After the U.S. invasion and occupation of Iraq has begun, global stock markets and individual consumers will react in ways both predictable and obvious.
Or at least it will seem that way in retrospect. For no matter which way stocks ultimately move -- up, down or sideways -- we are bound to hear a chorus of traders, policymakers, economists and friends declaring that the rest of us were idiots for not understanding the result was clear as day many weeks before.
So what will be so obvious in retrospect?
More important than the right answer -- which is probably that investors overdosed on caution -- is the method used to develop the answer. For as I learned from the Williams Inference Center last week, the trick to preparing for both short-term, event-driven market moves as well as long-term, culture-driven market moves, is to learn how to symbolically separate meaningful clues from trivial ones.
The Past Is No Predictor
Jim Williams, whose 40-year-old organization professes to offer corporations and institutional investors help with thinking about thinking, insists that the usual method of determining the future, which is to assume that it will be similar to the present, seldom works. Trading after major, unpredictable events does not typically follow the current trend, it creates a new trend. And that new path may be a reversal of the current trend, or it may be a new direction entirely.
To discover the most likely new path, Williams says, seek unintended social, political or financial messages by turning over and correctly interpreting a "down" card. In games of chance like blackjack and poker, down cards have values that are typically known to one player but not to the rest. If powerful enough, they can change the course of the game. In the game of life, he believes that down cards surface as anomalies, or strange, telling little facts known initially only to a niche group, which reveal deep truths valuable to all.
Williams and his small staff spend their lives hunting in newspapers and trade journals around the world for down cards, and stacking them in piles around his office. He visits large clients like
about four times a year to deliver and interpret the results, and he publishes them in a quarterly magazine called
to all other clients. Then, he throws his clippings away and starts collecting again.
At investment firms, he says he talks mostly to portfolio managers, not analysts. "Analysts are our enemy," he said. "They only want numbers. We don't have numbers. We are after symbols that have the power of myth."
Williams believes that a variety of down cards today reveal that both public and professional investors are overly focused on risk rather than opportunity. In the late 1990s, he said, the concept of risk virtually disappeared. Now, companies for the first time are hiring chief risk officers to sit in meetings at parity with chief financial officers and chief executive officers; additionally, bonds and gold have soared while stocks have plunged. "The hunt for opportunity is missing," he says. His interpretation: It will soon be time to look for the next bull market, possibly in such commodities as natural gas and water, along with gold and even base metals like nickel.
He has taken his own advice in a small hedge fund that his firm runs to test its ideas in the marketplace. "That's why we are long stocks and short bonds; we were early, but we anticipate that risk-taking will return," he said.
Anticipating an Early Rally
For a practical example of the value of down cards, consider the trading following the terror attacks in New York and Washington on Sept. 11, 2001. During the week the U.S. stock exchanges were closed, most experts predicted that the bearish trend already in place that summer would accelerate once trading resumed. That was true for the week of Sept. 17-21, but on Sept. 24 an entirely new, sharp upward trend began that was impervious to continued terror and anthrax scares for three months.
One of the few experts who got it right was the hedge fund trader and research director I call "Mr. P." He told me in an interview during the week the market was closed that his analysts had noticed a small item in a news story that suggested that mutual funds would have five days' worth of sell orders to clear when trading kicked back into action on Sept. 17. This single clue led him to predict that stocks would trade down the first week purely from the point of view of market mechanics, and that it would seem obvious in retrospect. And so it did.
Two weeks ago, Mr. P called to say that all the pundits calling for a significant bounce in the market precisely off the October lows would be disappointed. He argued that because everyone on the Street was waiting for a rally around those levels once the bombs dropped, the smart money would jump the gun and buy early -- a view that I first discussed in mid-February. (The rally arrived last week. At the end of trading Monday, the
Dow Jones Industrial Average
was up 8.21% from the lows of March 11; the
was up 7.8%; and the
was up 9.5%. The bounce in the S&P 500 and Dow began slightly above the October lows.)
You could call this sort of thinking "anticipatory reflexivity," which means that to be successful at trading you must consciously deviate from the consensus point of view and prepare for the reflexivity of other investors' thinking. It's similar to retired hedge fund trader Michael Steinhardt's concept of "variant perception," which I explained in the November 2001 column "Three Steps to Turn Gut Instinct Into Profit."
Three Possible 'Down Cards'
After speaking to Williams, I was struck by the similarity between his team's method and that of Mr. P, who sleeps less than five hours a day, as he constantly reads news from online newspapers around the world -- not analyst reports -- for out-of-the-mainstream clues. When he finds something interesting, he peppers his staff and friends with the nuggets and awaits their reaction, because it's key not just to find something potentially illuminating about the world but also to see how others react to it as well. That's the reflexivity component.
Putting the down-card theory to work myself, I spent the past few days prowling obscure news Web sites for down cards and found a few interesting ones right away. Here were three:
In F.A.Z. Weekly, the English-language online edition of the
Frankfurter Allgemeine Zeitung
, a major German paper, I learned that Japanese multinationals are increasingly moving their European headquarters to the Netherlands from Dusseldorf. Bicycle components supplier Shimano, for one, has moved across the border to Nunspeet. "Lower taxes and rents as well as living costs made the move advantageous," Frank Pfeiffer, the company's marketing chief, told FAZ. The item suggests that Germany's current economic troubles are structural, not ephemeral.
In the online edition of a Malaysian newspaper, I learned that retail sales are down in that country for the same reason they are down in the U.S.: war fears. The item suggested that a quick resolution of the war could help the global economy, not just the U.S. economy.
In the online journal Euractiv.com, which covers European Union news, I learned that the alliance's so-called small countries -- Austria, Belgium, Finland, Ireland, Luxembourg, Portugal and The Netherlands -- would meet in a minisummit today to discuss their joint opposition to the way that the EU is run by large countries Germany and France. The item suggested that the very fabric of the European Union was under attack from the inside at the same time that it is troubled externally by diverging approaches to Iraq disarmament.
Plays on Aging Boomers, Weak Consumers
For his part, Jim Williams is looking well beyond the war to deeper demographic and political change. In particular, he says he loves the theme of the aging baby boomers. He believes the boomers are the most "worn out" generation of all time. An article pointing out that people in the 54-plus age group exercise much more than teen-agers made him realize that boomers are going to require a lot of knee, hip and shoulder replacements. For a long in his portfolio, he has settled on
), the orthopedic implant manufacturer whose shares made a new high in trading on Monday.
On the short side, his firm has bet against companies whose fortunes are tied to consumer debt. "The consumer has debt over his ears," Williams said. His research leads him to expect a double-dip of recession by the third quarter, and he will be ready for that with shorts of bank and credit-card stocks -- and in particular,
. However, he is quick to note that his work does not offer timing clues, so many of his positions are held for a long time before they pay off. "We are dealing with the subconscious," he said. "When a down card gets turned over -- that is, when the subconscious becomes conscious -- no one knows. You just want to be ready when it does." He says his firm's published list of about 40 stocks, rebalanced quarterly, has beaten the S&P 500 every year for the past 35 years based on this type of analysis.
I'll keep track of his suggestions and report back from time to time. In the meantime, for a wide assortment of examples of down cards, visit his archive page at his Web site.
Jon D. Markman is senior investment strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at email@example.com. At the time of publication, he owned none of the equities mentioned in this article, but positions can change at any time.