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Pros Swear Off a Four-Letter Word: Risk

Fund managers put money in sectors they don't necessarily believe in as they hear the herd's footsteps.

Editor's note: This column, which reflects market activity from the day before, originally appeared June 16 on To sign up for RealMoney, where you can read Bill Fleckenstein's commentary every day, please click here for a free trial.

The markets were a mixed bag overnight, with Asia a little soft and Europe firmer. This morning, our market bolted out of the starting gate, such that within a few hours, all the indices were up 1%. In the early going, chip stocks lagged the speculative leaders from housing, biotech, and finance. After the early-morning surge, the market ground steadily if only slightly higher. Then, with about half an hour to go, it tacked on another little surge to the upside, basically going out on the high of the day.

Tuesday To-Do: Inflate Market Cap: All of the speculative darlings got into the act today -- with SOX stocks, biotechs, and financials strong, and housing stocks on fire. From wire to wire, it was just one giant feeding frenzy. Since most of the indices closed at new highs for the move, one could reasonably expect that the momentum players will be back, ready to pile on again tomorrow.

Away from stocks, fixed income staged a big reversal to the downside, with the long bond down about a point. The dollar was a tad stronger. The metals were up about 0.5%.

A Field Trip to Fund Land

: Turning to the news, there is a good behind-the-scenes look at the professional money management industry in a story in today's

Wall Street Journal

titled "Experts Duel Over Fate of Bellwether Rally." In his profile of two fund managers who work for the same firm (one bullish and one bearish), writer E.S. Browning illuminates a point that I have made in the past: Some "professionals," in the aggregate, are acting loonier than the public, in that they have failed to learn some of the lessons absorbed by the public since the market peaked three years ago. The more conservative of the two fund managers, one John Rutledge, has done better than his peers over the last few years (by losing less). As someone who has been following tech stocks for 35 years, he remains rather skeptical of the market and doesn't much believe in the current rally. "There is no evidence of an upturn in demand

for tech gear," he tells the


. But lately, his peers have been outperforming him, which is why his boss called Mr. Rutledge in for a talk, "to discuss ways to stop his slide in the rankings. The discussion was friendly and constructive, but the message was clear: Mr. Rutledge mustn't keep trailing the competition."

Faith-Based Money Management

: This, folks, is part of the problem. The investment business is not like a horse at the track, where you can crack a whip to make it go faster. Sometimes, you do better than others, and sometimes you do worse. Nobody has all the right ideas at the right time, and folks should expect that from time to time, their money manager will not do as well as everybody else. The idea is to find somebody who you trust, who rewards confidence, who can provide a reasonable rate of return over time, and who does not take too much risk -- "risk" being defined as the loss of your money.

Now if you're going to give money to somebody to manage, and you have any sanity at all, I can't imagine that your perception of risk would jibe with how the investment business perceives it. To them, "risk" centers around this notion of underperforming the competition for 15 minutes, period. It is a belief that's fundamental to too many fund managers throughout the industry, as well as to the lunatic consultant community that serves them. To them, risk is all about falling behind in the rankings, when in reality, and to repeat, risk is the chance you will lose money.

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The popular idea of volatility or beta is a poor measure of risk. Only after the fact is it clear that you took too much. A competent money manager who demands a margin of safety will likely "underperform" in wild times, but so what? Long-term returns are built by negotiating many up and down periods. Anyone who sets out to maximize wild times is destined for failure. Think Ryan Jacobs or Munder Internet funds, vs. John Templeton or Warren Buffett.

In any case, during market rallies these days, risk is literally perceived to be a four-letter word, not something anybody worries about, as the little vignette from the Journal article makes clear. To bring his fund's ranking up to speed, the less-than-optimistic Mr. Rutledge has now allocated 17% of his portfolio to semiconductors, even though he is not at all sanguine about them. That's how the game is played these days. Now if one of its less bullish players is acting this way, can you imagine what the bullish contingent is doing?

Self-Fulfilling Profit Scenario?

: Shifting from risk to the rally, the article makes a worthwhile point, via a quote from Jon Brorson of Neuberger Berman: "If the rally fizzles, business confidence will ratchet down further and we will have more unemployment." I actually believe that is true, because so many people have gotten their expectations up about what the rally means. On the other hand, the fact that the market has become a performance derby -- in which everyone piles on because everyone piles on -- suggests that now, moves in the market may portend less about the future than they did in the past.

In the past, you could make the argument that a move in the market was the collective wisdom of millions of people. Now, it is more the collective anxiety of lots of fund managers. This is not to dismiss market action but, again, to say that it may be less significant than in the past. Japan's bear market, as I

noted last Friday has had a number of significant rallies that didn't mean anything.

Welteke Wisdom vs. Greenspan Gobbledygook

: Turning, finally, to the central-banker-with-a-brain department, Ernst Welteke, a council member of the European Central Bank, said the following in a speech given on June 11 (thanks to the reader who passed his comments along, via a story on


): "The German DAX index is now at 3200 points compared to 2400 points a few weeks ago. We should not let us be deceived again. Double-digit growth rates for companies are simply not realistic in the current economic situation. If the economy grows by less that 1 percent and with inflation hovering at about 1 percent, companies cannot earn profits of 25 percent or more. That doesn't work."

Notwithstanding my previous comments about the professional investment community, let me say that markets do discount, and we should allow for the fact that the German market, in this case, could in fact be discounting something better down the road. But I believe that Mr. Welteke's point is worth noting. Here, at least, is someone in the central bank community who seems willing to consider the notion that when stock markets zoom, problems -- not good times -- can follow. Obviously, this fellow learned something from the last mania.

William Fleckenstein is the president of Fleckenstein Capital, which manages a hedge fund based in Seattle. Outside contributing columnists for and RealMoney, including Mr. Fleckenstein, may, from time to time, write about securities in which they have a position. In such cases, appropriate disclosure is made. At time of publication, Fleckenstein Capital had no position in stocks mentioned, although positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Mr. Fleckenstein's columns are his own and not necessarily those of While Mr. Fleckenstein cannot provide personalized investment advice or recommendations, he invites you to send comments on his column to