Page 1 of 2 BOOK REVIEW Show me the exit! When Markets Collide - Investment Strategies for the Age of Global Economic
Change by Mohammed El-Erian
By Julian Delasantellis
I think that it's time for me to write an investment advice book. I'll call it How
to Make a Small Fortune in Today's Investment World.
I could fill it with page after page of economic and financial gobbledygook;
few would understand any of it, but a lot of people would buy it just to place
it on their coffee tables. That way,
guests leaf through a few pages, then, after being duly impressed with their
host's intelligence, quickly put it down.
Along with the disgorgements of all the turgid prose would be page after page
of charts and scattergrams demonstrating a supposed correlation between the
impossible and the idiotic, maybe a chart showing the relationship between math
test scores in the Seoul school system and the export price of cashew nuts from
Mozambique.
If, like a searcher for the Holy Grail, you'd managed to stay with me for
300-odd pages of this (and many will be very odd, indeed), I'll finally reveal
the secrets of how to make a small fortune in today's investment world.
First, start with a large fortune.
I in no way am implying that the above was the operating philosophy of Dr
Mohammed El-Erian when writing When Markets Collide-Investment Strategies for
the Age of Global Economic Change. We should only have been so lucky
I remember watching an evening news broadcast with my father during the
recession of 1973-74. There was a report on how badly the financial services
industry was being hit by the calamity, as illustration of such a stockbroker
was shown eating a brown bag lunch on a park bench.
My petit bourgeois father was aghast. He apparently had such a high and exalted
opinion of stockbrokers, indeed, of all financial industry professionals, that
a broker lowered to such an outrage violated his sense of an orderly universe.
This was before the 1975 "May Day " US Securities and Exchange Commission
deregulation of stock trading commissions, which created the modern discount
brokerage industry and put tremendous pressure on all the old brokerage
institutions to cut the monopoly pricing that had made the industry such an
elite, happy little club.
Now, for every well-bred and well-raised, fair-haired Brooks Brothered Ivy
League broker selling bonds to the moneyed and wizened gentry before leaving
the office at 3pm for drinks at the club, there's probably a couple of hundred
guys in Knightsbridge drip-dry Sears suits and cheap imitation leather mock
"State Street" wingtips from Payless Shoes, in the words of Gordon Gekko from Wall
Street (quoted often by me, since, of course, it is the Iliad of
modern finance) - "cold calling dentists and widows to buy 20 shares of some
dog stock".
But if there still is an elite class in modern American finance, Mohammed
El-Erian should certainly be one of its members. The son of an Egyptian
diplomat, he was educated at the prestigious "public" (aka, private) St John's
School in Leatherhead, Surrey, UK, before "taking" a bachelor's and master's at
Cambridge, along with a second master's (why stop at one) and doctorate at
Oxford.
Recruited to work for the International Monetary Fund in 1983, he spent 15
years at that august institution, rising to the level of deputy director of the
fund's Mid-East bureau. In 2005, he took a pay cut in exchange for a huge
status raise as director of the gargantuan (around $60 billion in those far
off, halcyon days) Harvard University Endowment. At over US$900,000 in salary,
he was the highest paid employee on campus, a fact which, I'm sure, pleased the
neo-Maoist deconstructionists over at the Critical Studies Department to no
end.
After earning over $5 billion for the endowment for the fund in 2007 (see
Dry times for hedge funds, Asia Times Online, September 5, 2008 - what
money manager wasn't earning 5 billion a year back in those, leveraged, easy
money days?) El-Erian left the dour monastic penury of Harvard to return to
sunny Newport Beach, California, to work for the Pacific Investment Management
Company, better known as PIMCO, the world's largest bond trading house, as a
co-chief executive officer.
Do you want to know just how respected and revered Mohammed El Erian is in the
world of finance? Well, for one thing, When Markets Collide has been
awarded the joint prize by the Financial Times and Goldman Sachs as the 2008
best business book of the year.
More importantly, when he comes on to provide a morning commentary at cable
channel CNBC, the anchors - rather than continue exchanging obscenity-laden
pejoratives while whacking each other with office chairs, the now standard,
Jerry Springer-inspired manner in which debates on serious issues are now
conducted on US cable television - pause to listen to him.
Hey, that's respect.
Therefore, it was with great anticipation that I waited to get my hands on his
book. Early press buzz on this tome had it that El-Erian would provide his
unique and invaluable (well, if not invaluable, certainly highly pricey)
insight into the current world financial crisis at the center of the planet's
attention.
The book's jacket cover certainly whetted my appetite: "When Markets Collide
is a timely alert to the fundamental changes taking place in today's global
economic and financial systems, and a call to action for investors who may fall
victim to misinterpreting important signals ... One of today's most respected
names in finance, Mohammed El-Erian puts recent events in their proper context,
giving you the tools that can help you interpret the markets, benefit from
global economic change, and navigate the risks."
Sounds good. I'm still - waiting. Novice investors seem to think that the core
skill that determines one's investment success is knowing what, be it a stock,
bond, commodity or baseball card, to buy. I suppose that's good, but what's a
whole lot more important is knowing, after you've bought something, when to
sell it.
Unless you're a short seller (a very profitable avocation these days, assuming
you're willing to accept the many misplaced government approbations that you're
a cause of much of the financial system's current travails), investment means
that you've bought something, and are hoping to at some point sell out of it to
profit from some measure of price appreciation that has occurred while you
owned it.
If you plotted the price movement during the duration of your ownership on some
kind of simple chart, you'd like to see the price start in the lower left
corner of the chart and finish in the upper right. This is what you should be
looking for, a market in a trend, in this case, an upward trend.
But look closer at that uptrending line. In almost all cases, it is not a
smooth, unbroken line crossing from lower right to upper left, but a jagged
line, like the peaks and valleys of an ascending mountain range, until you
reach the top. The valleys, or troughs, are temporary price pullbacks off the
just-reached new high; for technical analyst traders who are primarily guided
by looking at chart patterns, the pullbacks are just natural retrenchments
allowing the markets a chance to rest and regroup for another push upwards.
But, frequently accompanying all these temporary price pullbacks is some bit of
news or information that puts the investment's future prospects in doubt. For a
drug company, it may be a rumor that a proposed new medication is proving less
effective than promised; for a company that makes skateboards, it may be news
that health insurance companies will no longer cover injuries suffered by
teenagers riding one of the company's products straight down a steep hill into
a brick wall.
The investor is then faced with the central dilemma of this avocation. Should
he sell out, realizing that the recent developments have fundamentally altered
the future prospects for this investment, or should he hold on, and hope that
this price reversal, like so many others, will soon reverse itself, leading to
newer highs and even fatter profits?
El-Erian presents this dilemma within the familiar decision-making framework of
noise and signals, with noise being the complete panoply of information faced
by any decision maker, and signals being actual, valuable information that
should not be ignored. In the long run, the vast majority of noise should be
ignored since only rarely will it be proven to be signals, that is, important
market-changing information.
As El-Erian puts it:
Noise is all around us, and because it is so
prevalent, we are tempted to go to extremes and ignore it completely, or to
obsess over each and every component of it. In certain circumstances, going to
either of these two extremes can be quite risky. If we ignore the noise, we
might miss an important change; if we obsess over it, we might be overwhelmed (
and potentially paralyzed by minutiae. So how do we strike the right balance?
What a great question. I searched and searched for El-Erian's actual
operational wisdom on how to differentiate the two, but, except for some advice
that one should take daily notes focusing on how actual market behavior has
differed from the projections derived from either your implied or explicit
model, I found little.
The truth is that it's virtually impossible to differentiate signals from noise
until after the fact, when it's really too late for your insight to do all that
much good. For instance, in both 1941 and 2001, United States government
intelligence officials had credible warnings of an upcoming attack - Pearl
Harbor in 1941, 9/11 in 2001. Still, in both cases, the warnings were mixed in
with such large quantities of other, often contradictory data, the noise, that
it's easy to see how the signals were missed.
On December 6, 1941, the day before Pearl Harbor, and on September 10, 2001,
the warnings of the following day's catastrophes were just pieces of paper in
some analyst's overstuffed inbox. Only the next day did they become signals.
Not too long ago, those of us playing the finance game had one source of
information, usually the Wall Street Journal in the USA, or the Financial Times
in Europe. Now, with online newspapers from all over the world, web-based
financial information services and blogs, most of us could spend half or more
of the day just getting information, picking up the noise, before we even
attempted sifting through it for signals. It's not that the problem is not
important, and getting more so, for it is. It's just that, after tantalizing us
for almost 300 pages that soon will come the sharp blade to cut the
signals/noise Gordian Knot, at the end, we're left with not much more effective
than a dull butter knife.
Drawing on the now hot field of behavioral economics, El-Erian posits some
speculation on why the human brain is so resistant to change, to insistent on
doing today what worked yesterday, to ignoring signals.
"Our ability to identify and adapt quickly to structural transformations faces
many headwinds that go well beyond the traditional notion of market
imperfections; they relate to some basic considerations as to how our brains
operate ... the analytical segment of an investor's brain will be so crowded as
to allow it to be fairly easily overcome by the emotional segment. These
insights also speak to the phenomena of people's generally limited openness and
slow adaptation to change. Indeed
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If, like a searcher for the Holy Grail, you'd managed to stay with me for
300-odd pages of this (and many will be very odd, indeed), I'll finally reveal
the secrets of how to make a small fortune in today's investment world.
