I often come up against a real disconnect in the way that most people perceive the market versus the way they perceive their perception of the market actually is.
Didn't understand the above? Yeah, me either. Work with me.
I've been reading about some of the folks who were bearish during the big boom of the 1990s, in particular Jeff Vinik, who took over after Peter Lynch left Fidelity Magellan; Jean-Marie Eveillard, who runs the First Eagle Global Fund (SGENX); and Bill Fleckenstein, who started a short fund in 1996, "a little early," as he put it in a speech recently.
Here's what I noticed about these guys: They each have deep intellectual fortitude. They had opinions about the market -- about the total disconnect between price and value that developed during the time involved. And they all just stepped off the train, right into the path of an oncoming bus. Before the bubble finally popped, Vinik had lost his job and Eveillard lost more than half of his clients.
Bill Fleckenstein's periodic columns during the time period had the distinction of being pleasures to read, uniformly smart, and nearly uniformly wrong, as the market continued to climb. In early 1999, Fleckenstein made this point, referring to a conversation between Bob Olstein of Olstein Financial and Joe Kernen of CNBC, noting that Kernen had dressed down Olstein for pointing out the accounting trickery going on at Lucent (NYSE:LU). Kernen told Olstein that "We all know that. Nobody cares. The price is where it is." Fleckenstein then made a statement that resonates with me: "Therefore, anyone who has been negative is simply wrong because the market has gone up."
Here's something that superior investors understand: Just because a risk has yet to manifest itself doesn't mean that it doesn't exist. It's certainly true in life, so why would it be any different in investing? Some examples:
1) You and some friends spend the afternoon drinking, riding a motorbike, and operating a chainsaw. No one gets hurt. Was this a riskless activity?
2) A man wanders into a random bar in Philadelphia yelling, "The Eagles suck!" He is dressed head to toe in Dallas Cowboys gear. The bar patrons laugh and buy him a drink. Does this mean that he didn't put himself in harm's way in the first place?
3) You run through a dynamite plant with a lit torch. Nothing explodes. Does this mean that you aren't an idiot?
4) You bet a friend $100 that Tiger Woods will completely miss the ball the next time he steps into the tee box. Tiger Woods hasn't whiffed since he was 6. Against all odds, he whiffs. Good bet?
Obviously, in each case the answer is no. So how can it possibly be any different in investing? A risk taken without consideration of the consequences is a bad move, regardless of whether the worst of those consequences comes to pass.
Look at it this way: In April of 2001, someone was able to sell his shares in Enron for more than $70 per share, even though the company had been diddling its numbers for several years. Most people who have commented on Enron have said the same thing: "We couldn't figure out what they were doing." It is extremely doubtful that someone who held Enron at the time suddenly looked at its footnotes, noticed there were some funny related-party transactions, and said, "I'm out of here." No, anyone who sold at $70 was probably more lucky than smart. He snuggled a wolverine, and the next morning it made 'em breakfast.
Exiled from Magellan
Even though we would like to think that the people who are managing large sums of money have a greater sense of what is going to happen in the market, or even with individual stocks in the short term, they absolutely, positively do not. All you can deal with, then, are the risks involved, and determining whether you have a chance for being fairly compensated for them.
This is not easy. Particularly when the stock market starts to run like mad, you risk being, or at least seeming, wrong. While it's easy to look at the scoreboard and kick yourself for a stock that keeps going up, remember that for every Microsoft (NASDAQ:MSFT) there are dozens of Kmarts (NASDAQ:KMRT), Tycos (NYSE:TYC), and WorldComs -- companies that succumb, temporarily or permanently, to risks that have been building up for years.
It can take some fortitude, particularly when your performance affects others. In early 1996, Jeff Vinik determined that he didn't particularly trust technology companies, so he began selling. Fidelity Magellan, a $50 billion-plus fund at the time, went from being two-fifths technology shares in late 1995 to almost none by mid-1996.
We know what happened. Technology continued to skyrocket. Magellan couldn't keep up with its dowdier profile, and by May 1996 Vinik had departed the firm, leaving in his wake thousands of investors furious that he had missed continued gains. Never mind that Vinik had provided market-beating returns during his tenure. He made a decision, and -- in the short term, at least -- he was wrong.
The pain of being right, but early
Similarly, Eveillard had noted in 1996 that trying to determine what investors will do next, as opposed to what companies are worth, is a game he would not play. His point was simple. The U.S. stock market was in a bubble, and rather than trying to guess, using client money, where it would end, he would simply wait and invest elsewhere in the interim. He had to wait more than four years, and half of his clients left for funds that had bigger and better returns.
Think about that for a minute. Eveillard's asset base is shrinking because clients are leaving in disgust. He has to endure day after day of stories about profitless wonders like Internet Capital Group (NASDAQ:ICGE) skyrocketing to $40 billion market caps, and other companies like Inktomi rising $90 per share in a single day. For four years all of the evidence pointed to Eveillard being nothing but wrong, but he knew where the risks lay and how much he would be willing to pay in spite of them. And he waited for that price!
Eventually, when other funds were melting down, the First Eagle Funds began to strike, to use the cash that Essentials of Fund Management 101 taught was foolish for funds to hold. In spite of this handicap, each $10,000 invested into his First Eagle Global fund in 1996 would become $16,300 by April of 2000. And by the end of 2003, it would have risen to $26,985. That latter part came as some of the funds that chased the bubble dropped by 70%, 80%, even 90%. Having seen what happened to Jeff Vinik when he sold too soon, most elected not to make the same mistake. And they didn't.
It seems that every investor who doesn't consider himself a momentum junkie now wants to grab hold of the appellation "contrarian." Being contrary has its benefits -- you're by definition going where most investors are not. But the true contrarian has to have two elements in his favor. He has to be willing to seem wrong for long periods of time, and he must actually be correct. It doesn't do you any good to be "contrary" about a Bethlehem Steel, which provided shareholders with little more than 50 years of misery before finally falling to bankruptcy. But if you have conviction and discipline, it needn't matter that the folks who do little more than trade four-letter codes are doing great for a time. It only lasts for a precious few of them.
Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards
Bill Mann got all four Final Four teams right, yet has no chance of winning his pool. Confounded Xavier! Bill owns none of the companies mentioned in this story. To learn of other fund companies managed by independent thinkers like Jean-Marie Eveillard, consider subscribing to The Motley Fool's newest premium service, Motley Fool Champion Funds .
