Post Mortem 2007-8 and Pre Mortem 201X

In last week’s blog, I promised to devote this week’s musings to the causes of the recent declines in the economy and markets. You will find my focus is more of a systemic approach than singling out specific instruments, organizations, regulations or people.

The history of the rise and fall of markets and related economies goes back to the beginnings of recorded time. This history can be described graphically as undulating waves following a cyclical pattern. As these waves began long before the creation of hedge funds and credit default swaps, there must be something more basic in human nature. I believe the drive that causes these cycles is the four letter word that a well known labor union leader enunciated more than a century ago when asked what his laborers wanted; the reply was “More.” It is each person’s desire for more of what is in short supply that drives the demand side of the economic equation. The supply side is provided by those who produce or possess “more” than what they can consume. In periods of population growth and net immigration, there is normally more demand being generated than supply coming onto the market. Spurred on by the dynamite of rising expectations driven by all forms of media, the demands for higher priced goods and services drove demand. There is hardly a human alive today who does not want more of something, including ‘peace of mind,” which itself can be costly. (Think of various forms of physical, medical and financial protection.) In this sense, we are all the sinners of driving for “More.”

There is a two letter word that we do not want to hear from our government or employer. That word is “No.” Thus, governments rarely say no to a demand for more services. The normal solution is reliance on inflation, as governments can repay their enlarged debts with currency that is worth less due to inflation. Employers also want to avoid saying no to increased wage demands if they can avoid it. Employers count on both increased productivity and higher selling prices to meet wage demands.

The growing demands for more goods and services could not be satisfied in their entirety through growth of the market. Most developed economies, including the US, have been growing more slowly than the escalation in demands. The solution to this problem was to borrow money in ever- increasing amounts. In effect, borrowing new money to repay old debts. In the corporate world, debt grew faster than equity, so any shortfall in the ability to issue new debt for old debt would have a dramatic impact on a proportionately smaller equity base. (Leverage has this annoying characteristic of working both ways to magnify gains and shortfalls.)

As an equity analyst and portfolio manager I did not pay much attention to fixed income securities. Neither did most individual investors. I should have been more conscious that segments of the fixed income markets were showing signs of distress by requiring higher yields to clear transactions. These particular securities were housing-related, and mostly the hot new Wall Street product called structured finance securities (which were large packaged and sliced residential mortgages). Their rising prices at the same time that more of the financial community’s capital base was being devoted to this trade, should have been the proverbial chirping of the “canary in the mine.” Like most others, I missed these early warning signs. Along with the regulators, I further failed to understand the implications of counterparty risks on a global basis. I missed the fact that overseas participants had taken on much more leverage. One could borrow more money, at better terms, in London than in New York. The poorly identified mortgage products were sold around the world to satisfy local needs for income to meet “more” demands.

Space and time do not permit for a more inclusive analysis of what went wrong and how we missed spotting the problems. What I want to focus on now is the possible “Pre-Mortem” for a future decline, which history tells us will surely come at some point. (Let us hope years in the future!)

Many people fear two possible causes for the next major decline that I do not. The first is a dramatically worse real estate market. Could residential market prices drop further, causing more defaults? Yes, but in terms of magnitude unlikely to be major. (Remember, I missed spotting the first decline when I knew local prices were unsustainable.) Many have identified commercial real estate as the next big problem. I think these problems have been largely identified. Vacant properties are a problem but I believe the order of magnitude is much smaller than the residential real estate hit we sustained, and the market is prepared for defaults.

The second popular worry at the moment is the relative decline of the US dollar. In the last couple of weeks, I have commented on the decline compared to other currencies, not commodities.

My true concerns however, are for two other problems that I perceive on the horizon. Either one could cause major instability in our markets.

The first concern is the increasing level of speculative foreign exchange trading. Corporations, financial institutions (including hedge funds), and increasingly individuals, have discovered these markets whose daily volume is larger than the traded securities markets on many days and nights. (Currencies are traded around the clock, around the world.) The advertised leverage potential for the retail participant is 500 to 1. (Many of the frauds in the financial markets have been caused by attempting to regain undisclosed losses by the rapid trading of highly leveraged products.) Foreign exchange that goes through banks has some regulatory oversight, but not heavy. Those trades executed outside the bank channel have little or no oversight. Either a suspected (or actual) fraud, or a surprise devaluation/revaluation by a government could cause a significant amount of margin calls. Many organizations and individuals could not immediately meet the repayment obligations on their loans from such margin calls, possibly leading to some bankruptcies. Nevertheless, a foreign exchange collapse is analogous to other kinds of margin calls, with enough case law in place that we should quickly seal off the problem.

My second concern is pure conjecture. Assume, whether, we like it or not, some healthcare legislation is passed. Initially the first victims of this price- control legislation will be the profit margins of doctors, hospitals, pharmaceutical companies, medical equipment providers, as well service companies. Most important of all, individuals will find their costs will rise; particularly the elderly and the formerly wealthy. Many different approaches will be attempted to restore their past financial relationships. Almost guaranteed, more debt will be found on hospital balance sheets,* doctors’ practices, as well as many other organizations. I suspect some individuals either by happenstance or by conscious decision will find it necessary to borrow money against some future financial stream. As many of these groups are inexperienced in shopping for, and managing external debt, they will fall behind in their repayments. My fear is that we will see medically-induced bankruptcies with enormous emotional pains, and very little easily convertible collateral. As a society, we are not prepared for this contingency. Pity the judges who will have to deal with these issues.

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*I sit on the Financial Oversight Committee and chair the Investment Committee for an important not-for-profit hospital group that currently holds a very good credit rating.

Winning Calls

Life rarely presents us with celebratory events sponsored by others for us. Thus, occasionally we need to create our own in the fashion of Lewis Carroll’s wonderful invention of the “Unbirthday.” With this as a premise, I am indulgently going to celebrate the recent successful calls in our blog. If I don’t, who will?

The first correct call was the recognition that the month of October, 2009, had specific characteristics; which this year resulted in a negative bias to equity performance for the month. I also pointed out that mutual funds end their tax reporting year in October. While most funds have accumulated large realized losses created in ’08 and ’09, it would be possible (and perhaps prudent) to recognize some gains. The gains would not trigger a tax payment because the gains would offset the losses. Since there are no “wash sales” rules on gains, the smart thing to do is sell some of this year’s winners and either repurchase the same stocks, or perhaps to use Sir John Templeton’s phrase, search for “better bargains.” As the SEC no longer requires funds to disclose transactions on a quarterly basis, we no longer see a list of transactions made by the funds, thus I do not know what happened.* However, during the last three weeks of October, a significant number of the best performing stocks for the year were met with selling. On an overall basis, the month of October was down. My supposition is, that with the removal of the incremental mutual fund selling, the short term performance (at least in early November) would be up. This actually happened. I call it a win.

The second call was on the relative value of the dollar, which I felt was bottoming. This appears to be happening. Please note that I phrased my comment in relative terms. I agree with many of the views of the dollar’s detractors, that the buck should be worth less due to the present deficit, the almost certainty of a larger deficit, and the strong odds of a pick-up in inflation, probably induced. Why then should the dollar stop falling? World trade currencies are priced relative to other currencies. From a managed trade point of view, the decline in the US dollar is an increase in the value of the counter currencies. In many countries exporters are politically important. They see a rising price of their own money as an inhibitor to their export sales. Thus, I believe that other countries will buy some dollars to prevent their own money from being priced out of the world market. I have great respect for George Soros and his investment accomplishments over the years, even though I rarely am in agreement with his political views and actions. When he was recently asked about the worth of the US dollar, he replied that it was over-valued, except in comparison with other currencies. Today, I do not see a better value in other paper currencies, even though personally I own some other currencies to support my foreign equity investments.

From the standpoint of those who are focused on the absolute value of the dollar, that is to spend rather than trade, the price of gold (and to a lesser extent prices of some other commodities) is instructive. The nominal price of gold is at record levels, about $1100 a troy ounce. However when translated into today’s dollars, the old record price of over $800** an ounce in 1980 would be at least a thousand dollars higher. One reason for the recent strength in the gold price is that several central banks have made it known that they will not be carrying out their previous plans to sell gold. In addition, both India and China are buyers. I will claim this call as a winner in light that the other side is not winning.

On a tactical side, my recent calls for long term investing for growth, and particularly technology-driven innovation, appears to be winning relative to bets on value, and to some degree on industrials. I will claim these as short term winners, even though they were meant for long term investment.

Emotionally, the final two words in last week’s blog, “Go Yankees,” (written by the ‘born in Manhattan boy’ in me) proved to be the week’s biggest win. Please remember that there are legions of New York haters who resent the swagger generated by this culture of winning. Thus while I am very pleased, after eight long years of lack of fulfillment, my guard is up to defend against those who wish to punish New York. New York is a state of mind and not just a place. The biggest threat we face is a repeat event as severe to our economy and the financial markets as we experienced last year. We will retain our “license” to be central to the progress of the world only if we have learned something and we change our thinking.

I believe that we must change our thinking, thus next week’s blog will be devoted to my attempts to become more aware of the shape of future problems before they overwhelm us.

Any contributions from readers will be appreciated.

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* Years ago, the SEC required mutual funds to report their transactions quarterly, allowing a deeper dimension to the analysis of funds than is now available. The SEC caved-in to the funds in abolishing this report, reasoning that the SEC and its staff could get the specific information anytime they needed it. Fund owners and their analysts no longer have access to that insight.

** A very valued former associate of mine, the late Alling Woodruff, of Greenwich, CT, did sell his physical gold position above $800. He was an independent director of what was then the largest US gold fund and was going to South Africa to visit some mines, thus out of touch with the market for a couple of weeks.

Random Thoughts on November 1st

One of the pleasures and pains of writing a weekly financial blog is determining what to say. This weekend I have a number of incomplete thoughts from various stimuli I received over the weekend. Any of these ideas could be developed into blog in and of itself. However, by focusing on a single subject, one would not see a number of the cross-currents that are washing over my mental boat in rough seas. In no particular order, my thoughts include the following ideas:

1. Peggy Noonan writes in The Wall Street Journal that many people either believe our various structural problems will not get better and we have to live with the current imbalances, or that they have a sense of optimism without any focus on innovation. I believe that both views are wrong. Some of the structural imbalances are cyclical, made worse by government intervention which prolongs the period of healing. Other imbalances will get worse, such as structural unemployment; we have produced a labor force that does not know how to labor in today’s world. I am afraid this is a multi- generational problem of education in the home. On the optimistic side, I believe that technology will create new products and services that will make much of our existing ones obsolete to a point that we will replace the old with the new, even before the old wears out. My optimism, particularly in technology, leads me to favor funds that have significant technology holdings, often found under healthcare and energy classifications, as well as those that have a separate technology classification.



2. Alan Abelson in Barron’s quoted John Williams of Shadow Government Statistics, stating that 92% of the 3.5% gain announced for the 3rd quarter 2009 GDP was essentially contributed by “one-off” items, i.e. “Cash for Clunkers,” and expiring first-time home owner mortgage credits. Abelson’s comments reinforce my concern on the reliance on government numbers. One might add to the list, the President’s claim of 1 million jobs created or saved by the stimulus. As primarily equity investors, our focus should be on the revenue production of companies and the bottlenecks they are discovering in their sales and delivery processes. Commodity prices and transportation data are much more reliable indicators.



3. Little mention is being made in the financial press, and none in the stock market comments of the general press, about the fact that Mutual Funds operate on an October tax year. Most of the equity funds have large realized losses created in 2007 and 2008, as well as earlier this year. I suspect that in October, a number of portfolio managers sold some of their positions that had gains, without incurring any additional tax liability for their shareholders. They may share my point of view that it is unlikely that any significant news will break in the next thirty days, suggesting at best, a flat market for a month. This hiatus in the market recovery will allow them to reallocate their portfolios or return to their prior positions, (we will never know for sure, as the funds that report on a calendar quarterly or semiannually do not have to report on intra-quarter activity). In my mind, I believe this factor is a possible additional explanation why the month of October was flat. If I am correct, the stock price weakness shown in the last week is not a canary in the mine giving us a signal to get out of the stock market.



4. Another market phenomenon is that in the last week Berkshire Hathaway disposed of another major portion of their holdings in Moody’s, at current prices. The credit rating company is regularly under attack in the press, the regulators and some well known short sellers. What I find significant is that the stock absorbed this selling without further declines. As the company is not currently buying back its shares, the other side of the trades may represent one or more substantial buyers, as the public does not appear to have any interest in this stock. Often I find when a stock does not decline much in the face of a strong, well-known seller, there is a “story” in the unidentified buyer. Perhaps these thoughts are wishful thinking in that Moody’s is a long-standing position in our Financial Services Hedge Fund.



5. Now for a non-market thought: Saturday night’s, or more accurately Sunday morning’s, victory by the New York Yankees in the third game of the 2009 World Series is something of a cultural identity. People have a visceral reaction to the New York Yankees; they either like them or hate them. Friends of mine from all over believe that everyone who currently works or lives in New York, or ever did, is a Yankee fan. Never mind that many of these people are not baseball fans, and like me, have difficulty in naming the starting team, but the Yankees represent something. I would suggest they represent a culture of winning. (The image is greater than the statistical history. Nevertheless they have won more pennants and World Series than any other team, although in any many years they are not the best team). To many others, the Yankees represent a swagger or arrogance. This is one of the deep root causes for the current Administration’s and Congress’ desire to “reform,” or some may say punish, Wall Street. During the rain-delayed game I saw the Vice President of the United States in the front box seats. As a kid growing up in Pennsylvania, and a long-time Senator from the neighboring state of Delaware, one can easily understand his affection for the Philadelphia Phillies. Parenthetically, I find it interesting that his brother and son are involved with a hedge fund.

We should not expect any solace from the vice president, his administration or Congress for New York. One of the critical issues recognized by the current CEO of the New York Stock Exchange is that its future is dependent upon on what Washington pitches at New York. In the long-run, those of us who are spiritual New Yorkers have to find ways to become more loveable to the rest of the country. This tension is not new, as Alexander Hamilton and Thomas Jefferson, as well as Theodore Roosevelt and JP Morgan somewhat successfully worked on creating conditions from which all benefited. That is our job today. Go Yankees. .

When Experience is not the Best Teacher

In my book Money Wise, I began with the desire to explore the principles of investing to find laws of certainty similar to that found in the physical worlds. I have been unable to find these supports in terms of securities selection or in portfolio decisions. Many others, however, have believed that they have found such rules.

One can often learn more from reading the apology letters from poor performing funds than from winning funds. Brandywine Funds is one of the better communicators of this group. Their basic investment approach is to invest in stocks that they believe are selling at a discount to a future price, based on their estimate of future operating earnings. In bemoaning their under-performance, they focus on the “Quality Ranking System” of Standard & Poor’s, an analytical approach that focuses on relative growth of earnings and dividends over time. Using letter grades to signify the best of these measures, S&P assigns “A” to the best and “C” and “D” to the worst. In the first nine months of 2009, the “C” and “D” companies gained on average 134%, while the high quality “A” stocks were up 21%. To add insult to injury to the earnings modelers, the best performing stock in the Russell 3000, Human Genome Science, was up more than 3,300%. The company has not reported an annual profit since 1994, and is expected to have larger losses in 2010 than in the current year.

Another currently poorly performing manager focuses on the fact that the companies reporting earnings gains often are doing so by significantly reducing expenses. In many cases they are also experiencing reduced sales and/or share of market. Yet in the current market, these stocks are substantially outperforming others that are showing revenues gains and increasing or maintaining market share. Consumer stocks are doing well on Wall Street, but not on Main Street, and they have attracted significant short interest.

Under normal conditions, the focus on accelerating earnings produces performance leaders. The apologists for current relative poor performance have, in some ways, been bitten by one or more Black Swans. In the nineteenth century many Europeans believed that all swans were white, thus there was shock and consternation when they were introduced to Black Swans from Australia. This introduction violated their experience. For hundreds of years before the early twentieth century, the world was an orderly place following the rules of science as pronounced by Isaac Newton. Then Albert Einstein’s thoughts changed the way we looked at the world. In these two instances we are confronted with the choice of the experienced and normal, but recognize that under some conditions exceptions will occur.

Our market and economic experience over the last two years does not follow the normal past experiences. We clearly have been in an exceptional time. History suggests that past exceptional periods eventually coalesce into some form of repetitive patterns that become the new normal. I am not sure what these new relationships will be. PIMCO believes that they have found the new normal, which produces more subdued growth. I am not sure. In view of the fact that, in general, equity returns for the last ten years have been flat, I am of the view that over a longer period we will see growth. My feeling is that at least we will see high single digit growth with some years, like 2009, showing double-digit gains. Further, I believe some form of the old “normal” rules will work for investors, perhaps when we least expect it to work. In other words, this is not like saying to hold on to your Confederate Dollars. But rather, it is a recognition that the South did recover eventually, and is now often a growth leader.

Keep an eye on formerly successful managers, for some of them may be future leaders again, particularly if they do not chase the new normal.

Are We Selling the US Too Short?

Almost everyday the global financial headlines discuss the decline in the value of the US dollar relative to other currencies. Many economists and others talk about a slow recovery here, and faster in Asia. Because of the difficulty in obtaining student visas for university students since 9-11-01, there is wide-spread concern that we are no longer attracting the brightest minds to study and work in the United States.

The fear (and perhaps a distaste) of investing in US stocks has been translated to Main Street. As of September 30th of this year, 53% of all money invested in Stock funds are in US Diversified Equity funds, according to my old firm. Another 6% is invested in Sector funds, some of which have a distinctive global tinge to them. Combined, Global and International funds alone account for 22% of American fund owners’ assets. These numbers understate the total exposure we have to non-US influences on our wealth. A number of analysts have estimated that over 40% of the revenues of companies within the S&P 500 come from overseas. Foreign earnings of these companies are not often disclosed, but I would not be at all surprised to learn that they represent over half of the total earnings of American companies (particularly if we include earnings from exports). I am well aware, and have benefitted from the fact, that investing globally for many years have produced better results than investing primarily in the US. This may not continue forever.

One of the first things I did as a Wall Street bank trainee was to physically account for the foreign shares in our bank’s vault (investors were issued American Depository Receipts or ADRs). Many years later my fellow trainee became one of the leading investors in both domestic and foreign bonds for central banks outside of the US. Almost from the beginning of my personal investing at the odd-lot, below the 100 share size, I invested either directly or indirectly in foreign trends. At times over recent years my foreign exposure in equities was over 40% including funds, individual stocks, currencies and some operating investments. I am no neophyte to investing globally.

One of the many lessons that I have learned from a number of older and wiser investors is to tend to invest against the headlines. The current pessimism about the long term future of the US is just such a time. For the accounts that I am responsible for (including my own), I seriously doubt that I will be adding to the international allocation in the near term.

Why do I take this point of view? Is it just to be contrary? No, while I am professionally trained to look at the other side (or sides) to any investment before making purchases, my optimism is based elsewhere.

We are incredibly fortunate to have three of our family beginning studies this year at William and Mary, Georgetown, and Carnegie Mellon. Not only are we listening to them discussing their courses, but also hearing about what their friends are doing at other leading universities here and abroad. They all appear to be working long and hard, and their courses are subjects that their parents and grandparents would like to take now. Our young will be much better prepared for the globally competitive world that they are inheriting. Their youthful enthusiasm, with some idealism thrown in, has a much more practical base to them than when I was in college. We are producing great raw material for the future.

While waiting for our young to earn their commanding positions, the current pace of technological development in many fields appears to be on the verge of major improvements for mankind. The discussions from graduates, professors and current students that I hear from my exposure to Caltech, suggest that we do not live in a static world. There will be breakthroughs in energy, medicine and their underlying physics, chemistry and biology. Big problems will be addressed and solutions identified. In the scientific fields, most of the awards are going to people who teach or were educated in the US. In science we have been punching way over our population weight class for some time and this is likely to continue at least for a few more years.

Focusing briefly on the price of the dollar, I would rather be a buyer than a seller. At some point, perhaps right now, our trading partners will want to prevent a further decline in the dollar. They will become buyers rather than sellers to protect their own export books and internal currencies.

My bottom line is I believe that one should not now be increasingly short of US dollar investments.

On Building Effective Investment Committees

Investment committees are the heart and soul of many non-profit organizations. The deliberations of these groups determine the near term and perhaps the long term ability of the organizations to accomplish their missions. Combined with the organizations’ Development (fund-raising) efforts, the scope of near term activities is determined. In an ideal world, investment should focus on the long term. In the real world, from a pure investment viewpoint, the pressure of near term funding needs often get more attention than warranted.

Currently, I have multi-faceted relations with several investment committees. I chair two very different investment committees, act as a consultant to some and an investment manager to others. Thus, I read with great interest an excellent seventeen page piece on investment committees by Michael Mauboussin of Legg Mason Capital Management. In his summary, he highlights twenty-one thoughts broken down into general findings, advice for committee members, and advice for committee chairs. With due regard for the patience of blog readers I will not discuss each of his excellent points, but will focus only on a handful.

The best committees are made up of members who bring different points of view from their varied experiences and thought patterns. In effect, intense discussions are the mother’s milk of a successful committee. As distinct from a reporting function which dwells on the past that can not be changed, the committee should focus on the future. Important in the deliberations should be the recognition that after exceptional performance, good or bad, the odds favor a reversal of relative, if not absolute performance. Along this line of thinking, the committee should challenge the obvious. One way to do this is for each member of the group to come to the meeting with thoughts that they share about what could go wrong. Before one can properly come to an assessment of investment risk, one should identify what could go wrong. Up to two years ago, there was no discussion of “hundred year storms,” which actually happen much more frequently. ( For those who are interested, I would be happy to discuss the similarities between the market collapse of 1987 and the defeat of the Spanish Armada.)

Perhaps the biggest contribution to increasing the success of investment committees is to record the essence of the discussions that lead to decisions. Subtly, these records can lead to a shift from an exclusive focus on outcomes to lessons gained from the process. We need to recognize that many outcomes are more a function of luck than skilled judgments. However, if our process allows for luck, or if you prefer the unexpected, we are more likely to be the beneficiary of change than those that have a high degree of certainty.

In applying the last thoughts, maybe we should spend time looking at funds that are currently performing badly, particularly those with managers that have been successful a number of times in the past. Will their successes be repeated?

What do you think?

Old Money vs. New Money Mistakes

One of the truths about investing is that to invest is to make mistakes. I am not suggesting that investing is an avoidable mistake. We have no choice but to invest our time, talents, and capital. The reason we have no choice is that these resources already exist in some form and if we do not change them, we are reinvesting them in their present forms. Innately, humans and animals instinctively know that our resources will deteriorate and perhaps disappear over time. Thus, we choose to do something with our resources. For most of us, we have no choice but to invest or attempt to improve our condition.

How we choose to invest is primarily a function of our experience. Our experience is not just what we individually have lived through, but also what we have consciously learned through the experiences of others with whom we choose to identify. Whether we like it or not, one of the inputs to our experience is our own DNA. This DNA is composed of elements of human race characteristics and more directly, family background. This is not to say that since there have been four separate (and not connected) Lipper brokerage firms, that for all time members of my family are condemned to be members of the New York Stock Exchange. What it does suggest is that we have a disposition to be attracted to transactions and services for others who transact. These tendencies can be applied to the various worlds of art and computer services among others. Luckily for the world, people are wired differently so we can find essential diversity in what we do. For the most part, our experience, no matter how formed, does not trap us into certain behavior, despite our propensities. Thus, as we enter each new theater of experience, we either treat what we are about to do as something new, or part of a continuum from the past.

Experienced investors, or if you will, old money, invest differently than those with new money. Each of us is human, and therefore makes mistakes; but often the mistakes of old money are different than the mistakes of new money.

Most of the old money that I know did not materially change the disposition of their financial assets after the experience of the last couple of years, even though their money piles are smaller. Their “normal” asset distribution might have been 5% in cash, 35% in bonds, 20% in domestic growth stocks or funds, 20% value stocks or funds and 20% international stocks. At the end of last year they may have had over 60% in cash and fixed income, 15% in value-oriented stocks or funds, 15% in international and 10% invested with a growth objective. An experienced investor believing that almost all relative performance is cyclical, might not change any commitments. For what the market takes away it will return over time. Further, from their experience, they believe after a major decline they should not change most managers or stocks of currently profitable companies. Old money has an affinity to long term records as they have had their money over the long term. They also generally prefer investing with organizations rather than in the success of any particular CEO or money manager. Thus, they chalk up the declines they have experienced as just a “normal’ cyclical decline which will be corrected by a “normal” recovery followed by some secular growth. In many ways this is almost a Newtonian view of a grand watchmaker overseeing our universe.

Owners of new money are full of themselves. They earnestly believe that their investment results are largely, if not totally, dependent upon themselves. They look at the current market always as an opportunity to show how bright they are relative to the mistakes of others. This personality-driven approach often identifies with specific hero CEOs or hot money managers. A somewhat over-simplification of their choices is that they believe in participating, if not leading momentum. Everyone recognizes that at any given time there are numerous unknowns that are likely to dramatically impact security prices and trends. If momentum won’t supply the answer, the new money is more likely to divine the right answers. They have more tools, or if you prefer gadgets, than the old money players and this give them an almost insurmountable advantage.

In these stylized cases, both the old money and the new money are making fundamental investment mistakes that others have committed in the past. Old money is betting on repetition, as in history repeats itself. If that was entirely true there would be no progress, as everything would circle back to our beginning point. In truth, history does show an uneven upward bias to the human condition and valuations. What many do not realize is that the upward bias is caused at least in part by the abandonment of failed, or too weak to survive, elements; as well as the pull of some new potential riches. Further progress is made by recognizing mistakes/opportunities. In the “old money” asset allocation example shown above, some wise investors might reallocate their money back to their “normal” portfolio. (There may be a seldom-declared advantage to this tactic: By increasing one’s commitment to a currently depressed area, if successful, the quicker one will get to the upper limit of the allocation causing a cut-back. One of the reasons for the dramatic declines in numerous portfolios last year was their over-investment in what was “hot” was not automatically corrected.)

New money often does not recognize that what is working so well now is very similar to similar beneficiaries of momentum in past market cycles. One of the many lessons coming out of the Great Depression of the 1930s was the peril of the extreme use of leverage or margin in the 1920’s by various utility holding companies, the great Goldman Sachs Trading Company and individual investors. Applying those lessons from the ancient past might have reduced the 2008 losses in various leveraged vehicles.

Both the stereotypical old money investor and the new money investor do not take into their considerations that they may be wrong. Their “system” like those of many disappointed race track bettors, does not contemplate that judgment mistakes are as normal as other accidents. Both set of investors can reduce their odds on big individual mistakes of judgments by using professionally sound funds. (Caveat Emptor: I manage portfolios of funds for institutions and a very limited number of individuals.) One might combine both the old money and new money approaches (using the asset allocation example above), by reweighting the equity portion of the account in favor of growth stocks or funds as momentum appears to be picking up in that direction. Another example of combining the lessons from these two habit patterns is taking the view that in terms of high-quality fixed income, it appears unlikely that interest rates will drop materially and therefore the capital appreciation potential from this particular segment is limited, and thus the commitment to high quality fixed income should be below “normal.”

Which kind of an investor are you old or new?