We were sitting outside Jimmy's Pub on Tuesday night when a friend approached me and said that I must be very "proud." I looked at her and realized that "pride" has never been an emotion that I've felt when it comes to Minyanville. In my mind, it's never been about me; it's been about you. It's been about us. A vision is only as powerful as those who believe in it and I'm truly humbled to be surrounded by such tremendous talent: financial professionals who are very good at what they do but even better at who they are.
When it comes to forthright financial commentary, I often opine that in the absence of water, people are so thirsty that they'll drink the sand. With only a handful of platforms serving up financial news-and with many of them focused on ratings and advertising revenues-it's easy to see why fiscal literacy is often lost in translation.
In an age when lightening rounds pass as value added financial content, I'll offer that there is no such thing as a quick fix. To achieve a level of understanding necessary to make intelligent choices, being told what to do-without understanding how and why-is doing more harm than good as we struggle to navigate the flickering ticks.
The goal of this conference-and indeed, our goal each day in Minyanville-is to lift the curtain on the Wall Street wizard and provide the insight and acumen necessary to make better and more informed decisions. As the saying goes, if you give a man a fish, he may eat today. If you teach a man to fish, well, he very well might be undercut by cheap foreign labor!
It's difficult to talk about the market without noting the collective frustration on the Street. I've heard alotta horror stories this past year from virtually every peg on the Wall Street totem pole.
• Hedge funds are standing in a circle shooting at each other
• Overcapacity and heightened expectations continue to weigh on the sell-side.
• The retail sector is being overwhelmed with an abundance of regurgitated information.
• And many individuals have become passive as a function of intimidation.
They say you're only as good as your last trade but that's the nature of the beast. In 2003, a ten percent return would have triggered redemptions at many funds but those same results last year would have earned you a gold star.
At some point during the bull run, the collective mindset began to view profits as a right rather than a privilege. That's abated a bit in the last few years but I would argue that an inflated basis of comparison has set unrealistic expectations for future returns.
There's truth to the adage that the financial industry has endured and adapted throughout history. It's a testament to both the capital markets and human spirit, both of which will surely survive. However, as business cycles go, we've yet to absorb the other side of the bubble or chew through the overcapacity that remains. The onus is on us to recognize the evolving dynamic and proactively position ourselves for what's to come.
By attending this retreat, you've already demonstrated a thirst for knowledge and the desire to surround yourself with a trusted network of human capital. The financial markets are far from easy and increasingly complex. However, as I look around this room and soak in the vibe, I'm infused with a confidence and optimism that is difficult to put into words.
For many years, the point of differentiation on Wall Street was execution and facilitation. Over time, in an attempt to augment the sell-side product offering, research and IPO's emerged as added incentives. Customers paid for information and were in turn rewarded with hot deals that padded their portfolio. It was a neat little relationship in a clubby community and nobody asked any questions.
The irony of the dot.com boom was that the very same companies that made Wall Street rich were doing so at a profound cost. The information superhighway paved the way to total transparency that allowed anyone with an instant message to be a click away from a shared network.
There is certainly no shortage of information floating around the Street. The task at hand is to identify trusted sources that aren't tied to particular agendas. My good friend Jeff Saut likes to say that where you stand is a function of where you sit. And if we look at the S&P and see that only 7% of all recommendations are currently skewed to the sell-side, it's clear that alotta folks are sitting on the same side of the table.
As a function of perceived agendas, and as research expenses can no longer be justified by investment banking revenue, an emerging trend of "outsourced information" should soon emerge as industry standard. In time, a customer will have the ability to "opt-in" to a pool of tailored information from around the world much the way they can currently craft a risk profile.
While my intention when starting Minyanville was to provide a forum for shared learning and fiscal literacy, the Buzz & Banter application, our center channel of finance, plants some intriguing seeds as we sift through the information-and in many cases-the disinformation age.
The ability to provide and package information, filter unwanted noise and offer dynamic real-time insight throughout the trading session--all in the context of total transparency--is perhaps a precursor to the next generation sell-side model.
Yes, these are interesting times in the wilds of Wall Street. With 8000 hedge funds chasing the tail of return, the earnings curve has gotten considerably steeper. It seems to take thrice the effort to make half the money in today's tape. Managing your expectations and those of your clients is the first step in what promises to be a most challenging journey.
As many of you know, I've long believed that the bull and bear coexist daily, with the residual grist dripping to the front pages of tomorrow's financial press. But to understand where we're going, we must also look at how we're getting there. That, to me, is the true disconnect between perception and reality and the key to making smart financial choices as we look ahead.
There is indeed a difference between legitimate economic growth and debt-induced demand. Our friends at the Federal Reserve know that the stock market is the world's largest thermometer and they took historic fiscal and monetary strides on the back of the bubble, in the aftermath of 9/11, during the invasion of Iraq and into the election.
Is this some grand conspiracy? I'll argue that the only difference between intervention and manipulation is communication. When the Bank of Japan telegraphs their actions and buys Yen, it's intervention. If they don't communicate their actions, then it's manipulation. It's a subtle yet important distinction that is the difference when discussing central bank policy.
I believe my buddy John Succo summed it up on last week's Buzz when he said--and I quote--"Yes, the economy is growing, but Why? Because real estate speculation is driving growth. Why? Because long-term interest rates remain low. Why? Because investors are still buying financial assets. With What? Liquidity that is being created by more and more debt."
While this process has boosted both performance and psychology, seeds of discontent continue to percolate under a seemingly calm surface. We now find ourselves as the world's largest debtor nation (total debt that is 300% of GDP), levered to home equity and dependent on a low cost of capital. This isn't a downside causation but we must recognize the basis of our current strength.
In particular, I'm concerned that one of two things must happen in the years ahead. Either the US dollar must further devalue, as it has to the tune of 25% since 2002, or asset classes will deflate in synch. I'm unsure if these are mutually exclusive events but we'll likely jockey between the two as we figure it out. I will also offer that the greenback will serve as a proxy of isolationism as America delicately dances through a difficult war and sets protectionist policies in place.
As we edge through the new world order, our economic ranks and societal structure will continue to shift. While last year's election brought the dichotomy between blue states and red states to bear, a more disturbing conundrum has evolved that has little to do with party lines or political affiliations.
As we digest initiatives of eminent domain, understand the motivation of the new bankruptcy laws and come to accept that our social security and pension programs are inherently flawed, the growing chasm between the "haves" and "have nots" has become increasingly apparent. The middle class is steadily eroding as we balance the lifestyles of the rich and a struggle to exist.
Indeed, almost 40% of all US wealth is in the hands of the top 1% of the population, compared to 13% 25 years ago. As this dichotomy manifests, the implications for consumer spending, real-estate investment and long-term savings will be profoundly impacted.
There is a distinct difference between being branded a bear and being conscious of the landscape. I've learned to respect the power of a coordinated agenda and have come to understand that liquidity and momentum can last longer than most believe. History is littered with those who were correct in their view but askew on the timing and as many of you know, the only difference between being early and being wrong is whether you're still there to collect on your bet.
This talks to the importance of having your risk profile and time horizon in synch. I was reminded of this lesson a few years ago, when having just resigned as president of Cramer Berkowitz, I decided to create a symbiotic little ecosystem that would support and finance my various endeavors.
At the beginning of 2003, I started a small hedge fund, which was largely comprised of my own money, while at the same time launching Minyanville, being the only writer on the site and creating the Ruby Peck foundation for Children's Education. It was a perfect plan on paper but I soon found out that Henry Hill from Goodfella's was right-every once in a while, everyone's gotta take a beating.
Without getting painfully specific, suffice to say that my fund launched almost to the day that we invaded Iraq and I was positioned short. I saw the imbalances in the mechanism but ignored the constructive technical developments as they emerged. Perhaps most humbling, I was sharing my experience online and suffered an equity enema for the world to see.
Lou Manheim once said that man looks into the abyss and he sees nothing. It is at that point when a man finds his character. Well, at the bottom of my personal 2003 cycle, I didn't just have character, I had an entire menagerie of critters surrounding me. It was, in many ways, like I was a piece of driftwood floating through a perfect storm.
Having lost sight of my cardinal rule of trading-that discipline must always trump conviction-I was reminded that nobody is smarter than the market. Most traders in this room know what it's like to be on the wrong side of the bet but for those who haven't, I can tell you this. Stay humble, for if you don't, the market will do it for you.
I learned a lot that year, including the necessity of balance and the truth that net worth and self worth are not one and the same. It was the most difficult year of my career-and, perhaps my life-but I emerged from it a better trader and quite possibly a better man. It's one of life's great ironies, I suppose, that wisdom is often bred as a function of pain.
As I turned that corner in my career, I openly opined that energy and metals would emerge as the new tech and financials. Perhaps my most lucid thought, then and now, is that energy will once again assume the top weighting in the S&P. I believe that migration is in the early innings although the sudden popularity of crude makes it ripe for a sharp correction that shakes out the bandwagon bulls.
While a meaty pullback in the energy space seems likely, I believe that it'll offer an attractive entry point for those with patience and a longer-term horizon. I also sense that the metals are poised to take the baton and share the leadership spotlight for years to come. I've elongated my time horizon in these two sectors and will look to add exposure on dips.
The risk to that view is outright asset class deflation, which is possible, but I believe that they'll both offer relative value versus other sectors in the marketplace. I know you can't spend relative performance-a fact lost on many mutual fund managers--but the goal is to identify opportunities that will have secular winds at their backs.
Along those lines, I will offer that I am particularly wary of the financials, the main beneficiary of the easy money policies these last few years. As the yield curve flattens, margins get squeezed and compression builds in the system, the risk/reward seems particularly unfavorable.
Adding spice to that mix, a complex maze of derivatives has tied together the balance sheets of the world's largest organizations. With the emergence of bearded financials such as General Motors, General Electric and Ford-all of which have considerable finance arms-it's quite possible that a ripple in Fannie Mae or JP Morgan will have an exponential impact across a wide array of sectors and industries.
So-does any of this matter? We've heard the bears talk about derivatives, debt, the dollar, pension liabilities, social security, geopolitical risk, stagflation, oil, for a long time but it hasn't "mattered." In fact, as a function of the persistent price action, we seem to have built a collective immunity to bad news.
The problem that comes from engaging in high risk behavior for which the consequences are absent, even if only temporarily, is that such high risk behavior begins to appear normal, and the entire scale of risk gets adjusted and pushed out. When we look at sentiment proxies such as the volatility indices and investor's intelligence reports, investors seem to be saying that it doesn't-and won't-matter.
There is a tremendous difference between respecting the price action and deferring to it and that's the bottom line when assessing risk. There is a human tendency to focus on rewards when the market is higher and risk once the tape has turned. The trick is to stay ahead of the curve and avoid the path of maximum frustration.
So what, you ask, is on our watch list as we edge forward?
• Hedge funds. With volatility at decade lows, we've seen tremendous compression as players increase the size of their bets and the use of leverage. While neither hedge funds nor derivatives are inherently problematic, they've stretched the financial fabric and increased the risk in the system. Hedge fund losses and closures will litter the landscape in the years ahead-the question, for purposes of risk management, is one of contagion vs. containment.
• Real estate remains a viable concern as we're seeing the same kind of reactive rationalization and speculative excess as we did during the tech bubble. There is little doubt in my mind that we're edging through another bubble-one that is potentially more acute and far-reaching than internet stocks-but the billion dollar question is one of timing. (JDSU $50, $100 or $150?)
• Interest rates should remain on our radar as an uptick will has nasty implications for a finance based economy flush with adjustable rate mortgages. With 27% of all earnings financed based-not including the financials in drag we talked about earlier-an increased cost of capital will impact our already fragile "recovery."
• Multiple compression. I've never been accused of being an analyst but it seems to me that there aren't many folks talking about this. If you subscribe to the theory-as I do-- that excess breeds excess, the other side of triple digit multiples is a continued contraction of earnings valuations. This is a caveat for the pure fundamentalists as "cheap" stocks have a tendency to get "cheaper."
Most of us have lived on both sides of the bubble and the trick to the trade is to breed wisdom from the pain. The only difference between a mistake and a lesson is the ability to learn from it and we'll need to draw on those lessons as we forge ahead.
One of the great misconceptions of bear markets is that they're defined by negative price action when, in fact, TRUE bear markets are haphazard, frustrating and difficult for everyone-including the bears. The goal is to marry the foresight to identify opportunities with the understanding that timing will dictate ultimate performance.
What can we do to better prepare ourselves?
• Be aware and alert of the evolution around us and don't get caught up in the next best thing.
• Make sure that your risk-profile and time horizon are in complete synch.
• Save when you can and avoid debt that is tied to variables outside your control.
• Hedge potential dollar devaluation with silver and gold exposure.
• Don't let the definition of an investment be a trade gone awry.
• Allow for an ample margin of error regardless of your aggregate view.
• Make capital preservation a priority as it's the first step towards prolonged profitability.
• Don't let the fear of missing trigger emotional financial decisions.
This is tough business in a tough world and the ability to stick together and fortify a stronghold of human capital is perhaps our best weapon in the fight for performance. By bridging our collective networks, the benefits of this gathering should simply serve as a starting point that we will together build.
We're all here because we believe that there is a better way to do business. We believe that there are good people in our industry who believe in doing the right thing. And we believe that by giving of ourselves, we can realize a return that means more than just the bottom line.
The Minyanville community is predicated on our people and this vision will remain as strong as those who believe in it. Take a look around you-
Steve Shobin, Tony Dwyer, Greg Collins, Charlie Poe, Kevin Wassong, Sean Mueller, Jeff Saut, Phil Erlanger, Jason Geopfert, Jeff Macke, Laurie McGuirk, Mark & Michelle Kellner, John Succo, Greg Weldon, Vanessa Ohayon, Kevin Depew, Jim Bridges, Bernie Schaeffer, Jon Najarian, Scott Reamer, Rich Gula, Adam Katz, Michael Santoli, Richard Allen, Fari Hamzei, Dany Johnson, Ron Coby, Ronald Sen, Sal Morreale, Adam Michael, Michael Gat, Jason Roney, Herb Greenberg, Todd Hibbert, John Dunn, Alan Harter…
This is the genesis of something truly special. And significant. And for all the right reasons.
I want to thank you for sharing your journey with us and on behalf of the entire Minyanville family, many wishes for continued success.
We can-and will-get there. Together.
Thank you very much.
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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