Here we go again. We have another Ben Stein column, “Can Their Wish Be the Market’s Command?” which says, I kid you not, that we have a bear because a whole bunch of traders got together and made it so.
Since undue contemplation of Ben Stein logic is bad for anyone’s mental health, I will limit myself to the main outlines of his argument. The first half of the piece describes how Ben learned in law school that court decisions are completely arbitrary. Judges decide based upon personal prejudice and can always find precedent somewhere to justify their verdict. He then tells that a UK trader buddy described how his firm once ran IBM stock down even though it had just announced great results (note that this apparently occurred during UK trading hours, and some years ago since said trader is now dead, which means there was far less depth in the stock than there in the US, a not trivial detail).
Stein then goes on to say:
As I see it, this is what traders do all day long — and especially what they’ve been doing since the subprime mess burst upon the scene. They have seized upon a fairly bad situation: a stunning number of defaults and foreclosures in the subprime arena, although just a small part of the total financial picture of the United States. They have then tried — with the collaboration of their advance guards in the press — to make it seem like a total catastrophe so they could make money on their short sales. They sense an opportunity to trick other traders and poor retail slobs like you and me, and they generate data and rumor to support their positions, and to make money.
More than that, they trade to support the way they want the market to go. If they are huge traders like some of the major hedge funds, they can sell massively and move the market downward, then suck in other traders who go short, and create a vacuum of fear that sucks down whatever they are selling.
If the current market action is the manifestation of some sort of evil trader genius, they have executed it pretty poorly. Every major firm should have been net short, not just Goldman. The investment banks, with their sales forces and research arms, are in a much more powerful position to push rumors. If the market fall was by design, pray tell me how it benefited the Street? They have taken over $100 billion in writeoffs, and the fourth quarter results are still coming in.
Similarly, the charge that hedge funds are rolling in dough as a result of these gyrations is also badly misguided. It has been widely publicized how the quants have been whipsawed and taken big losses because the action in August were so out of line with historical patterns. November and December have been poor months for them also. Most other portions of the industry, for different reasons, are also not going to benefit from a bear market. As a post from Roger Ehrenberg pointed out:
The real question is, how will a persistent down market impact the returns of the hedge fund and private equity industries? My handicapping: most participants will suffer and suffer badly. Why? In summary:
The net long exposure of most hedge funds will weigh on returns. Historically it has been difficult for most hedge funds to add significant alpha on the short side, the side which may well be the key driver of returns for quite some time….
Bridgewater Associates had a very interesting report yesterday that addressed this very issue. Here are some of their thoughts as it relates to the hedge fund industry:
For the most part, hedge funds have gotten through the credit crunch relatively unscathed. For example, the average hedge fund generated a return of 12.5% last year and 2.5% in the fourth quarter. And private equity funds generated an average return of 11%. The main reason that these two groups held up as well as they did is because the equity market has not fallen nearly as much as the bond markets (i.e., spreads), and the majority of the risk allocation of these funds is in the equity market. And because their performance held up, they have not been forced into much asset liquidation to speak of. But stock market action is beginning to pressure the hedge funds and private equity players.
Hedge funds used to be a lot more hedged than they are today….hedge funds are now heavily long the equity market. Based on fund by fund holdings data we estimate that hedge funds are net long about $150 to $200 billion in U.S. equities (foreign equities are not included in this figure).
So who are these mysterious evil traders killing our collective prosperity? Stein isn’t able to provide the name of a single perp.
The most successful, John Paulson, who was massively short the subprime market, was remarkably low profile until his trade reaped huge profits. He certainly wasn’t trying to talk the market down; the fundamentals did it just fine on their own.
Yet we get stuff like this:
I know this because I know traders. They’ve told me that they love to sell into fear because fear is bottomless — you can make money selling all day, while buying eventually slows because enthusiasm has limits. The amount of money available to large professional traders is so large that they can overwhelm the market, at least for a while, anytime they want. And they like to do it when the market least expects it.
It is one thing to move the prices of single securities, quite another to move entire markets, particularly ones as big as the global equity markets and the US credit markets. We must have a simply staggering number of traders all conspiring together.
And then we get as close as Stein gets to analysis:
The losses in the stock market since the highs of October 2007 are about 14 percent. This predicts — very roughly — a fall in corporate profits of roughly 14 percent. Yet there has never been a decline of quite that size for even one year in the postwar United States, and never more than two years of declining profits before they regained their previous peak.
Aside from the questionable assumption, that the 14% fall is a predictor of a calendar year decline, Stein reveals complete ignorance of bear market patterns. Stock market falls are due to both declines in earnings expectations AND multiple compression. Seeking Alpha has a very nice table showing the change in the S&P during bull and bear markets since World War II. The average bear market was 393 days with an average decline of 30.6%. So we aren’t even to the halfway point by historic standards. And the most recent bear market, in 2002, was less than a year but steeper, a 33.75% fall in the S&P.
Finally, I am not sure the correct comparison for our current situation is past US economic cycles . We are in the process of unwinding a large scale debt-fueled asset bubble, and the closest comparable is Japan in the early 1990s. Indeed, many of the policy remedies are going down the Japanese path of shoring up asset prices and socializing losses rather than letting the markets find a new, lower clearing price. The Nikkei has failed to since reach even 50% of its all time high of 38,957. I don’t expect our trajectory to be as bad as Japan’s, but the point is that US history may be the wrong place to look for precedents for our current credit woes.
Stein’s certainty that there are faceless, powerful enemies in our midst called traders reminds me of Joe McCarthy’s’ conviction that there were commies in every nook and cranny plotting America’s demise. That comparison quickly breaks down since McCarthy was formidable for at least a while and Stein isn’t. But then again, Marx said that history repeats itself, the first time as tragedy, the second time as farce.
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The most rational explanation for Stein’s current nonsense is that he is laying the groundwork for an entry into the world’s second oldest ccupation –
politics.
“I know traders.” There is no more compelling proof that he’s never actually met one than this.
What’s amusing is that my co-blogger and I have been getting variants on this accusation for at least the last year. Every now and again some goofball erupts in our comments to accuse us of being MasterShort Villains and demands to see a list of our trades. I’ve tried to just be flattered that they think I’m a market-mover (The Great and Powerful Tanta!) but that doesn’t seem to satisfy them. I tell them my money’s in Vanguard index funds and they never buy that either. I find it hard to believe that anyone can read my posts day in and day out and not immediately suspect that whatever money I have is in Vanguard index funds.
They simply do not believe that anyone can have motives that are not cynical. They think professional traders must all be little Karl Roves, and economics bloggers must be traders in drag. They’re a minor irritation in blog comment threads and quite an embarrassment on the pages of the NYT.
Ben needs to retire ASAP and sorry to say, but blogs need to ignore any of the trash he spills! Ignore him and maybe he will crawl away?
He is like a troll on a messga board looking for attention; what does he offer?
If he were referring to Trader Joe’s it would make as much sense.And Tanta,I always suspected you of being cloned from Jessica Mitford,living a life of ease from the proceeds of “kind and usual” watching the butler clip your coupons whilst drinking scotch out of a teacup.as far as ben stein,he is neither as useful or as entertaining as cramer.
Hey There Yves,
OT
There was a nice subtle revamp over @ Calcultaed Risk yesterday and last night, where the was sort of an upgrade.
In regard to that “event” I was just playing with your site features and links, buttons and looking around, but not under the hood…I dont do that kind of thing.
I am thus curious as to what the top row of knobs do under the title of Naked Capitalism….sure, I thought some porn pop ups would be available, but how does the blogroll work? Im also so friggn new to this new highly evolving media that I really dont have my head wrapped around the feed reader things. Also, i have to check outthe subtle nature of International charity and how I can lose belly fat or create a blog, etc.
Not to go off here in some postal ranting, but these blogs are obviously a huge part of future media, where our fragmented society will connect itself and thus define itself through the information which will be spinning out of control in this type of hybridized hyper reactive nano second network previously called the information highway; I think this highway will be like a cross between lightening bolts and the infinite expansion of entropy, i.e, we will be struck by things that we dont understand…… very superstitious, writing on the wall:
http://www.youtube.com/watch?v=Jl4DAlHlw5A
Don’t such rants customarily end with an accusation that it’s all the fault of The Jews, perhaps in co-operation with The Freemasons, or The Pope, or even Queen Elizabeth?
I give Stein a 50 for this article. I agree with him about “legal realism” and agree with you about the “trader menace”. Traders only make money if they are right about the market, i.e., just like the rest of us, they buy low and sell high. Traders can “overwhelm the market”. What does that mean? For how long? 30 minutes?
Say something nice about the NYT. It also printed an opinion piece by James Grant, which I agree with.
I have learned the hard way to keep the Sunday morning cup of tea more than arm’s length away. If I absent-mindedly take a sip and then start reading BS (appropriate initials) in Sunday Business, I am likely to splutter, choke and spray Darjeeling all over the wife, the cats and the Border Collies. What a reliable source of hooey he is.
Anon of 11:37 AM,
While dissecting Stein may not be everyone’s favorite use of this blog’s space, I don’t think there is much risk that the attention will encourage him. And in any event, the intent of writing about him is not to try to change Stein’s mind or embarrass him (clearly hopeless) but to do what we can (along with fellow bloggers like Felix Salmon and Dean Baker who are also on this beat) to shame the New York Times into dropping him or at least featuring him less often.
Unfortunately, Senator Dodd taking up Stein’s nutty charges in his Goldman Sachs attack piece last year probably made this a hopeless effort.
A very enjoyable takedown of Ben Stein.
You say this “may not be everyone’s favorite use of this blog’s space” but for finance amateurs out here (like me), it can be very helpful to see a supposedly “intelligent” article in the popular media picked to pieces and demolished like this.
Thank you Yves.
What we’re actually seeing is that Stein is moving from the first stage of grief – Denial – to Anger.
In this case, it’s anger misdirected at short sellers.
Watch for Stein to move quickly to the Bargaining phase – if the Fed will only give us another 50 bp cut…
When he embraces the final phase of Acceptance, you’ll know it’s time to go long again.
Yves,
How much confidence do you (and should we) have in anyone’s reports about hedge funds’ average returns or net investment positions? Isn’t this stuff highly secret? And even if Bridgewater Associates or someone else has access to the hedgies’ audited financial statements, is there any reason to believe those audited financial statements are any more reliable or transparent than those of the banks? I’m asking out of ignorance, not because I am a conspiracy theorist. Thanks.
This is pretty simplified, but hedge funds report their net asset values to investors every month. A high proportion of hedge funds also report their results to data services (the consultants who are gatekeepers to institutional money take a dim view if you don’t).
If the hedge funds are in illiquid assets, they may be able to game their results a bit (ie, by calling various brokers for prices and picking the most favorable. But in fact they’d do that if they were selling too). There are also other factors in which funds in firms that run multiple funds get included that can lead to the industry appearing to have higher returns that it does (a big issue is survivorship bias).
well, it is an election year, might explain the spike in bs.hopefully.
Is that all you have, Yves? I find your rebuttal considerably less convincing than Stein’s thesis. “We must have a simply staggering number of traders all conspiring together,” and “Stein’s certainty that there are faceless, powerful enemies in our midst called traders reminds me of Joe McCarthy’s’ conviction that there were commies in every nook and cranny plotting America’s demise” do not make for a good counter-argument.
I think the closest you came to a rational response was your comment that, “Stock market falls are due to both declines in earnings expectations AND multiple compression.” Of course, that statement implies that there’s a weak association between the two measures. Is the market really that inaccurate?
I think Stein’s on to something. I’ve seen it with my own eyes…
10L00, What planet are you from? The Street is bleeding losses and you believe Stein’s nuttiness, that this is a trader conspiracy? Cui bono?
Do you have the fogggiest notion of how big the global debt and equity markets are and how much firepower it would take to move all of them in the same direction for months on end? Stein extrapolates his thesis from traders moving a singe security for one day clearly more than a decade ago in a market that is not its home market. Creating a big intra-day move and creating a move that lasts for months on end across instruments are two different propositions.
The money markets seized up too, so badly that the Fed and ECB had to go to unprecedented measures for them to operate somewhat normally. They money markets are a thin-margin business; the people who trade there (if you can even call it that) are badly paid and into risk avoidance. There is no obvious profit opportunity to be gained from that train wreck and that is where the crisis began. So how does this fit your paranoid world view?
The big dough that can move markets is at the big houses. The idea of the gnomes of Zurich is long dead. Stein would be more credible accusing the Chinese or oil producing state sovereign wealth funds of being behind a global, cross market conspiracy. At least they have the firepower. But everyone know they are conservative and mainly stick to US Treasuries.
The reason that Yves didn’t say more, or need to say more, is the sort of thing Stein puts out is beneath comment. He shouldn’t be wasting his time on someone as painfully and willfully ignorant as Stein is.
Following up on Archer’s comment, this is from Roger Ehrenberg in “‘How to Lie With Statistics’ a/k/a Ben Stein’s Modus Operandi”:
“This is the title of a legendary book written in 1954 by Daniel Huff. In short, it explains to the layperson how they can be misled by the way information is presented, how those serving up the figures can be economical with the truth and to generally be on guard when consuming numbers, charts and graphs. Well, my bells were going off as if I were in the midst of a five-alarm blaze as I read Ben Stein’s piece in yesterday’s New York Times. It is articles like these for which Mr. Huff’s book was written: reader beware. Because if you take Mr. Stein’s figures on their face, you might actually believe his thesis. However if you dig down a few layers and think a little bit, it doesn’t take long for you to realize that what he is saying is the same weak-minded analytical drivel that he has been dishing out with such frequency of late….Mr. Stein’s indictment is both factually inaccurate and actually destructive of the conversations we should be having on how things should be fixed (like, say, the post I wrote yesterday concerning lessons we can learn from the recent crisis). In any event, the article was truly a drivel-fest and worthy of much scorn and derision.
“In short, Mr. Stein’s thesis is that traders push the market around, plant stories with the press, get the hype machine going, and make a ton of money on the backs of dumb retail investors like you and me. Sure Ben, I’m sure every trader out there wishes it were only that easy. Unfortunately it isn’t. Your deep-seated conspiracy theories are coming to the surface again, Ben. There are the little issues of the depth of liquid markets (in terms of being effective in pushing it around except around small moments in time, i.e., the close) and the shallowness of illiquid markets (in terms of how do I get out without giving up all my ill-gotten gains?). The world has gotten very flat when it comes to the liquid markets, and if certain traders are trying to push the market in irrational ways there are always those who are willing to take the other side and push back just as hard. Eventually the market settles where it should based upon fundamentals, but for short periods of time it can deviate for any number of reasons. But to say that a trader’s core strategy is to establish a position, devote massive energy to hype it and then have the ability to profitably exit is a pure flight of fancy. It’s just not that simple. Sorry.”
More at http://www.informationarbitrage.com/2008/01/how-to-lie-with.html
as a chicago pit trader, when i read ben’s article, I couldn t agree more. When the big boys want it up, they move it up, when they want it down, they move it down. I ve been there for over 15 years. but you don t have to be there for 15 days to see how it works. ben is getting a bad rap. the vast majority of pit traders, i think, would agree.