We Americans adore flawed heroes, particularly if they have endured poverty, cancer or a broken heart en route to their Olympian heights. And thus it's a little bit odd that so few private investors know the name Michael Steinhardt, long renowned on Wall Street as a mean, overweight, lavishly philanthropic cuss who rose from a single-parent household in the tenements of wartime Brooklyn to become one of the few hedge-fund managers to average 30% returns annually from the mid-1960s to the mid-1990s.
His moving, enlightening and frustrating new memoir,
No Bull: My Life In and Out of Markets
, should relieve Steinhardt of some of his obscurity even as it embellishes his legend as one of the worst people managers among money managers on the Street. (He notes in one passage that a hired organizational psychologist told him that employees considered themselves "battered children." He fired the psychologist.)
Investors in Steinhardt Partners probably couldn't have cared less about his personality -- shaped in part by a dysfunctional relationship with his gambling-addicted, free-spending, ex-convict father who split from his sainted mother after just one year of marriage -- because it consistently made them hundreds of millions of dollars over the years: From the go-go 1960s, when wins came from short-term bets on high-multiple "story stocks," to the bearish mid-1970s, when victories came from shorting many of the very same names, to the 1980s and 1990s, when his revolving-door crew of traders and analysts moved uptown into the rarefied world of "macro" trading in currencies, bonds and commodities.
The thread of success is a little hard to pick up in this memoir, because Steinhardt offers no 1-2-3 lists that explain exactly how you can make money by following the master. Transparency isn't exactly his strong suit -- and a knowledgeable source who declined to be identified told me that in any case, Steinhardt's reputation was built on his trading skills, not his analysis.
But if you want to Be Like Mike and don't want to buy the book, at least stand in the bookstore and read Chapter 8, titled "Variant Perception." That's where he comes closest to revealing the method behind his abusive madness. I'd recommend actually buying the book, however, and not just because his editor and publisher are handling my next book. You'll also enjoy anecdotes about the colorful life of his roguish father; his paradoxical devotion to Israel and Jewish charities despite lifelong atheism; and his philanthropic work on behalf of plants and animals.
A "variant perception," he explains, is the result of having an "intellectually advantaged disparate view" of a market or security. Meaningful profits, he says, come first from developing a keen understanding of market expectations, then developing a distinctly variant view, which, if correct, ultimately later becomes the consensus view. "Most of our success resulted from our implementation of perceptions that were meaningfully at variance with consensus wisdom," he writes. "We shorted near the top, in the face of great bullishness, and we got long at the bottom, in the face of keen pessimism."
Now retired for six years, he says that the difference between garden-variety contrariness and a valuable variant perception is "the degree of conviction" that's earned from disciplined, intensive analysis, not intuited in a hunch. He adds: "Reaching a level of understanding that allows one to feel competitively informed well ahead of changes in 'Street' views may justify making unpopular investments."
Steinhardt doesn't teach us much about how to develop variant perceptions, however, and that's the frustrating thing about the book. So I called his New York office last week to try to pry out more insights -- and get his current view of the market. I was mildly surprised to discover a soft-spoken, almost-professorial gentleman on the other end of the line who didn't sound at all like the tyrant of the book.
The upshot: He's bearish on both the economy and stocks, thinks both technical analysis and stock systems are useless -- and considers conventional "value investing" to be inherently dangerous. Here are the highlights of our talk.
Capitalizing on Variant Perception
To make money on a variant perception, Steinhardt said, it's important to have an easily articulated view that represents a significant variation from consensus over a relatively short period of time. That is, if the consensus believes
will earn $1.20 per share in 2003 and you think it'll earn $1.15, that's too far out and not enough of a difference to yield a profitable short sale.
He took me through an exercise. Let's assume, he said, that 32 economists' consensus view of inflation next year is 2%, but your research and guesswork lead you to believe that inflation will be 5%.
- First, make sure you understand exactly where your conviction comes from. You might, for example, believe that the first phase of the war on terrorism will end quickly, bin Laden will be killed, U.S. forces will leave Afghanistan, the economy will show a big pickup, and price pressures in energy will rise. If it's intellectually defensible, go on to Step 2.
Next, decide how much conviction you have in your intellectual construct. If it's strong, then go onto Step 3.
Last, determine the single best way to take advantage of your view. If you want to make the bet that as the world slowly comes to recognize that the inflation rate will be higher, it'll be felt most critically in the bond market, for example, then you might have, at one time, decided to short the 30-year U.S. Treasury bond.
How to sell or cover your position to capture profit? Sometimes, Steinhardt said, he had a short-term trigger in mind for the events that would cause a change in consensus in favor of his view, and sometimes he had a long-term trigger in mind. When he believed that the world had swung around to his point of view, he would sell. "God bless gut instinct," he said. "I'm not a tape reader, and I'm not a chartist. I don't believe in any of that stuff. I believe in getting as much input as I can, some of it very nuanced, and then being very sensitive to short-term performance. In other words, I usually sold too soon."
Usually, perhaps, but not always. Hey, no one's perfect. Steinhardt told me that the single worst trade of his life was too painful to include in the book. It was a short position that he held in
in the early 1990s. He said he got snookered by a number of phenomena that "normally comfort one who shorts stocks that sell at a wild multiple": Substantial insider selling, increasing competition from strong rivals, and seemingly superhuman (and thus unsustainable) earnings growth.
The result: He lost nearly $250 million in 18 months. He laughs that his aversion to expensive stocks would have led him to short all the Internet bubble stocks in 1998 and 1999 if he were still in the game, and "they would have carried me out on my shield!" Then he skipped a beat, and after a pause mused that maybe he would have figured out the new game and played along after all, as he did in the '60s. "I did this for 28 years and the number of down months is something like 3% of my total," he said. "Therefore, it's not unreasonable to say that I would have figured out what to do and been OK."
All of the foregoing might lead you to think he'd consider himself a value investor, but you could hear bile rise in his throat when he heard that term. "I wouldn't choose the word value because there is something presumptuous about the conventional concept of value," he said. "By implication, someone who thinks he has a portfolio filled with value creates false comfort in his mind that there is an underlying quality in his securities. That allows him to be less sensitive to the market, or to quarterly earnings disappointments. Value in my view is just an artifice, and thus it's a very dangerous point of view."
The Current Market
To end our chat, I asked for his thoughts on the current market consensus and his variant perception.
On consensus: Even though the broad market is down a lot from its 2000 highs, he believes the consensus remains bullish. He believes that most people expect that lower interest rates and fiscal stimulus will work over the next 6 months to 12 months to revive the economy as they have in the past, that the market has bottomed and will continue to rise.
Steinhardt's variant perception: He cautioned that I was talking to "a geriatric fellow who's close to clipping Social Security coupons," but then allowed that he sees big risks ahead. Most importantly, he thinks that the enthusiasm, vigor and unthinking patriotism accompanying the war now might not last forever -- and he would look for triggers that might cause a change in psychology. In other words, he thinks the likelihood of things turning out badly in the war on terrorism is not properly discounted in the level of the stock market. Moreover, he doesn't see the pent-up consumer demand that's usually required to lift an economy out of a recession.
stocks would have to trade in the low- to mid-7000s to reach the level of pessimism he believes is required to mark a final bottom in the bear market -- and that touching 7,926 for a few minutes on Sept. 21 wasn't enough. All in all, he's long-term bearish until the building blocks for a lasting economic recovery start appearing.
So if you want to be like Mike, my guess is that you'd want to identify high-multiple tech stocks that could come crashing down in the event that sometime between next week and February, worsening earnings will sour investors' newfound ebullience. Leaning on my own perception that 2002 could unexpectedly be as tough as 2001 for telecom equipment and services, I would prepare a list of potential shorts such as
RF Micro Devices
At the time of publication, Jon Markman owned or controlled shares in none of the equities mentioned in this column.
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