Sentiment Can Change So Fast

My apologies for the recent break in transmission, the result of travel and other commitments. The way the equity markets have rallied since the beginning of March, perhaps I should stay away for longer! This is the full text of my latest FT column. It seems a safe bet that we will now see a new wave of bullishness from commentators, arguing (with Anthony Bolton and in today’s FT, reasonably persuasively, Tim Bond of Barclays Capital) that the bear market has now bottomed out. I am not prepared to go that far, as the risk of more pain remains significant, but the recent recovery in financial stocks, a necessary pecursor to any new bull market, is certainly encouraging. Sentiment can change very quickly in this game.

Contrition, whether real or simulated, appears to be the new watchword in financial markets, if not in political circles. In the spirit of the times, my confession is to own up to having taken a certain amount of guilty pleasure from reading Cityboy, a coarse and unpleasant book about the workings of the City of London, published last year. By all accounts this terribly written piece of tosh, billed as revealing the “explosive secrets about life in the devious, murky and often corrupt heart” of the Square Mile continues to sell very well.

The reasons are not, in truth, hard to find. Public anger over the attitudes and behaviour of bankers is being whipped up by the media and politicians desperate to divert blame anywhere but onto themselves. Professionals who once thrived on the back of the explosive growth of investment banking, derivatives and hedge funds are suddenly facing lean times. Many banks, City law firms and accountancy practices, one hears, are cutting back on graduate recruitment and some have been forced to move, unprecedentedly, to part-time working.

With unemployment rising and the recession deepening, it is no surprise that popular sentiment about the City should be turning so hostile. Books such as Cityboy are both symptomatic of the trend and responsible for its wider propagation. The reason they sell well is that there is a sufficient amount of truth in the picture they paint of how the financial markets function to confirm the most painful prejudices, just as Caryl Churchill’s memorable play Serious Money did for the Yuppie generation twenty years ago.

Some of the recent histories of investment banks, such as William Cohan’s riveting history of Lazard Freres, or Philip Augar’s excellent series of studies of the modern Square Mile, of which Chasing Alpha is the latest, have painfully exposed how the dysfunctional management processes and ego-driven internal feuding that often characterises such institutions typically results in most of the economic rents obtained by investment bankers accruing to the employees while the owners continue to bear the risks and eventual losses. They are the High Priests of the “return-free risk” that victims of the sub-prime crisis, investors with Madoff and others have discovered they were really being sold.

Geraint Anderson, the author of Cityboy, gives his slant on the same phenomenon by caricaturing what he sees as the unhealthy motivation of research analysts, hedge fund managers and other investment professionals. His fictionalised account of the cynical advice he was given on how to get on as an equity analyst is, however, painfully close to that I recall being given myself when I was offered an analyst’s job by a well-known stockbroking firm shortly after Big Bang.

“The moment you take this job seriously”, runs Point Number Six in his litany of must haves in the analyst’s life, “the moment you give a shit that a share-price movement goes against your recommendation or that a client doesn’t like you, you’re done for. Never forget this job is just about money-grabbing dickheads pointlessly pushing around bits of paper. It ain’t curing cancer – it’s just the best legal means of making vast amounts of cash as quickly as possible”.

In the case of the firm that approached me all those years ago, it was made very clear that more time would be spent drinking with and schmoozing fund managers than engaging in fundamental research of any kind. It was better, so the advice went, to be precisely wrong than roughly right.
At all costs keep the client happy, whatever it takes. And so on. Has the game changed much since then? The answer of course is both yes and no.

The City has always been capable of reinventing itself with astonishing regularity, and will surely do so again. With hindsight, the speed with which the investment banks in the US were able to shrug off the findings of the Spitzer enquiry, for example, was breathtaking. My prediction is that current public hostility to banking excess and indefensible greed will also pass more quickly than many imagine possible.

Some things remain constant. The requirements for successful investment, as opposed to winning the game of short term performance, remain much the same now as they have always been: an enquiring mind, an ability to think for oneself and if necessary act alone, an understanding of the meaning of fiduciary responsibility and a degree of humility in the face of the market’s unchanging capacity to surprise and confound the views of even the smartest participants.

In the last few days, which have seen the S&P 500 index rally by 16% in six trading days, the old witch is clearly playing its tricks again. “Is this rally the real thing? Have we really reached bottom?” asks Albert Edwards, the splendidly bearish strategist at Societe Generale, one of several who meets the criteria mentioned above. He adds: “It would be wrong to say I do not agonise that I might not be missing a turn. I’m riddled with self-doubt”.

So are we all. Although rarely a saleable commodity in equity markets, doubt is the permanent condition of the true market prognosticator. My prediction remains that we will get a big market rally this year, too big to risk missing out on, but that the odds on equities breaking through their recent lows nevertheless remain worryingly high. Gold continues to look an attractive two-way bet, even though so many now profess to think so.

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