Has Goldman Sachs staff collectively taken a Bear pill? I would say yes. Last week or the week before each analyst team covering the tech space, which as you will all know by now is my beat, wrote a note updating their estimates and recommendations as if a severe consumer recession in the US and rest of the world was going to take place. I imagine, but cannot be sure, and don’t have the wherewithal or time to check, that the teams in other sectors have done the same. Given the diversity of beliefs between randomly selected equity analysts on any particular topic — except maybe on Google, Apple and RIMM, where they march in a lockstep “BUY” formation, it would seem odd that such a collection of highly intelligent and adaptable, if not necessarily wise, individuals, can all share the same deeply held conviction at the same time. It would make lunchtime conversation at the canteen particularly boring at the very least. To me, it has the smell of a “policy decision”.
Ben Stein sees a nefarious plot by GS to destroy US prosperity by talking up their short book. The econo-bloggy firmament, led by the redoubtable Felix, has written a collective pooh-poohing back at him. Stein speaks for many, however; just this week I myself suspected the horned and tailed GS head of Asian research of going thru my portfolio from the top to bottom, getting his homunculus-like minions to downgrade to either a sell or a neutral (which as we all know is merely a polite way of saying “sell”) all our largest and most beloved positions, from Korean and Taiwanese LCD panel makers, to Ali Baba, the Chinese internet holding company and recent star IPO, and a certain Chinese handset component name of whom I may write more about one day (and who GS is going to take a serious bath betting against). This makes me very cross. I complained to my GS salesguy that this was beginning to look personal. Oh no of course not, he said. But something in my lizard brain told me he was lying, that GS employees are in fact trained to lie from birth.
As Stein writes, there is a particular hegemonic quality to Goldmans that makes it easy to be paranoid. In my judgement I do not think there is enough data out there yet to be able to make a definitive bearish judgement on markets or not — on certain sectors sure,but another 2000-2002, certainly not. Stein makes the good point that at the very least we don’t know the effectiveness of the policy response yet. By going out on a limb like that, GS lays itself open to the accusation that it is trying to push the market and later the economy in a particular direction, in a sort of Sorosian reflexivity thing. With so many fingers in so many political and financial pies, should one suspect GS of such a motive, it would be easy to conclude that they also had the means.
But of course reaching both conclusions would also mean you were wrong. All GS is doing is “taking the under”. It is a classic broking best practice. Let me explain:
On any stock or controversy in the markets, there are a number of possible positions to take. Buy, Sell or Hold sum most of them up. A research led broker stakes out his claim to one of these positions through research, and (note emphasis) uses it as an excuse to call his clients, spin them a story, and hopefully get them to trade something and pocket some commission if they think of you when they do. Being right on the stock or controversy is of course good too, as it will make the punter think more fondly of you when it comes to the bi-annual broker review common to many investment management companies, when the broad outlines of who gets what share of total commission in the next 6 months gets decided. This sometimes stops them from trying to flog any old rubbish just to make some phone calls. Other issues come into play too, such as “if we put CSCO on sell, we may get commission, but they’ll never talk to the analyst for ages and we will piss off I-banking”. But these are all considerations rather than musts. You’ve got to keep those clients’ phones ringing: armies of salespeople and analysts cost money. Sometimes paying the medium term price is cheap for the short term benefit.
I remember as a young Equity Capital Markets peon at a now non-existent London global equity powerhouse being shocked that our top rated telco analyst had put our target to a sell, just as it was about to do a huge secondary privatisation. This even was pre-Blodget, so this was simply not done. We were in the deal as a co-manager –think tertiary bag-carrier’s assistant. But as the analyst explained to me, everyone on the street had this stock on a buy, partially in the hope of getting in on the deal. By “taking the under”, we would corner the market in the bears, many of whom would sell short going into issuance and hope to cover by getting allocated shares in the deal, and needed someone independent who wouldn’t tell the syndicate. There were even some issues with the stock, so it was not even a terrible call. For the weeks before and after the deal our salesmen had some great calls to make; we got 40% (I am guessing here) of the heightened “flow”, or volume, in this very liquid stock. We made far more money as a bank off this than we would ever have got as co-manager in an over-populated syndicate. The analyst preserved his reputation for iconoclasm and independence, and if he pissed off the company in question, as the top-rated guy in the sector IR would definitely come back and sell him their daughters if they thought they could flip him back to buy. It was a no-brainer, a great deal.
GS doesn’t have a great plan to lay waste to the Earth. It’s trying to make some brokerage revenue in a tough market. Conventional wisdom on the street is always optimistic: we will muddle through the current difficulties. We won’t go into recession. Buy growth, sell value if you have to, but don’t switch your portfolio to full on bear mode just yet. Brokers, who have to hold inventory, are generally always long; they talk up their books. GS sees the opportunity to take the under, carve out an ecological niche for itself as a temporary bear, at a time where there are frankly good reasons, if not wholly conclusive ones, to get more negative. It’s a great call for a salesman to make: “are you sure your portfolio is recession proof? Don’t you want to hedge just a teeny-weeny bit? Here are some names to avoid.” And if in a few months time the policy response proves effective, and/or Fed funds get cut to 3% or something, or the data changes, or CSCO has a huge quarter and says enterprise spending is stronger than ever then guess what? More calls to make! “Hey, we’re making a big bullish call; things are OK again! Here’s a list of beta stocks our analysts like.” Of course, if things do turn out badly, GS called it. It is, once again, a no brainer.
Prop desk orientation can change overnight. In the end, GS will make more money, long term, off a continued bull market than it will off a horrendous bear swoon. It has no motive to create doom, and Hank Paulson does not want to go back to GS (or wherever) being the SecTreas on whose watch it took place. Moreover, I don’t really think GS is going through our portfolio: we have had a great year, and many the stocks in our portfolio have all gone up big, Asians in particular. Ali Baba is up like 200% or so from its IPO a few months ago. GS Asian research (not their strongest department I have to say) is playing the mean reversion trade, again, one of the more trusty weapons in the broker’s arsenal as I am sure you can now imagine.
Should GS apologise for selling CDOs? Of course it could, but do you honestly think they will mean it? GS does not suck; they remain the best at what they do on the street. I watch in admiration as they think up new ways to screw me.