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The TSC Streetside Chat: Merrill Lynch Strategist Rich Bernstein
By Justin Lahart , Associate Editor,
and David A. Gaffen , Senior Writer
Originally posted at 9:00 AM ET 6/17/01 on RealMoney.com


One of the little ironies of the tech stock bubble was that at its height
investors had never been so well-informed. CNBC blared all day, and people
checked in on their portfolios throughout the day, anxiously looked for news of
the latest upgrade, the next product launch, the last whisper number.

Yet all that supposed information didn`t end up doing much good. The carnage in
tech stocks since March 2000 decimated many investors` wealth. Where a little
more than a year ago many thought, as one online broker`s ad put it, that they
were "going to retire rich," now the mere idea of being able to retire at all is
a welcome one. Why didn`t all that information help people bail out in time?
More to the point, why didn`t all that information keep the euphoria from
mounting in the first place?

That`s easy: Most of the information was useless.

Or maybe even worse than useless, but actually dangerous because it forced
investors into shorter time horizons, drew the focus away from the fundamentals
of investing and made people take greater risks than they should have. Consider
the increasing importance attached to getting Level II Nasdaq quotes -- and not
just any Level II quotes, but the best ones available because every second
counts. Or after-hours trading -- the idea that everyone would, and should, be
in the market 24/7. Many investors put a lot of time into trying to be as
up-to-date on the market as possible and forgot about things like the importance
of a diversified portfolio and capital preservation.

Meantime, Merrill Lynch chief quantitative strategist Rich Bernstein was a voice
in the wilderness, counseling investors to take money out of tech and put it
into the bottom 450 stocks in the S&P 500, or to take money out of the market
altogether. Nobody paid much attention -- which gave him more time to work on
his just-published book, Navigate the Noise: Investing in the New Age of Media
and Hype. In it, he looks at the problem of noise in the market, how to discern
that from true investment information, how to think about diversifying one`s
total capital and, perhaps most important, how to make investment decisions that
will allow you to sleep at night.



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Justin Lahart: Let`s kick off with two questions. What is investing noise, and
is it time to buy tech stocks?

Rich Bernstein: Noise is just the incredible flow of information, the daily flow
of information that bombards everybody. Specifically, what the book looks at,
obviously, is investment information. Everybody believes that the more
information there is because of all the different media -- Internet, magazines,
radio, television, everything -- isn`t this great, there`s more information.
What the book tries to point out is that most of it you don`t want to use. Most
of it is actually quite detrimental. It gets you looking at things you shouldn`t
care about, and it gets you to do things you shouldn`t do.

Is it time to buy tech stocks? The answer is no. We`ve been telling people on
the rally in the Nasdaq to sell into strength. The fundamental problems in
technology are still there, both cyclical and secular. The damage that was done
to both the technology sector and the rest of the economy by the technology
bubble, you don`t wash that out in a matter of months.

Justin Lahart: How do we see investing noise in the technology arena?

Rich Bernstein: Oh, that`s easy. To a large extent the popularity of momentum
investing over the past few years is directly proportional to the amount of
noise that people believe they have to listen to. Everybody is looking at every
this, every that, and people are less and less really focusing on fundamentals.
The thing you hear from everybody now is that the market is "telling" us
something, that if a stock`s going up, the market is "telling" you something. I
would argue that all the market is telling us is that we`re all fools.

A lot of the reason we had the bubble was that people paid more attention to
noise than fundamentals. In fact, people who argued against listening to the
noise were ridiculed.

David Gaffen: Why write this book now?

Rich Bernstein: I started writing it early 2000. It was in the works late `99.
The reason I thought it was such an important issue is that I realized the
bubble was starting to inflate, that people were not looking at fundamentals,
that people were doing very foolish things. We all say there are things we want
to do. If you`re an individual investor, you want to plan for the future. If
you`re an institutional investor, you want to have a disciplined approach, you
want to plan for the future. What I saw was that people were just abandoning
what they were doing because everybody thought they could find the next
Microsoft (MSFT:Nasdaq - news - commentary). And everybody thought they had
found the next Microsoft -- it was really pretty silly stuff.

I thought that it would be an important book either because the bubble would
still be going on and it would be controversial -- I still think it will be a
controversial book -- or, if the bubble burst, people would say, "What just
happened?" and clutch their chest and never want to invest again. The point was
to say here`s what happened and here`s what you should be doing. Don`t take `98,
`99 and 2000 as the real world -- it was the exception more than the rule.



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"To a large extent the popularity of momentum investing over the past few years
is directly proportional to the amount of noise that people believe they have to
listen to."
--------------------------------------------------------------------------------



Justin Lahart: One of the things you talk about in the book is that the time to
sell is when noise is on the ascendant and the time to buy is when the noise has
just gone away.

Rich Bernstein: Right.

Justin Lahart: And one of the things that we`d say about tech stocks right now
is that there`s still a lot of noise. Most of the headlines are still about
tech.

Rich Bernstein: Absolutely. Everybody likes to think of themselves as being a
contrarian, and one of the things I try to point out in the book is that a true
contrarian doesn`t look for negative sentiment, a true contrarian looks for no
sentiment. Where people just don`t care. There have been plenty of examples of
that in the last 12 to 18 months, of sectors that people would have never
thought of looking at so significantly outperforming technology -- it`s been
silly.

If you`re really going to be a contrarian, you`re going to sell as the noise
reaches a crescendo. Most people won`t do that. It`s very hard to do that
because you get all this positive reinforcement. "This is the greatest thing
that`s ever happened." The greatest company, the greatest management, the
greatest this, the greatest that. You`ve got all this positive reinforcement
behind you, so you decide, "I should hold on to this stock here, I`ve made such
a great decision." And what happens is it starts keeling over. But of course the
noise doesn`t stop. It keeps telling you, "This is great, this is great, the
decline is just temporary." By the time the noise tells you, "This is a dog
stock," it`s usually too late.

My point is you don`t want to keep all these avenues of information open. You
want to be very selective as to what you actually listen to and what you pay
attention to.

David Gaffen: The bubble has burst, but investor psychology doesn`t seem to have
completely burst. Many people remain focused on beating the market. Their
assessment of how well they`re doing is based on whether they`re beating their
neighbor, not whether they`re preserving and adding to capital. Do you see that
changing in the next few years?

Rich Bernstein: I think over the next several years there`s going to be a wave
of conservatism in investing. People have been in one corner screaming, "Capital
appreciation -- I need the maximum growth for the long term." In doing that they
completely mis-assessed their risk tolerance and paid no attention to whether
they were doing something that they could sleep with at night. My guess is that
they`re going to move to the other corner, which will be capital preservation.

There are two things that will cause that. Number one is just the demographics.
Baby boomers are getting older and as you get older you tend to be more
conservative. Number two is this complete miss-assessment of risk tolerance.
People really didn`t think about what they were doing. They were just looking at
returns and didn`t worry about risk. The natural reaction is that you go from
one extreme to the other. Instead of being aggressive and trying to beat their
neighbor, they`re going to try and sleep better at night than their neighbor.



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"If you`re really going to be a contrarian, you`re going to sell as the noise
reaches a crescendo."
--------------------------------------------------------------------------------



Justin Lahart: The two seem related -- the demographic and the pedal to the
metal. There are a lot of people who have seen five years of their investment
life just destroyed, and of course you don`t get those five years back. You`re
five years closer to retirement.

Rich Bernstein: The timeline only goes in one direction, unfortunately. We think
there`s another leg down in the Nasdaq. I think when we get through that leg
down is when the wave of conservatism is going to really show its face. People
are going to realize that they potentially have less than they had when they
started saving for retirement, and I think that`s going to freak them out.

Think about Jeremy Siegel`s book, Stocks for the Long Run. It`s a great catch-22
for him. If everybody buys the book and everybody believes that stocks will
outperform for the long term, they won`t. People will bid up the price, they`ll
bid down the risk premium and they`ll be taking too much risk, and the whole
thing will fall apart like what we just saw in the Nasdaq. However, if nobody
buys the book, or if for some reason nobody believes it`s true that stocks will
outperform in the long term, then it will work. For Jeremy Siegel it`s an
interesting situation. Does he want to sell the book, does he want to be popular
and ultimately probably have his theories not work? Or does he not want to sell
books, not be popular and have his theories proven true?

I bring that up because as everybody gets scared and goes into this capital
preservation mode, stocks will outperform for the long term because you`ll start
getting the risk premium back up on risky assets. It`s a weird scenario, and the
only way to deal with it is to put something away and don`t look at it. That`s
part of my book -- if you`re a real long-term investor you should not be reading
the papers every day, watching TV every day. Noise and the volatility of the
markets will only make you make bad decisions.



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"Everybody thought they had found the next Microsoft -- it was really pretty
silly stuff."
--------------------------------------------------------------------------------



Justin Lahart: If everybody buys your book and everybody starts to look at
noiseless areas of the market, we`re going to have immense volatility as people
go from noiseless sector to noiseless sector.

Rich Bernstein: The problem is that that requires they do more work than they
probably want to do -- unless everybody leaves their job and becomes a full-time
strategist or something.

That`s actually something I bring up in the book. Everybody thinks they`re an
expert, that they can do it themselves. That`s really pretty foolish. We`d never
remove our own gallbladder.

David Gaffen: What do you think of this theory that gets bandied around that
people have been overstating the risk in stocks for a long, long time?

Rich Bernstein: Are you talking about this Dow 36,000 sort of thing?

David Gaffen: Yes.

Rich Bernstein: I do go into that in the book. What those analyses have done is
they`ve mixed up ex-ante expectations with ex-post returns. You can always look
backward and say, "Gee, look, stocks have outperformed bonds and they`ve done so
with less risk." But the reason that`s happened is that ex-ante expectations of
stock risk were so high. It`s just like this Stocks for the Long Run. If ex-ante
return expectations begin go up, ex-post returns will go down because the risk
premium goes down and you are taking too much risk. Again, think of the Nasdaq.
When you really should have invested in technology stocks, nobody wanted to.
That was like 1990, 1991 and 1992. Through the latter part of the `80s tech
stocks were pig stocks -- nobody wanted to invest in them. The sector that
actually got all the attention through much of the `80s, even though it was
already dead, was the energy sector.

What those analyses do is they make it sound too simple. They say, "Look, they
outperform, so why worry about it?" But the point is that if you`re not worried
about it, it`s not going to work. You`ve got to worry; there has to be some fear
element in here.



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"By the time the noise tells you, `This is a dog stock,` it`s usually too late."

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Justin Lahart: In the book you talk about a friend`s father dancing on the
table...

Rich Bernstein: Around the table, not on the table! Because his money-market
mutual fund for the week hit 25% return. He was dancing around the kitchen; I
can vividly remember it.

Obviously, that was ridiculous. How could you get so much out of a short-term
instrument? It was unusual, and everybody began to invest in money-market mutual
funds, including myself at the time. And nobody realized there was a bull market
in stocks going on because everybody was playing money markets.

Justin Lahart: Talking about before-the-fact, after-the-fact, one of the things
we see is people talking about "the next Microsoft." That`s a classic example of
after-the-fact investing. A guy who`s actually done a little blurb for your
book, Meir Statman, talks about that. People are always saying what a genius you
would have been to put all your money in Berkshire Hathaway (BRK^A: - news -
commentary). And he says, "No, you`d be lucky. You`d be an idiot, and you`d be
very lucky."

It`s the same sort of thing -- there`s the idea that you could have foreseen
Microsoft. Looking back, we say we could have seen this and we could have seen
that, and we would have seen the other thing. Well, we didn`t. And nobody did.
Otherwise, we would have bid up the stock incredibly to begin with.

Rich Bernstein: Exactly. People look at price charts and they say, "Look at this
stock, what a great company." What they forget is that at the beginning of the
price chart nobody thought it was a great company. Why didn`t everybody realize
it was a great company then? Well, it wasn`t a great company. It`s only been in
the last 10 years, as the stock went up, that everybody began to call it a great
company.

I don`t know if you saw the interview in Fortune with me, and I said things have
gone so well, if I were a stock, I`d short me. They thought that was really
funny, but the point was they didn`t come to me about the article last year.

David Gaffen: The market has lived through long periods -- 14 to 16 years --
where stocks were not a good investment. The late `60s to about 1982, the 1929
to World War II period -- could we be on the cusp of that?

Rich Bernstein: I think that`s a bit extreme. You have to remember that the tech
bubble was one sector. The energy bubble blew up, but it didn`t ruin investing
in stocks. I actually think the energy bubble was bigger than this -- most
people disagree, but they haven`t looked at the data. If you look how much
capital they raised, allowing for the difference of market caps through time, it
was a more dominating force in that period.

Justin Lahart: They had a TV show.

Rich Bernstein: Dallas! And it lasted a long time and was all about oil
drilling.

I think energy might have had a bigger impact on the economy. But it didn`t
bring down the economy and it didn`t bring down the stock market. It`s a little
bit different if you`re talking about Japan or you`re talking about 1929, when
it was more the entire stock market. It may not be very bullish for the Nasdaq
long term. But I don`t think it`s bad news for the asset class as a whole.



--------------------------------------------------------------------------------
"Everybody thinks they`re an expert, that they can do it themselves. That`s
really pretty foolish. We`d never remove our own gallbladder."
--------------------------------------------------------------------------------



David Gaffen: One of your topics in the book is diversifying your total capital.
Can you talk about that a little and where it came from?

Rich Bernstein: It came from a number of things. Part of it came from personal
experience. I worked at EF Hutton in the `80s. Hutton, as we all know, basically
went out of business. Shearson bought them out after the crash in 1987, but it
basically went out of business. There were a lot of people at Hutton who had
been there for many years. Hutton was considered a firm that was a cornerstone
of the financial sector in the United States. There were a lot of people, older
people at Hutton, who had put their retirement savings in Hutton`s stock. I
remember one woman in particular who was devastated that Hutton stock went down
to something like $6 a share. That was the first time it dawned on me that
putting all your eggs in one basket is not such a good idea. We`re all taught
that, but I could see it -- I could physically see it.

So I thought about all the different ways that people had not diversified their
total capital. It dawned on me that people have no idea how to think of their
total capital. Even people in the industry don`t. My broker every now and then
asks me why I have so much cash in my portfolio, and the answer is because I
have so much Merrill (MER:NYSE - news - commentary). How are you going to
diversify your holdings in Merrill stock, because we`re so tied to the markets?
From my point of view, the way to do it was to hold a zero beta asset. I have a
high beta asset, Merrill stock, and then I have a zero beta asset, cash.

People don`t think about things like where they live -- what are the eggs they
should be worrying about putting in one basket. They only think in terms of
stocks.

Justin Lahart: We clearly saw this problem with people who lived in Silicon
Valley, worked in Silicon Valley and were playing in the stock market at the
same time. Now their real estate is not looking as good and their jobs are not
looking as good and their stock holdings...

Rich Bernstein: The hardest speech I`ve ever had to give was in March 2000 to a
set of Merrill brokers in Silicon Valley -- 1,100 brokers and me. It was March
2000 -- the height of the bubble -- and I`m decidedly antitech. I decided if I
got up there and gave my normal speech saying I don`t like tech, I`d probably
get stomped.

So I decided to take a different tack and say, "Listen, this is the epicenter of
what`s going on. Your clients have amassed a tremendous amount of wealth. You
don`t want to be the one who has the client who`s written up for having gone
from $5 billion of wealth to a couple of hundred thousand. You don`t want to be
the broker who was involved in that. What an embarrassment. You`re supposed to
be a financial manager."

So my whole point was, get your clients thinking about how they have all their
eggs in one basket. And it`s not like we`re going to buy Asian semiconductor
stocks -- that`s not diversification. It`s got to be: Where are we going to find
assets that have no correlation to this immense wealth that we`ve built here in
Northern California?

Of those 1,100, my guess is about six of them understood what I was talking
about and three of them probably did something. Everybody thought I was an
idiot. What was I worried about? This is the next industrial revolution!

[falang]

Gibs das auch auf deutsch??? Denke das ich ich da ein paar Übersetzungsfählär drin hab....

[DimStar]

leider nein

[falang]

schade...........

[inminki]

guter artikel,

bis auf ein paar punkte seh ich das ungefähr genauso. rich bernstein (cooler name) scheint mir das ausmass der us-bubble zu unterschätzen. m.e. liegen neben tech offensichtlich folgende weitere bubblen vor:

bubble fast aller large caps (z.b. ge, hd, wmt usw...)
real estate-bubble
masslose überschuldungs-bubble
bubble bei staatsanleihen
strong dollar policy bubble
derivate/leverage bubble

grund aller bubblen: fast schon lächerliche geldpolitik des offenmarktausschusses


fazit: gambling in us-märkten, aber investieren sollte man tunlichst wo anders.