[The title of this blog is penned with apologies to Edwin Lefevre, the writer of what is possibly the greatest book on the stock market ever written]
In February next year, I shall have worked in stock markets in various guises for 29 years, and will have to up-date the bio below. In the meantime, in what will be our last blog of 2015, I shall attempt to describe the similarities that have endured and the differences that have emerged in that period. It is by no means exhaustive, merely a personal account of what it was, and is, like to work in the City of London.
I arrived straight out of University in February 1987. Within six months, I was let loose on clients, some of whom clearly knew much more than me. But we had an advantage that clients rarely had – information; boy did we (ab)use it. The business was fantastically profitable, and within three years I was earning far more than my father had retired on. Of course, we were, to a man, convinced that it was due to our own efforts that we were doing so well – the bull market peak in Japan put paid to that line of thinking: for of all the global markets I could have chosen to work in, I had picked the next quarter-century’s worst performing – an early lesson on the importance of asset allocation. As the 1990s wore on, and you could almost hear fund managers yawning at the prospect of discussing Japanese equities, we had to get creative: and this we did, inventing ever more elaborate and technical-sounding justifications for owning Japanese shares, bonds, options etc, which served us (though not necessarily clients) well for a time. But you can’t cheat bear markets forever, and over the next five years, we all gradually drifted into new fields of endeavour, which for myself included fund management. It is instructive to look back over the period and ask what has changed and what has remained the same in nearly three decades.
Let’s start with the similarities:
Human nature hasn’t changed. Bubbles and crashes are still with us, as investors get carried away with new ideas (paradigms as they are now called). We still mistake complexity for sophistication – portfolio insurance was all the rage in the late 1980s, the irony being that the perception of lower overall risk meant that investors took on more risk, thereby negating any potential benefits thereof. Now we have risk parity, which has been blamed for the sharp declines in late August. Investors still fall for stories (the Internet in the late 1990s has been replaced by the clamour for private equity “unicorns“, which, upon being publicly listed, promptly implode). From Long Term Capital Management to mortgage bonds, history is littered with the remains of investor’s bizarre fixations, caused by over-confidence and herding, all accompanied by the belief that this time is different.
There is still a culture of “win at all costs”. Analysts and traders are still obsessed with gaining an “edge” over others, convinced that if they can only find he next star stock, or fund, or manager they will become rich, famous, or whatever they desire. Although the US and UK governments have introduced reforms post the mortgage crisis, and strengthened the divide between traders and analysts(1), the desire for extremely lucrative corporate finance deals still inhibits the latter from challenging management (brokers’ sell recommendations are notoriously thin on the ground), allowing the likes of Fred Goodwin (for example) to recklessly overstretch the RBS balance sheet to little immediate shareholder benefit, but immense future losses. There is still a reluctance to criticise CEOs for fear of compromising future business, which means investors see no opposing viewpoints that challenge the conventional view, which in turn leads to much bigger market moves when that orthodoxy becomes untenable.
What about the differences?
Quite a bit has changed, mainly in the realm of technology; some might say not for the better. The rise of high frequency traders has led, ironically, to a drop in market liquidity, as all they appear to do is place themselves in front of genuine customer orders, skimming risk-free profits in the process. As this article points out the fact that they have had virtually no losing days in three and a half years, is to say the least, suspicious. All trading was done by phone in the 1980s and 90s, which seems positively antediluvian in the current context, but it meant that markets were slower to react to every twitch, and the more personal contact made it psychologically more difficult to try to cheat someone. The impersonal nature of computer trading makes it that much easier to act unethically as the victim is anonymous.
Which brings us to another major difference that has appeared over the years: Dennis Levine and Ivan Boesky both served time in prison for insider trading in the 1980s, whilst no one has been jailed for the behaviour leading up to the 2007-09 crisis, and Fred Goodwin has walked away with a £16 million a year pension. It appears that not only are banks “too big to fail”, but that bankers are too big to jail!
Finally, the role of central banks has changed dramatically, especially in the last ten years. There was no thought of central bank intervention in markets, even during the height of the 1987 crash. Now, courtesy of the Greenspan, Bernanke and now the Yellen “put“, there is an assumption that central banks will intervene to stop all but the most minor market declines. It is currently happening in all markets and all asset classes, from Chinese shares to the Euro, from bonds to state amendments to buy-to-let property rules, the market is having to constantly adjust to both actual and potential policy changes that can come with little or no notice. This is another factor making markets much more twitchy, and prone to reaction and overreaction in turn.
What of the future?
It is of course unknown – we will still have bubbles and crashes, political and economic shocks, wars and terrorism to deal with. We will witness thrilling rises and sickening plunges along the way, but EBI will underreact: we hope that our clients will do the same.
(1) Called Chinese Walls, they are intended to prevent co-ordination between analysts and traders, such that the latter is not made aware of the former’s recommendations until the information is in the public domain. Needless to say, it is almost totally ignored.