«This is no time to enter the equity market. It’s a time to be out. »

Black October just finished, Obama elected, all seems Main Street are finally safe. But the markets continue its high volatility and even the breaking news about the FED and ECB rates cuts do not convince completely the Wall Streeters. What’s going on? Is this the worst financial crisis since 1929? Who are responsible for this chaos?

We talk with Stephen McClellan, 66, the author of Full of Bull:  Do What Wall Street Does, Not What it Says, to Make Money in the Market, 32 years of Wall Street. He is full of bull. And most of us too!

Recently in his blog he concludes: «You think stocks might be a bargain at this point?  Some brokers are making this claim.  Look at the long-term picture.  For over a hundred years the average 10-year PE ratio (stock prices divided by mean annual earnings during the prior 10 years) has been slightly over 16x.  In roaring bull markets such as the 1920s, 1960s and 1990s, it broke out above 20x.  In bear markets such as the 1930s and 1970s, it ranged below 10x.  Currently it stands at just under 16x, not particularly depressed compared with previous bear periods. »

Who is Stephen

He was a Wall Street investment analyst for 32 years covering high-tech stocks as a supervisory analyst. He was a First Vice President at Merrill Lynch for 18 years, and ranked on the Institutional Investor All-American Research Team 19 consecutive years, the Wall Street Journal Poll for 7 years, and is in the Journal’s Hall of Fame. He was a Vice President at Salomon Brothers for 8 years, before that in a similar position at Spencer Trask for 6 years, and was an industry analyst with the U.S. Department of Commerce before commencing his Wall Street career. McClellan is a Chartered Financial Analyst (CFA) charter holder, a member of the New York Society of Security Analysts and the CFA Institute, was President of the New York Computer Industry Analyst Group, and President and Founder of the Software/Services Analyst Group. He is the author of The Coming Computer Industry Shakeout: Winners, Losers and Survivors, published by John Wiley & Sons in 1984. His current book is Full of Bull: Do What Wall Street Does, Not What it Says, to Make Money in the Market, published by FT Press.There has been no other investment advice book in recent years written by a career Wall Street investment bank securities analyst. His MBA in Finance is from George Washington University. He resides in San Francisco.

INTERVIEW

Q: You are a long time analyst, why now «Full of Bull»?

McClellan: I wrote Full of Bull after retiring from a 32-year career on Wall Street and realizing how individual investors are so deterred from proper long-term investing by the confusing and misleading Wall Street practices.Individuals take Wall Street directives literally. For example, they interpret a «Hold» investment opinion as an indication to retain the stock. That rating is actually negative, relaying the subtle analyst view that the stock should be sold. Individuals don’t understand the Wall Street code, oriented to its major institutional clients such as mutual funds, which if followed simplistically, is highly detrimental to sound investing.

Q: This on going crash is more violent than the ones of 1987 and 2000/2001?

McClellan: The current bear market is likely to be notably deeper and longer than those in 1987 and 2000-2002. The worst market crashes since the 1930s were declines of around 50%. Presently, the U.S. S&P 500 Index is down 41%. The worldwide economic/financial situation is the worst since the 1930s depression, so I expect during this bear market stocks will eventually plummet by more than 50%, perhaps by 60%-65%. The dot-com, housing, credit, commodities, and derivatives bubbles over the last decade were massively more extreme than those in the early 1980s. Therefore, the de-leveraging process will be vastly more painful and long-lived until an equilibrium is achieved, perhaps by 2010-2011.

STEPHEN ANALYSIS: «Almost all financial-related institutions succumbed to the enticement of easy money»

A: What’s the most important “engine” of the bullish behavior in the last 10 years? Can we say there’s a “business model” in the functioning of Wall Street since the JPMorgan inventions of the derivatives pyramid and the Greenspan low feds funds rates since the 1990s?

McClellan: The greatest engine behind the bull market excesses over the last ten years was the Wall Street encouragement and enabling of the debt derivative investment distribution. Almost all financial-related institutions succumbed to the enticement of easy money by participating in these instruments, with little regard for the risk. It would not have been possible without Wall Street’s role as middleman. The Street paid no attention to risk management. And yet it portrays itself as an investment advisor or financial consultant. In my book, Full of Bull, I emphasize the key investment strategy of preservation of capital.

Q: Wall Street is far from that honest strategy?

McClellan: Brokerage firms rarely focus on this, pay scant attention to risk, and are not in a credible position to advise investors on risk given the absence of their own internal risk management and resulting massive losses in debt derivatives. Now that Wall Street has been permanently altered, more along the lines of the banking industry, the new business model will be more regulated, less profitable, less risky, and less leveraged.

A: People in the Wall Street are overpaid? Or they are paid accordingly the status that financial “creativity” gained since the 1980s? Do you think the rules of payment and rewards in Wall Street must change dramatically and in what direction?

McClellan: Wall Street has traditionally been way overpaid compared to medical doctors, attorneys, and corporate management. Investment bankers were like croupiers at a casino but instead of taking a 1% cut, their payout is more like 5%-10%. This is changing dramatically and probably permanently in view of the new Wall Street bank-like business model. Bonuses and compensation are being sharply downsized to a fraction of the level a few years ago. I suggest several reforms in my book pertaining to Street compensation of research analysts. Their pay should be based on the research value they provide and what the clients are willing to pay for it in hard dollars, like a consulting fee. Currently, their income is largely unrelated to the accuracy of their stock recommendations. This seems skewed. Lower risk, less leverage, and more regulation of Wall Street mean lower profit levels than in the past and compensation will be similarly contracted.

A: How can we regulate the legal looting from the big sharks in Wall Street?

McClellan: As I point out in Full of Bull, several reforms are necessary to prevent future Wall Street abuses. More professional credentials should be required, such as the Chartered Financial Analyst (CFA) designation, or Masters of Business Administration (MBA) degrees, and more working experience should be required before responsibility is conferred. There must be more accountability by research analysts, management, and the Board of Directors at brokerage firms. Institutions such as hedge funds and mutual funds (the buy side) must play by the same rules as the brokerage firms. No more cozy meetings and exclusive access to corporate executives to glean privileged insight and information. Corporate executives must be regulated to avoid manipulation of Wall Street research analysts, playing favorites, and being selective with executive access, all of which create an unbalanced, favorable stock opinion bias on Wall Street.

STEPHEN ALERT: «This bear market crash is far from over, no where near the bottom in my opinion. Wall Street is eternally optimistic and will never admit the gloomy outlook.»

A: Do you think this crash is over, or we can expect a worsening evolution, even with the change of the Administration?

McClellan: This bear market crash is far from over, no where near the bottom in my opinion. The new administration will attempt to stimulate the economy but this is likely to be too little and the cost in terms of federal deficits and eventual inflation will be excessive. Wall Street is eternally optimistic and will never admit the gloomy outlook. It continues to advise investors to bottom-fish, that is, to purchase stocks that have already declined sharply. This is no time to enter the equity market. It’s a time to be out. The most important strategy I stress in Full of Bull is protection of capital. The best way to do that, in view of the dismal economic and stock market outlook, is to avoid stocks.

A: Until now, what was the most surprising feedback you received from readers of your book?

McClellan: I think my book surprised a lot of readers because this was the first time a Wall Street insider divulged the numerous Street practices that are so detrimental to sound investing. I am the first Wall Street research analyst that has written an investment advice book. Other investment books were written by professors, media writers and a few mutual fund or money market portfolio managers, not by security analysts. I detailed in the book Wall Street’s flawed investment rating systems; that the Street is bad at stock picking; the favorable opinion bias; the big-company favorable bias; the unbalanced, thin, distorted research; and several other aspects of Wall Street that individuals need to understand to put them on a level playing field with the insider professionals. My disclosure of these elements startled many readers since they have never seen this divulged in other investment advice books.

STEPHEN ADVICE: «Buffet can take risks that almost all others should avoid. He may be correct that stocks are a bargain at current levels but I recommend investors wait and see»

A: Warren Buffett, from the 17-member panel of president-elect Obama, said in October, after the first bottom at DJIA, that it was the moment to go «shopping» at the stock markets. You can pick bargains, that’s the assumption. What’s your comment, as you said “It’s a time to be out”?

McClellan: Warren Buffet, as the wealthiest person in the world, can afford to be early back into the stock market and if wrong, can sustain losses a lot easier than most individual investors. Buffet can take risks that almost all others should avoid. He may be correct that stocks are a bargain at current levels but I recommend investors wait and see. It’s safer purchasing stocks on the way up rather than on the way down. I make a point in Full of Bull that attempting to catch a falling safe will get you flattened. This is a time to stand aside and see how much damage the market may sustain over the new 12 months or longer.

A: In the first press conference of Mr Obama, former FED chairman Paul Volcker was one of the visible figures nearby the president elected. Do you expect that the New Administration will change Paulson/Bernanke’s medicines – until now a slash of 425 basis points in the funds rates and a pumping engine of $1 trillion of liquidity?

McClellan: Former Federal Reserve Chairman Paul Volcker stepped in when stagflation had resulted in interest rates ranging around 20%. He tightened control, shrunk the money supply and brought interest rates down to normal levels. The current financial/economic situation is quite the opposite. The economy is in a free fall, consumer spending has stopped, international trade is at a halt, and bank lending is almost non-existent. Deflation is evident everywhere. I believe Obamanomics and the new Treasury Secretary will move heaven and earth to stimulate economic activity, at any expense with regard to federal deficits. The government will throw money and loans at the problem, whatever it takes. This will eventually lead to huge inflation, a few years down the road, following the current long and deep recession.

STEPHEN ANALYSIS: «That Silicon Valley and the high-tech industry can be a material contributor to resolve the current economic debacle is a pipe dream.»

A: The presence of Eric Schmidt, CEO of Google, in the Obama’s panel, is an opportunity for Silicon Valley? Some Washington lawyers just said that the Valley should be selling itself as part of the solution in the crisis, probably balancing the lobby from Detroit…

McClellan: That Silicon Valley and the high-tech industry can be a material contributor to resolve the current economic debacle is a pipe dream. We cannot “technologize” our way out of this. Building bridges and infrastructure could help stimulate the economy and create a lot of jobs. But most high-tech products are manufactured in Asia. The technology industry is rather mature and economically cyclical as I discuss in Full of Bull. Demand for laptops and computers fall of during a steep recession. Cisco recently forecast a 10% revenue decline in the year-ahead. While I do not expect high-tech companies to line up at the federal loan window such as the automobile and probably airlines will need to do, neither will Silicon Valley represent the end-all solution.

2 Responses to “«This is no time to enter the equity market. It’s a time to be out. »”

  1. […] uma pechincha, mas na situação actual eu recomendo ainda esperar para ver”, responde-nos numa entrevista que publicamos em inglês na […]

  2. Great stuff. Nice to read some well written posts. A long way between them.

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