A Wall Street Menagerie

Anyone who has seen traders gesticulate to execute orders on the stock exchange floor, or heard boisterous brokers in after-hours bars, already knows that Wall Street is a zoo. But the stock market folklore and vocabulary also abound with other animals. Best known among those are the bulls and the bears, who are merely opinion holders. But many other animals, like the chickens and the pigs, are more interesting because they suffer from character flaws. These flaws, essentially, are rooted in insecurity.

Chickens, obviously, are investors that are afraid of risk. They can respond to this fear in two ways, depending on the breed of chicken:

Moth-chickens, with groupie tendencies and clicking-fingers that are faster than their brains, wind up like the CNBC-fed day traders of the last bull market. Their basic lack of conviction makes them hyperactive, convinced by the bulls one day and by the bears the next. Seemingly caught in a panicky but aimless frenzy, they behave much like moths near a light bulb. Today, with many dot-coms having turned into “flopped-coms”, moth-chickens have joined the newest craze -- group rotation. Once again, they are mistaking motion for action

Lamb-chickens suffer from intellectual tendencies. They don’t like to make a decision until it has become so well documented as to seem riskless. But, the appearance of no operating risk in a company’s outlook usually means that its stock is already so high as to present unacceptable price risk. As a result, these chickens wind up being the sacrificial lambs of every bull market. This is what happened to lamb-chickens who finally understood the New Economy in late 1999, when tech stocks were at their apex.

An old Wall Street adage says that “there are bears, bulls and then there are pigs.” The pigs would be investors who, for example, were imaginative enough to buy the “tech” stocks early in the Nasdaq bull market, but not wise enough to sell them before their gains evaporated. But was it really greed that made them hold on to their shares?

Greed, with fear, is supposed to be one of the two fundamental components of stock market behavior. But greed is really a personal vice, whereas markets are moved by crowd phenomena. My own observation is that most investors who participate in market bubbles such as the one we have just experienced do it less out of greed than out of another kind of fear -- the fear of being left out. Even if they were fully aware of the risks they are taking, they might still join in the bubble and consider potential losses as the price of “belonging”. (See an earlier paper: Asymmetric Pleasure).

This is also why momentum investing (buy late, sell late) has become so popular in spite of its poor long-term record. It feels like a series of bonding experiences; its practitioners are comfortably within the crowd and they hold the securities everyone is talking about. So, “pig” is often a misnomer for investors that fail to sell in time, and “sheep” would be more appropriate.

Then, of course, there are the ostriches, who prefer to bury their heads in the sand rather than face the menacing realities around them. They are the ones whom you hear chanting “but Cisco, Sun, Corning, Oracle… are good companies, aren’t they?” Unfortunately for them, neither hope nor nostalgia is a strategy, and ostriches usually wind up losers in the investment game. They did not know enough to assess the risks when they bought these stocks, and they don’t know enough now to decide if these same stocks have become attractive after 50%-70% collapses.

As an aside, whether a company is a good company or not is an irrelevant question, when asked out of context. A more relevant question would be: “what is a reasonable price to pay for this high quality company?” In fact, less-than-top quality companies at very cheap prices often represent the better bargains. This has been demonstrated by the success, over the years, of the “Dow Dogs” strategy of annually buying the ten cheapest stocks among the thirty blue chips in the Dow Jones Industrial Average.

The most recent fad is to seek and buy the “thousand-pound gorilla” in each industry where such an animal exists. The gorilla is the company that is so much larger and powerful than its competitors that it cannot be displaced. This is a sophisticated variation on indexing, which consists of investing in the largest companies making up the leading stock market indexes. The more money went into these stocks, over the past decade, the higher they rose, pushing the indexes to new highs while non-index stocks languished behind. This, however, could not go on forever and sooner or later, investors must be reminded that, when you buy something, the price matters. It now looks like the apes, not the eagles, will have bought the gorillas.

Bull markets are made possible by excess liquidity from central banks, beyond the immediate needs of the “real” economy. That liquidity, for a while, flows into financial assets and creates an environment where there are more potential pigeons with money to invest than legitimate investment opportunities.

In such periods, deals of decreasing quality get offered to a broader and broader array of investors. Many of these investors are incapable of understanding what is being sold to them, but are bluffed by the roster of other investors, or the reputation of the managers. The most spectacular recent instance of this was Long Term Capital Management, with a couple of Nobel prizes on board, whose threatened failure necessitated a Federal-Reserve-led bailout. We are reaching the end of an incredibly prosperous era for hedge funds managers, I get nervous hearing how new ones will now be made available to small investors. Lambs of the world, beware: hedge funds are not for small investors.

In other cases, it is the intellectual aesthetics of the proposed deal that capture the imagination of investors and dumb their common sense. Many of the Business-to-Consumer dot-com ventures fell in this category: intellectually attractive, but with no indication of moneymaking potential. It is always striking to find among the investors of glamorous, failed deals the names of brilliant businessmen, lawyers, accountants and financiers. Graham Green, explained it best, when he said that it is always easy to con an educated person. The educated have a tendency to trust intelligence and instruction more than common sense and instinct, to their detriment.

Of course, not all pie-in-the-sky schemes are frauds and not all promoters are sharks. But it is good to remember that commercially successful schemes often appeal to the public for the very same reasons as successful scams.

And, finally, there are the vultures. When many poorly conceived or executed business plans fail (the majority), creditors often become the owners of assets that have some value – from equipment, to software and various intellectual property but which they would rather liquidate. But vultures, really, are only the most extreme of the value investors – those, as Ben Graham described them, who like to buy one dollar for fifty cents.

We, at Tocqueville, are the mules of the investment world. Once we have reached a conclusion after much research, we seldom change opinions just because market prices seem to go against our best judgment. As a matter of fact, like many other value and contrarian investors, we tend to like an occasional bear market, because it makes good stocks cheaper and provides unique opportunities to add to our favorite holdings.

We had been highly skeptical of the stock market advance in 1998-1999 and its growing bubble characteristics – not only on the Nasdaq, but also among the fifty largest companies in the Standard & Poor’s index. We failed to participate in this folly to the end and now welcome the debacle that ensued, because it is creating plenty of attractive values. We believe that the stock market has entered the final phase of its decline, where indiscriminate selling may, for a while, drag our favorite stocks down with the rest. It won’t change the fact that we have reached the stage of the race where the turtles finally beat the hares. Get ready to shoot fish in a barrel…

François Sicart

© Tocqueville Asset Management L.P.
Mar 13, 2001