Greed Isn't So Good Any Longer

05/28/2012 8:15 am EST


Stephen Leeb

Founder and Research Chairman, Leeb Group

The great line from the movie Wall Street, when big player Gordon Gecko proclaims at a shareholders meeting that “Greed is good,” has fueled many a trader's dreams...but it's no longer the mantra that works today, observes Stephen Leeb of The Complete Investor.

Two major financial events that greeted us over the past week or so evidence a growing Wall Street greed, which we attribute to increasing austerity and/or the inability to achieve economic growth by the usual means. In other words, if you can’t make it in legitimate ways, make it any way you can.

First case in point: JPMorgan Chase (JPM). Anyone who believes this $3 billion-plus “accident” came from hedges gone awry is someone who would buy the Brooklyn Bridge or make a wager against somebody like the recently deceased Amarillo Slim, a legendary professional gambler known for his exceptional skills at poker—and proposition bets.

One definition of the latter phrase is “side bets,” i.e., wagers regarding the occurrence or non-occurrence of an event during a game that will not itself determine the entire game’s final outcome. Certainly, the derivatives involved in the JPMorgan debacle fit this definition. It’s clear that the company met disaster as it was trying to make a bunch of money from its own favorite types of proposition bets.

With the traditional banking business of making loans not growing, both because of lack of opportunities in this economy as well as the problem of excessive regulations in a complex society—or, ironically, because standards for making loans are a little bit too high right now—other avenues for generating profits are given a whirl.

Is this a canary in a coal mine? Well, at this point we don’t know. But we do know that the problems that JPMorgan Chase has to deal with in terms of growth characterize a lot of other financial institutions.

Morgan Stanley is certainly another one. This second-largest standalone investment banker was the primary underwriter of the Facebook (FB) IPO. Underwriters, as I’m sure you all know, get paid a fee based on the size of the initial funds invested in the companies they take public.

Facebook’s IPO, the biggest Internet public offering of all time, occurred last Friday. After much haranguing and shouting going back and forth over what the initial price should be, Morgan Stanley picked a value of $100 billion (we all love round numbers) or $38 a share—which would make it the most valuable US company ever at the time of its stock market debut.

And for a few minutes there on Friday, it seemed that Morgan Stanley had done a pretty good job, as the stock jumped from $38 to $45 a share. But as I write this column today, looking at the price of FB on my computer screen, I see that it’s trading around $34.

For those poor souls (and they were retail clients) who bought the stock at the initial price, they could find themselves down as much as 25%. Morgan Stanley in all likelihood is laughing all the way to what’s left of its investment bank.

For in a world in which there is not much growth, the pickings are slim, and virtually all investment banks are now shadows of their former selves. We wrote in our book Game Over, “Mothers, don’t let your sons grow up to be investment bankers.” And that may turn out to be one of our best and most accurate pieces of advice to date.

The developed world now desperately needs to foster opportunities for real growth. In this connection, this past weekend we read an interesting interview with one of the most successful hedge-fund managers of the past decade or more, Ray Dalio of Bridgewater Associates.

Dalio compares the current crisis in Europe, which is still a slightly bigger chunk of the developed world than the US, as being similar to the crisis facing the original 13 colonies right after the American War of Independence. There were at that time all sorts of problems regarding currencies, high debt levels, and a number of other issues about which we’ll take Dalio’s word. (We admit to not being astute students of history.)


In any event, Diallo argues that a lot was sorted out at the Constitutional Conventional in Philadelphia that took place from May to September 1787. And of course, the rest is history, as they say. Once blessed with a Constitution, those initial 13 colonies—now states—and indeed the entire country went on to great fame and fortune.

But what we think Dalio left out of his analysis is how much room, literally and figuratively, there was for growth over the subsequent course of US history. The land mass we now call the 48 states was extraordinarily blessed with natural resources and large tracts of untamed land, and the avenues of growth were perhaps never greater than they were in the 18th and 19th centuries for this country.

This is not the case with the developed world today, unless you want to argue that Europe and the United States will somehow manage to take over China, the Middle East, and other areas not currently controlled by them.

We desperately need a plan for growth, one that will take us further than ever-larger homes and ever-bigger cars, etc., a plan that will incorporate massive changes in the way we live, including new infrastructure, and yes, as you’ve often heard before from me, sweeping changes in the way we generate energy.

Resource scarcity may stand in our way, but a West united to do the job would be very formidable, and is probably the best chance we have for getting out of the current mess.

Other than a real plan for growth, the world remains on that knife’s edge. Except the only thing that’s changing is the distance we will fall when we step off in one direction or the other. On one side is massive inflation, on the other, massive unemployment, deflation, depression—whatever you want to call it.

Someone has to explain to me how a European Union holds together when in many respects the weaker countries such as Spain and Greece de facto have much stronger currencies than the stronger countries like Germany and France. Obviously this cannot stand. The inevitability of inflation or massive unemployment is clear.

Under these circumstances, our approach to investing is more and more to try to find individual investments with downsides that are dwarfed by their upsides. In this slow-growth, highly tumultuous world, the probability of an upside is somewhat small, even in the best of cases. That’s a big change.

But if things go right for such investments, that upside will be there. It’s just that, again, there is far less chance of everything going right than of it going wrong.

Still, for each of these investments there’s a positive expected value. By expected value, we simply mean that if you could repeat the experiment enough times, you’re likely to end up well in the black.

For example, if there’s only a 10% chance that a stock will go up fivefold, and a 90% chance the stock will go down 10%, your expected value would be nearly 50%. That’s a situation where your chances of losing are far greater than your chances of winning—but the payoff if you do win will be substantial.

There are a few stocks we’ve mentioned before that clearly qualify here. Your job as an investor in this slow-growth world is to find as many as you possibly can.

Eli Lilly & Co. (LLY), based on admittedly less than a 50% probability of success in treating Alzheimer’s, or of establishing an ever-greater franchise in the area of diabetes, would be an example. Success in either of these areas is likely to move the stock up 50 to 100%. And though chances of success may be less than 50%, the downside on this stock is no more than 20%—in other words, a positive expected value.

Ditto for a company like Intel (INTC), which is in the process of trying to extend its hegemony in chip manufacturing. If the company is successful (and we rate those chances very high), and if there is higher demand for the products it manufactures (here’s where the odds may not be quite as good), Intel will become a near-monopoly manufacturer of the latest and greatest technologies. And this could happen within the next six to 12 months. More precisely, Intel’s lead over the No. 2 company in this space could be easily as much as four years.

Our third category of stock, and here we might be cheating a little bit because the odds in this case are more evenly tilted between massive gains and substantial losses, would be the junior gold miners. These stocks nearly all trade at a fraction of asset value.

Unlike the senior miners, relative to their capitalization they have massive reserves to exploit. What they lack is funding. In a world in which we believe gold will be one of the few asset categories to produce very positive and strong results, these junior miners will very likely find funding sooner or later—market expectations notwithstanding. For a number of these miners, the results could be many-fold gains.

To sum up: Beware of the limited growth opportunities that surround us. But also know that even in this environment, there will be those few that grow to the sky. You have to pick more than one or two in order to assure yourself the kind of gains we think you deserve.

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