How many eyes are on the exit, you might be asking yourself, with the S&P 500 breaking records almost daily in this six-year-old bull market? Just when are stocks overvalued? What’s an investor to do?
Over the years, professional investors and academics have studied market valuation in great detail. Despite their intensive efforts, the best they could come up with are some very general guidelines. That’s because stock prices in general are significantly influenced by the emotions of everyday investors and the mostly futile attempts of institutional investors to anticipate changes in market cycles, meaning timing the market.
What’s more, all Wall Street insiders know about something that is very important to each of them individually that has a powerful influence on stock prices. And it’s not a subject you will see addressed on the Web, in The Wall Street Journal or even on the television news.
While it will be obvious after I explain it to you, most everyday investors haven’t considered how important this one thing is to market prices and, ultimately, how it affects your nest egg.
It’s highly personal to Wall Street’s elite money managers and probably has more influence on short-term market prices than any other factor you can imagine.
What do you think it is?
It’s their jobs.
And once you know how most fund managers protect their highly coveted jobs by managing their career risk, you will never view what is happening on Wall Street in the same way again.
Wall Street’s Lemming Approach to Investing
Because investment management is a privileged profession that pays fund managers (especially hedge fund managers) like royalty, the primary objective — after attaining a lofty position in an investment-management organization — is simple: Keep it!
And how do they make sure they keep it? The well-known and widely respected investor Jeremy Grantham explains it perfectly: “Never, ever be wrong on your own.”
As Grantham explains, you can be wrong when you have lots of company — that’s OK — but never go it alone. And that’s because no one is going to fault you if you’re part of the crowd that’s driving prices one way or another.
In other words, taking the conventional approach (meaning, buying the same things everyone else is buying, and selling the same things everyone else is selling) is the best way for a Wall Street insider to manage career risk.
As an example, think about the 2007 financial crisis. You have a situation where all of the men and women running the world’s largest financial institutions failed to foresee (or take any action to prevent) the housing bust.
When questioned about their actions, they all shrugged their shoulders and cried out in unison, “No one saw it coming!” The result was that most kept their jobs — or were hired by the government to help clean up the mess they created.
Obviously, failing to avoid the crisis and being sucked into its vortex was not a sufficient reason to get fired or be exiled from the business.
As the renowned British economist John Maynard Keynes said many years ago, “Alas, a sensible banker is not one who sees danger and avoids it, but one who — when he is ruined — is ruined in a conventional and orthodox way so that no one can really blame him.”
Or as Keynes said at a different time, “It is often far better for one’s reputation to fail conventionally than to succeed unconventionally.”
|Wall Street’s “stay with the crowd” behavior creates significant opportunities to buy what is out of favor with professional investors.|
In fact, to protect their paychecks, most investment managers look around to see what everyone else is doing and then do the same thing.
Obviously, doing everything you can to keep your job is completely rational. But, by definition, it creates irrational markets and a lot of price momentum (on both the up and down sides) as the professional investment managers surge from one side of the ship to the other — just because the other guy is doing it — without ever considering the wind direction!
Their Career Risk Creates Your Opportunities
But there’s no need to criticize Wall Street for its self-serving behavior; instead you can recognize it and be glad for it.
That’s because Wall Street’s “stay with the crowd” behavior creates significant opportunities — opportunities to buy what is out of favor with professional investors and to sell them the hottest trend.
It is Wall Street’s wallet, not its wisdom, that you should value most.
As I pointed out in a previous Money and Markets column, successful investors have the proper mindset. They’re contrarians — meaning they are willing to go against the public consensus when the odds and potential payoff are in their favor.
They understand Wall Street’s aversion to career risk and embrace the opportunities presented by running against the crowd, motivated by the great rewards that come from venturing down the path less traveled.
As the stock market hits new highs and margin debt surges, evaluate the holdings in your portfolio carefully because, by definition, an expensive market is a dangerous market and the Wall Street professionals are not necessarily on your side.