This blog post originally appeared on RealMoney Silver on Jan. 28 at 8:10 a.m. EST.
"These traders, not economists or securities analysts, can turn the world upside down, make governments tremble, give central bankers colitis and ruin the lives of ordinary men and women saving for their children's college education or their own retirement. In America today, it is the traders, not the politicians or the generals or the corporate bosses, who have the power." -- Ben Stein, New York Times"Can Their Wish Be the Market's Command?"
My Sunday morning routine is usually cast in stone. I typically wake up at around 5 a.m. EST and spend an hour or so writing my opening missive for Monday. Then, I read the obituaries -- I am, after all, still a short- seller! -- and then the Sports, Week in Review and Business sections in the
New York Times
. Thereafter, I work on solving Sunday's
New York Times
crossword puzzle. (I am proud to say that I have completed the last five in a row.) Next, I watch
"Meet The Press,"
"Sports Reporters" and
"This Week With George Stephanopoulos."
day starts, and these days, it is filled with thoughts about the stock market, cogitating over
the week that was
and what to do next and why, in addition to calls or emails between other hedge hoggers.
Yesterday morning, I was prepared to write a column preliminarily entitled "The Case for a Bull Market: What Could Go Right and How." I was going to emphasize the latent buying power of sovereign wealth funds and make the case that the equity market might be discounting a far deeper recession than might occur. I had planned to underscore that interest rates remain subdued, that the curative process of restoring capital bases at leading financial institutions continues apace and that a negative sentiment bubble seems to be emerging coincident with lower share prices. I was even going to highlight that there might be some
light at the end to the tunnel
of housing as fiscal and monetary stimulation is moving into overdrive.
That is, until I read Stein's column -- "Can Their Wish Be the Market's Command?" -- in Sunday's
New York Times
business section.No one has the concession on the truth, especially as it relates to investing. But rigorous analysis, logic of argument, power of dissection, weighing sentiment and modeling remain good ways to try to find that truth.
Stein's general lack of realism in his series of
New York Times
articles, in communicating and recognizing growing economic problems and in improperly isolating and laying blame on the stock market's poor showing to his list of imaginary ne'er-do-wells.
- Six months ago, Mr. Stein blamed the market's weakness on the media's hysteria.
- Seven weeks ago, he blamed the market's weakness on Goldman Sachs (GS) - Get Report and its economist, Dr. Jan Hatzius. (Note: Not even the Dr. Evils at Goldman Sachs benefited in the aggregate from the subprime meltdown (as suggested by Stein). Sure, Goldman shorted mortgage debt, but, in the main, the broker/dealer is long the economy/markets. Proof positive is Goldman's weak performing common stock, the source of how most Goldman principals make their incomes.)
- Yesterday, Stein blamed the market's weakness on traders.
From my perch, Stein's assertions have been consistently wrong and continue to be poorly reasoned.
I even submitted one of my columns to the
New York Times'
editorial staff as a rebuttal to Stein's articles.
My Grandma Koufax taught me to be nice, though she was a killer in her children's wear business (and in her stock market trading). She used to regularly say, "Dougie, he is a nice boy, and he is good to his mother." And I am sure Ben is and was.
I have tried to respond to Mr. Stein's words in a professional and respectful manner -- I even share my columns with him via email -- and I have avoided anything that resembled an ad hominem attack on him by addressing, point by point, his misguided observations and underlying assumptions of economic causality and his views regarding the stock market's outlook. (Note to Stein: My real view on your column is best answered by looking at 67 Across in yesterday's
New York Times
"In the short run, the market is a voting machine. In the long run, it's a weighing machine." -- Benjamin Graham
Stein and I both agree that statistics show, in the long run, stocks rise and economies prosper -- though that was not the subject of yesterday's column. And, yes, daily market volatility of 2% to 3% is occurring because of trigger-happy hedge fund traders' buying and selling. But it is a broad list of economic uncertainties (and daily headline risks) that generate indecision and lack of confidence in their trading actions that seem to be producing this volatility.
Traders influence volatility, but they cannot control stock prices over any reasonable time frame. Investors do.
Wild intraday price moves are unsettling to most investors, but the history of stocks shows that yearly market moves more often than not do produce meaningful price changes. Though sometimes impacted by an exogenous event, outsized changes are dependent upon the degree of confidence or certainty in economic outcomes. When uncertainties exist, stock prices and economies can stall for years (and sometimes even for a decade or more) and vice versa.
The view of a favorable long run is all well and good, but in the highly competitive world of hedge funds/personal money management, properly identifying and navigating monthly and yearly trends/moves (as well as finding superior individual stocks) can result in superior and differentiated investment performance.
Just ask investors who have prospered and outperformed and money managers who have demonstrated a consistent ability to time buying/selling and identify value in markets, sectors and stocks -- namely, Ken Heebner, Stanley Druckenmiller, Leon Cooperman, George Soros and Steve Cohen.
Back to Ben's vision of our economy and the markets.
Over the last two months, many previously bullish economic/market commentators have incorporated the reality of the economic, credit market and stock market situation by scaling back their optimism. Brokerage firm economists and strategists at
, Goldman Sachs,
et al. have adjusted their extrapolations of prosperity toward more realistic goals and assumptions.
While Stein has questioned the motivation of some of this (especially at Goldman Sachs), we all know that massive capital and people commitments are made to insure accuracy of those predictions. And, if wrong, again, as my Grandma Koufax used to say, "Dougie, they'll have less bread to be buttered."
Even Dr. Arthur Laffer did an about-face on
"Kudlow & Company" and has turned cautious, and several other of Sir Larry Kudlow's Band of Merry Men have grown less cheery.
At Wharton, I learned that the basis for determining market valuation lies at the foot of security analysis and modeling -- as delivered by Benjamin Graham and David Dodd in
-- not on the part of the whims of traders.
As Ben Graham wrote, in the fullness of time, stocks move toward the weight of value. Investors use many rigorous and disciplined methodologies in valuing stocks and in determining fair market value:
- 1. Many strategists and investors use top-down, discounted cash flow and dividend models to determine the fair market level of equities. These models are not static; they change as the underlying model assumptions change. The most theoretically sound stock valuation method is called income valuation or the discounted cash flow method, involving discounting the profits (dividends, earnings or cash flows) the stock will bring to the stockholder in the foreseeable future and a final value on disposition. The discount rate normally has to include a risk premium, which is commonly based on the capital asset pricing model.2. The Gordon model is the best-known of a class of discounted dividend models. It assumes that dividends will increase at a constant growth rate (less than the discount rate) forever.3. The P/E method is perhaps the most commonly used valuation method in the stock brokerage industry. By using comparison firms, a target price-to-earnings (or P/E) ratio is selected for the company, and then the future earnings of the company are estimated. The valuation's fair price is simply estimated earnings times the target P/E.4. Some feel that if the stock is listed in a well-organized stock market, with a large volume of transactions, the listed price will be close to the estimated fair value. This is called the efficient market hypothesis. On the other hand, studies made in the field of behavioral finance tend to show that deviations from the fair price are rather common, and sometimes quite large.5. In addition to fundamental economic criteria, market criteria also have to be taken into account for a market-based valuation. Valuing a stock is not only to estimate its fair value but also to determine its potential price range, taking into account market behavior aspects. One of the behavioral valuation tools is the stock image, a coefficient that bridges the theoretical fair value and the market price.
Today, the aforementioned underlying dependent variables that support some of the model assumptions above are either being downgraded or are uncertain in their outcomes, and this is pressuring stocks.
"Because I usually write about finance, I have come to believe in the theory of what I would call 'financial realism,' or what might more accurately be called 'trader realism.' Under this theory, on which I have an imaginary patent, traders can see masses of data any minute of any day. They can find data to support hitting the 'buy' button or the 'sell' button. They don't act on the basis of what seems to them the real economic situation, but on what's in it for them." -- Ben Stein
Stein's major assertion is that what his brother-in-law Melvin (a Harvard Law School graduate) taught him about legal realism applies to the stock market and to the traders running the stock market. Mr. Stein cites the following:
"What really happened (in the legal system) at the appellate level and probably at the trial level, too, was that judges made up their minds based on their predilections, their biases, which lawyer was their friend, what they had for breakfast that day."
He gives little rigorous documentation to his assertion. It is simply his feel that the traders set prices, as suggested in the following quote from his article, based on the magnitude of the stock market damage inflicted relative to his view of the economic damage that has occurred.
It is simply more B.S. from B.S.
"Note that the losses in United States markets alone are on the order of about $2.5 trillion in recent weeks. How can a loss of roughly $100 billion on subprime -- with some recoveries sure to come as property is seized and sold -- translate into a stock-market loss 25 times that size? The answer is trader realism. "The losses in the stock market since the highs of October 2007 are about 14%. This predicts -- very roughly -- a fall in corporate profits of roughly 14%. Yet there has never been a decline of quite that size for even one year in the postwar United States, and never more than two years of declining profits before they regained their previous peak."
And earlier in the article, he provides a synopsis of his almighty trader theory:
" More than that, they trade to support the way they want the market to go. If they are huge traders like some of the major hedge funds, they can sell massively and move the market downward, then suck in other traders who go short, and create a vacuum of fear that sucks down whatever they are selling. "Note what is happening here: They are not figuring out which way the market will go. They are making the market go the direction they want."
The above demonstrates such a degree of naïveté that I am really shocked that
The New York Times
published the article.
For example, when a company misses its earnings guidance by a penny or two, the same disproportionate impact occurs on its share price. The equity capitalization loss is vastly in excess of the miss to profits. That is because, generally speaking, the miss to expectation can sometimes be seen as a warning of larger misses to come.
The same observation is true with regard to the economy or to the credit markets.
More broadly, the subprime problem (originally expected to be contained) has metastasized into a global credit crisis that neither Ben (Stein or Bernanke) nor any of us mere mortals have ever experienced. With it has come hundreds of billions of dollars of permanently lost capital that has disappeared into "money heaven."
What concerns investors is that it has occurred at the time that the financial system (and the U.S. consumer) have never been more levered. The multiplier effect is unknown, though they have been accompanied by massive writedowns at the world's largest financial institutions, and markets hate the unknown.
Stein continues to dismiss the all-too-obvious economic and stock market problems that litter the world, many of which I have
ad nauseum. Rather than recognizing those risks, Mr. Stein prefers to simply place the blame on the body of avaricious and self-motivated traders who control and overwhelm the markets over the very short term.
I respectfully suggest to Ben that he listen to the
conference calls -- they are still available on replay -- and read the
and Merrill Lynch 10Qs in order to get out of the fourth estate's ivory tower.
Moreover, who are these "traders" that Stein blames? (Honestly, he is beginning to sound like Senator Clinton in 1998, with her
argument.) The traders I know are getting killed these days -- sometimes on both their long
The dedicated short community manages less than $5 billion in total -- that's under 10% of the size of the
Fidelity Magellan Fund
-- and most long/short managers, an asset class that dominates today's investment landscape, are substantially long-biased. (According to Ed Hyman's ISI surveys, they are about 55% net long.)
For Stein to be correct that the market's drop is simply a conspiracy of traders, test his hypothesis in reverse. Is the market ever dear? When it goes up, is it only a conspiracy of buyers as most traders are long-biased?
My conclusion? Stein is simply suffering from a conformational bias of the worst order.
Not surprisingly, I prefer the more substantive economic reality portrayed in other pieces in Sunday's
New York Times
-- those written by
-- to Stein's nonrigorous assertions regarding the power and culpability of the trading community.
In summary, one thing is certain to me: Ben continues to fiddle in
The New York Times
while the world's equity markets burn.
The answer to the investment mosaic is
. (I certainly don't possess the answer!) Market prices are based on numerous influences, generally grounded in market psychology, corporate profit expectations and the term structure of interest rates.
staring into a financial abyss
caused by real world problems, yet Stein pooh-poohs it all, almost dismissing the issues out of hand by blaming the whole thing on "traders" -- the definition of which I don't really understand, and Ben has not explained who exactly they are.
If Stein has only influenced one single investor to ignore today's market and economic headwinds, he is doing a disservice to that reader and to the
New York Times
I expect more.
At the time of publication, Kass had no positions in the stocks mentioned, although holdings can change at any time.
Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd.