Fleck's Interview @PBS
pbs.org
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Bill Fleckenstein is a hedge fund manager at Fleckenstein Capital Management.
How would you characterize the current market?
The current stock market, unfortunately, has all the ear marks of a bubble or a mania. It is very reminiscent of what occurred in Tokyo, especially the years 1988 and '89 where, no matter what news event occurred or what fundamental development occurred, the market simply went up. And you had a period where investors thought that, no matter what happened prospectively, the market would always go up. Risk was completely struck from the lexicon. Nobody cared about that. And, unfortunately, the investment environment today in the United States is very, very reminiscent of that mania. It's particularly dangerous. The attitudes that people have are very similar and if you look at the underlying math between what the prospective rates of return are from the levels of expensiveness the stock market is at today and you look at potential risk from when we've had this level of expensiveness, the risk-reward is skewed out of all proportion.
What's so particularly risky about this market?
Just looking at the math, whenever the market has been at this level of expensiveness, whether you look at divided yields or price to earnings ratios or the stock market capitalization compared to entire Gross Domestic Product of the country, whenever you've been at this place where we are now in the top decile essentially, the prospective rates of return have been four-and-half to five percent. On the other hand, there's a very potent force in the world called "reversion to the mean" and a phenomenon markets, industries tend to go in cycles and we tend to see these reversions to the mean. If that were to occur in the stock market, and I'm not predicting it will, but if it did occur, a decline to median valuation levels would be a decline of almost 50 percent.
The risk and reward are out of all proportion. You can try to get a handle on what the prospective rates of return should be from equities. You can look and see what the historical rates of return have been for the last hundred years. You can know what that is. You can look and see what the last 16 years has been, and then you can look and see what's been the rate of return whenever we've had the prices for US businesses that we see today. The returns in the equity market are a function of the underlying rates of return available in Corporate America. Since the '50s, that rate of earnings growth has been about seven percent. In the last 14-hour bull market, the rate of return has been something on the order of 16 percent. That has been a function of a revaluation, or a decision, or a thought process that has caused American businesses to be priced more expensively than they have been. It's the opposite of putting a suit on sale. They've been marked up in price. Same suit, higher price. When you compare what the rewards from this level of expensiveness are, they're rather small, four-and-half to five percent, if you look at statistical data. On the other hand, what often happens in businesses is you have good times and bad times. People are familiar with the concept of recession, boom and bust. And we tend to go from one endpoint to the other. The stock market historically has always done the same thing.
The risk is that if that process gets started again and we only traverse back to what the average level of expensiveness, never mind cheap like we were in 1982 when this process, this bull market started, but if we only get to average, that would mean a decline in the stock market of 50 percent. So the risks are, say, eight-ten times reward. That is not particular a great environment to put all your money in and say, "I'm going to wake up in 20 years and be rich."
So why are so many people doing it?
Because people are people. In Japan they had a name for this. They called them the "shin gin ri". And it literally meant "new human being". They were the 20-something year-old people who had no experience in that market who were put in charge of all the investing. And they thought that nothing would ever go wrong. I find it somewhat ironic that here we are, seven years after that bubble burst, the Japanese are still trying to pick up the pieces. At that moment in time we are doing many of the very same things. People are buying stocks for one reason, they are going up. People believe that they're really saving for retirement. That is the mantra today. However, if you look at the data and say, "If I'm saving for retirement, I would maybe be putting some money in bonds and some money in equities." Up until 1994, we would see a similar amount of money go into bonds as equities. In 1994 the Fed started raising interest rates. Bonds started doing badly. People for the last couple of years have virtually no money in bonds and only money in stocks. It's because bonds have gone down and stocks have gone up. If it was just about savings as opposed to speculation and changing higher prices, you would think that people would say, "Wait a minute. I was buyin' bonds when I could get three or four percent. Now I get six or seven. Maybe I should buy a few." So I think if you look at the behavior of people, you can see that it's a classic sign of crowd behavior.
In other words, the madness of crowds?
Unfortunately, it's the madness of crowds. Exactly, and people are kidding themselves because think that they really are saving. That don't realize that they're speculating, and there's a huge difference.
What's the difference?
Well, first of all, the difference between investing and speculating is when you're investing, I would say you're looking around trying to buy a dollar bill for 60 cents, let's say. And when you're speculating, the intrinsic value of the dollar bill has no interest to you. You'll buy a dollar bill for three dollars if you think you can sell it for four. And in the environment we're in today is much more about speculating. The risk is that the dollar bill's only worth one. And if people believe it's worth three or four, that works until it doesn't. It's the emperor not wearing any clothes kind of an argument.
So in savings, you're much more conservative. You understand what the risks are. You've thought them out and you say, "Well, you know, if I own a five-year bond, I know I can only get, say, six percent, but I know what that is and I'm going to have some of that." In the stock market, you don't know what you're gonna get. I mean people think they know they're gonna get 16 percent, but that's not guaranteed.
Have people become bored with the idea of six percent?
I think people probably have become bored with the idea of six percent. It doesn't sound very interesting, particularly when you look at the last couple of years. You're being promised six percent, let's say, but you just found out a couple of years ago that you can actually lose money in bonds. On the other hand, what you think you know is equities, they've returned, say, 16. The last two years have been ever better, and they never seem to go down. If you don't know much about the history of investing and the history of the investment business, which is, unfortunately, most people who have money in mutual funds don't, you might be tempted to say, "Well, why would I want six? I can lose money at six. I can get 16 over here and I don't lose any money. What should I do?" I mean you have to have a certain amount of experience to know that what sounds too good to be true generally is.
But people say, "History shows ...
Two interesting points. History does show that, on balance, equities have outperformed every other asset class. However, there have been gigantic periods in time that are longer than what I think people's time frames are where that hasn't been the case. Interestingly enough, the 16 percent rate of return we've experienced for the last 14 years last happened from 1949 to 1963. Over the next 14 years, stocks returned approximately five percent, which is about the same thing that analyzing the historical data would suggest they should return. So you could have a 14-year period where stocks only return five percent. Now, unfortunately, that average period would probably be pock marked with some serious size declines along the way. That's generally what tends to occur. People need to understand the environment we've just been through has been one of the rarest of all time when you look at how long we've gone without any set-backs. The belief that people will not sell stocks in a decline is probably a biggest fallacy that the American public has allowed themselves to be convinced of in the last 20 years.
The Japanese said the same thing. They said they would never sell, and yet as prices went down, they did. Tokyan Fund, their mutual fund assets were reported to have declined by some 90 percent. You can look at that. You can also look at the fact that what did mutual fund investors do in '94-'5 and '6 with the bond funds once they found out they can lose money? They've sold 'em. They've sold 'em and to this date, they really haven't come back. So you have the experience of the last group of human beings who were never gonna sell weakness, the Japanese. They did. Our investors just sold bonds as they went down and now we're supposed to believe that they're going to be immune from any kind of pressure to sell things? I think that's unlikely. The reason we've seen no selling to date is we haven't had any weakness. No one's been tested.
We also have this oxymoron of a mantra that says, "Be full invested and buy all dips." It's not possible to do both those things. You can do one or you can do the other, but when you finally get enough chances to buy the dips, it will stop working, I think. And it takes a long time to become a trained investor to be able to deal with adversity and not panic. I didn't learn how not to panic in certain situations until I did it wrong a few times. The American public now believes that they're new human beings, that they won't panic and they're gonna wake up 15-20 years from now and be rich.
Why didn't the Crash of '87 cause people to panic and bail out then?
They did. After the Crash of '87, people did panic a bail out. If you look at mutual fund statistics, they did. They sold 'em for, I believe, the next couple of years. I'd have to look at the data to be certain. They did sell them, okay? And now they kick themselves and say, "Gee, we didn't have to." But fear is a very powerful emotion and, as I've said, you know, we've seen what people have done in bond funds and they've sold them as they've lost money. So I think a lot of the new investors, I think a lot of the people managing mutual funds weren't even around in '87. It was just a down tick on a chart and they said, "See, but if we hadn't have sold, we'd have been okay." But the people who were in funds then actually did sell.
What do you mean when you say fear is a very powerful emotion in the market?
Well, people are buying stocks right now because they're afraid or they fear they're missing something. And so they've gotten a little bit greedy. And people can understand that thought process, but the fear of losing money, of seeing stocks you own go down relentlessly -- and it's not so much over a week or two. We've now seen a couple of smaller declines and have come back, but if stocks went down for a protracted period of time, which, in this case, would be as little as maybe a quarter or two, we haven't really tested people's resolve in a period that lasted as long as 90 or 180 days. Then I think people would start to think, "Well, gee, what if it doesn't work?" Once that confidence has been broken, then you start to have a little bit of fear and the fear of losing money, even though people haven't really experienced it, is far, far more powerful than the fear of not making it.
Where do the mutual funds fit into this whole schema?
The mutual funds have been the vehicle through which the American public has put money into the stock market. They are the vehicle of choice, and part of that's because you've got daily reporting. People can now look up and see how they're doing on the hour at the end of the day and how their funds are performing. But this has been the way that the public has gotten into the stock market. Unfortunately, because of the daily reporting and the way the system works, I think it's fomented speculative techniques in the way money is invested. This notion of momentum investing that is the sort of the vanguard of the mutual funds, to me, is an oxymoron. Momentum investing is not investing, as I find investing to be trying to buy a dollar for 60 cents. It's the belief that you can buy a stock for three dollars and sell it for four dollars.
What's particularly interesting, one might say dangerous, about the present mutual fund boom is that techniques that the portfolio managers use. Peter Lynch is held in great esteem. He was a terrific -- is a terrific investor. Unfortunately, the techniques now being used by all the top funds don't have a lot to do with what Peter Lynch used to do in terms of trying to really dig through and get all the research and be a fundamental investor. What is going on today, what is called "investing" is really speculating. The notion that "I can guess which way the crowd is gonna run next and I'll get there before them." The techniques are more about trading, rapid turnover, paying any price for a stock as long as it goes up or behaves a certain way. It is about crowd behavior and stock price behavior, not about analyzing the underlying businesses. It is 180 degrees away from what Peter Lynch did or what Warren Buffet does. The people that are held up as the genuine heroes in the investment business for the last 30-40 years are investors. What goes on today is not investing; it's speculation.
So the managers are managing the same way that we would buy stocks ourselves?
I think that's an accurate statement. There is not a lot of difference between the way that goes on or the way a relatively unsophisticated or untrained individual might go about doing it. I mean there's a lot of fancy techniques and there's gonna be a lot of computers and there's a lot of buzzwords like "stochastic" and "relative strength" and a lot of these type terms. What's different about this bull market is everyone's got at least one or two computers on their desk. We never have had this in the last bull market. So there's all kinds of fun computer techniques you can turn loose on stock market action. So it's analyzed to death and it's acted on and because the prevailing tend is up, it has worked and to the extent that a lot of the key guys have pursued the same techniques, you've had a bit of a self-fulfilling prophecy. So a lot of these what may historically be looked back on as questionable investment techniques all work and work spectacularly right now.
Tell us about your prospective about Garrett van Wagoner.
Well, I think Garrett has been the very best mutual fund manager throughout this entire 1990 to '96 period that we've seen so far. He has demonstrated an absolutely extraordinary ability to be in the right areas at the right time, and I think, to his credit, he has been quite good at avoiding areas that weren't gonna work. He's got in incredible instinct for knowing which way the wildebeasts the gonna turn and run next. I think he's been without peer in this. He's done a great job so far and I think he's avoided a lot of the troubles -- so far.
How much risk is entailed in being in his fund?
Well, I mean that's an excellent question. I don't know for sure, because I don't know what goes on. My hunch is that there's quite a good deal of risk if the equity market isn't going to go perpetually straight up. I think, unfortunately, one thing the public doesn't understand is, a track record is fine, but what matters is when you get in the fund. What often happens in funds is people start out with a small amount of money. The numbers are great. And then human nature being what it is, all the money comes after you've had a great period. And almost inevitably, any investor tends to have a bad following a great period. It's very hard to have a great period, great period, great period and no intervening set-backs. What tends to happen is, people come in, put all the money in right before a set-back occurs.
How much risk does Garrett van Wagoner take in his investment?
I don't know precisely how much risk he takes. It's not a knowable thing. All you can know is that these types of techniques -- you can look at the underlying securities. Inherently, businesses that are valued the way these are, with the historical data that you can look at, are inherently risky. As a portfolio, a collection of those things is still inherently risky. I think that one thing that people don't understand is that just because someone has a terrific track record doesn't mean that there might not be a certain amount of risk associated with it. What often happens is you'll have a fund manager will have a hot period and then, human nature being what it is, investors will put a whole bunch of money into the fund just before the investor has a bad period. So I think that's something that people need to focus on is, what happens when they enter these funds? The volatility can be quite large. A fund such as his is liable to be quite volatile. And I suspect the risks are quite high.
It would be very useful for you to tell us, in percentage terms, what Garrett did this year.
I think in Garrett's fund's case, it was very fortunate he started a new fund early this year. And I think by May, he was up close to 60 percent. Unfortunately, what I think tends to occur, and it's kind of an example of what happens over and over again is, at the beginning he had very little money under management. My guess is, as he got close to being up 60 percent, he probably raised 80 percent of the money he has under management. And then there was an intervening period where I think his performance decline as the market took a bit of a hit in July. So it's quite likely that the overwhelming majority of his investors, their first taste of his performance was a sharp set-back. And now the market has come back and its performance has done well again. But I think that is something that happens over and over again as people tend to chase hot money managers.
Talk about your views on mutual fund marketing.
The investment business has changed dramatically in the last 14 years. When I first got into the investment business in 1982, the investment management business was about making money and controlling risk. What people were particularly concerned about was how did you do in previous periods where money was lost? How well did you protect them? The focus was 100 percent on "Let's not lose much money and the up side will take care of itself." That has changed. We've gone 180 degrees in the other direction. Now the investment management business has become the investment marketing business. And hot fund managers are well known, like all-star athletes. Everyone knows who Garrett van Wagoner is and Jeff Vinik, Ron Elizia. I mean so these are household names. The public has been told that if they just keep putting money into mutual funds, they will be able to retire rich, as though it was a simple process. I don't believe it is. It is not that easy to get rich and it is not as easy as just putting money in the funds and waking up magically down the road and being wealthy.
Is society putting too much emphasis on making money in the market?
I think probably when we look back on this period, it will be clear that there was way too much focus put on the equity market. This is a rare period in history. A lot of the things that are occurring in terms of the behavior of mutual fund buyers, the behavior of society in general towards the market with the TV station focus and the newspaper folks and all that, these types of things only happen like this every couple of decades really. This is very rare period. So we are putting too much focus on it. It's a consequence of the mutual fund boom that got started in 1990 when the Federal Reserve lowered interest rates to three percent. And it'll be with us until it stops, and then it won't be like this anymore. That's a hard thing for people to believe. People don't believe it will ever stop, but, again, if you look back at Tokyo, they didn't think it would ever stop. They were proven long-term investors. They were compulsive savers. This is not debatable. The Japanese as a nation is known for this, and yet when their bubble burst, they got out.
Have we come to believe that retirement money will provide this kind of endless throw into the market?
Absolutely. People believe that the retirement flow of funds will power the market eternally in the same way that the Japanese believed money would always be there. We have our own set of triple merits. We've got the economy well under control. That's what people believe. Inflation will never be a problem. That's what people believe. Interest rates are always on the verge of going lower, even though that hasn't been the case in the last couple of years. So we have this belief of a virtuous circle and money will always come in and stock prices will always go up, and money will keep coming in and it will just go on like that. However, there are signs that the process is starting to end. We need about three to four billion a week now to keep the market stable. People forget that Wall Street is in the business of creating stocks and they're doing' it hand over fist now. That was one of the reasons why we had the decline in July. So while the money is gonna come in, it's going to require an ever-larger amount of money to keep the market going up.
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