Beat the Street: Tips from Michael Steinhardt

Nifty BSE | NSE 31/05/12 Are Mutual Funds betting on Nifty?

Michael H Steinhardt , Managing Member, Steinhardt Management , has one of the greatest investing records in Wall Street. A USD 1,000 invested with him in 1967 became almost half a million dollars by 1995, versus only USD 19,000 for the S&P. A pioneer yesterday, and a philanthropist today, Steinhardt is a true blue legend of Wall Street.

 

Steinhardt says he has an extraordinary ability at times to predict, on a day-to-day basis, the change in the direction of the Dow Jones Average. "At one point, I made a bet with one of my counterparts and was right 21 days in a row."

 

He takes great pride in distinguishing things that were statistically significant from noise, and got more pleasure from making money on the short side in a down market, than from making money on the long side in an up market.

 

Excerpts from CNBC-TV18's exclusive interview with Michael H Steinhardt:

 

Q: You have had a legendary career on the Street. How did you get started in equities? What interested you in it?

 

A: In my coming of age or my Bar Mitzvah, my father did not know what to give me for a present. He had been gambling with a stock broker and the stock broker had persuaded him to buy 100 shares of two different stocks which he did not know the first thing about. So, he gave me as my Bar Mitzvah present 100 shares of two companies: Penn Dixie Cement, which has long gone bankrupt, and a company called Columbia Gas. The value of these shares at that time was USD 5,300.

 

Q: A fortune?

 

A: Exactly and it changed my life. On my first job on Wall Street; I started at USD 80 a week and USD 4,000 a year.

 

Q: A dollar move up in the stock price made you USD 100?

 

A: Which is an enormous amount of money. It was just so exciting. So, what I used to do is I used to get three newspapers a day with a morning stock price edition, a noon stock price and a closing stock price. I have never quite understood why my career went in a certain direction.

 

But there was a point where I had an extraordinary ability at times to predict on a day-to-day basis the change in direction of the Dow Jones Average. At one point, I made a bet with one of my counterparts and I was right 21 days in a row.

 

Q: And that cannot be random?

 

A: I don't think so. I took great pride in distinguishing things that were statistically significant from noise. I thought I was good at that. Then, I became an analyst and a trader. In those periods, being a trader was a denigrated occupation. Traders were uneducated and anti-establishment.

 

Q: Where was your first job?

 

A: My first job at Wall Street was with a white-shoe mutual fund firm called Calvin Bullock and it was a firm that took pride in its history and in its quality. It had all sorts of Napoleonic relics in the office and there was a great sense of history there.

 

Q: Was it about research, history, facts and figures?

 

A: Yes. I was a Research Assistant and it was a good grounding. I was lucky frankly to be offered a job at Loeb, Rhodes & Co., which was exciting.

 

Q: By the 60s, you had started making your name on Wall Street. Tell us how you got started and what were your insights at that time?

 

A: When I came to Loeb, Rhodes & Co., I was asked to be a durable goods analyst. Part of my responsibility was agricultural equipment. I analysed a company called Massey Ferguson, and Massey Ferguson at that time was the leading company in worldwide agricultural sales. The concept in the 60s was that there were many, many concept stocks that hit some vision of growth and one of the clear growth areas for instance was electronics. So, most companies that ended with O-N-I-C-S, caught the imagination of the stock market.

 

Q: The Dow was in a great bull market and the American century was unfolding. It was a perfect platform?

 

A: You are right. It was a perfect platform. So, Massey Ferguson is a perfect example. I calculated their percentage of market in harvesters and tractors and all sorts of things and I recommended the stock. I do not exactly remember the price any more. But it was the all time high for price that the stock ever got to. So, it was the worst recommendation I ever made. I was not impervious to making mistakes.

 

Q: You are being modest but you had some great stocks that tripled and quadrupled?

 

A: Early on, it was brought to my attention that a number of companies particularly in some of the less glamourous fields were growing via acquisition. At that time, and perhaps even now, that was viewed as a dubious way to grow. The right way to grow was through innate organic product growth; Polaroid, Eastman Kodak, IBM, Xerox, the go-go years, the Nifty 50 was the most exciting thing. Those things sold in multiples through the move.

 

But when you think about the durable goods companies, it is a whole different world. So, I was in that company area and someone insisted that I visit a company that was called Gulf & Western Industries that had a character named Charlie Bluhdorn as its Head. I was absolutely overwhelmed by his charm and his willingness to say in his Austrian accent, "I am going to acquire 50 companies in the next year, maybe only 40, and I am going to increase my earnings by 200%." He spoke that way and it was fantastic. I recommended his stock before the paper was dry on the recommendation and the stock seemed to have tripled. That was the beginning of a career I made of sorts for a year or two in recommending many companies and that was my world for a period of time.

 

The Nifty 50 did not end. What ended was my career at Loeb, Rhodes because I was approached by a particular person who asked me if I wanted to start a hedge fund. I barely knew what a hedge fund was. I became educated and hedge fund at that time had an extraordinary attraction. The attraction was that someone in one's 20s without very much capital and very much business background, with a presumption to think that at 25 or 27 he could outsmart the market and could figure out market and stock moves better than people with far more experience and far more judgement perhaps could start a business.

 

Q: Steinhardt, Fine, Berkowitz was a result of that?

 

A: Steinhardt, Fine, Berkowitz was started in 1967 based on the sheer presumption that people with very little experience in the stock market can go into business. For most hedge funds that started in the 60s and the 70s, they did not last. It was difficult and a challenging thing. Most people were not comfortable with shorting stocks. Most hedge funds used the shorts more as cosmetics than as a real policy. I didn't, I shorted stocks. It fit my dual personality.

 

When it came to the early 70s and the time of the Nifty 50 bubble, I probably had more stocks, shares sold short and more of the most well held institutional favourites than anyone else. It was a scary, frightening, anti-establishment and difficult period.

 

Q: When you started your business, what were you looking to do? Were you looking to become rich in the business? What was your motivation?

 

A: The peculiar thing is I was never interested in becoming rich per se, I never thought about the money. What I was interested in was being successful and was interested in having the best performance of any money manager in America.

 

You might say if you have the best performance of any money manager in America, you are going to make a lot of money. That is true. It was secondary though, I didn't think about the money. If I made no money and I had the best performance in America, it would have been enough because that is where pleasure was.

 

In a peculiar sense, and this is really a psychological phenomenon I got more pleasure from making money on the short side in a down market than I did from making money on the long side in an upmarket. Can you figure out why? Because everybody else was losing money and the market was going down. Very few people had the courage to short.

 

So, money management can be viewed in a very airy, philosophic way and it can be viewed in a very psychological down and dirty sort of way. It depends on how you think about these things. Performance is all I care about. Performance - daily, weekly, monthly, yearly and I was never smart enough to separate my performance from myself. So, if I did badly; if I had a bad week or a bad month or in one case a bad year - it really just tore me apart.

 

Q: By the time you started your own firm, you started developing a philosophy and started with a top-down approach to markets?

 

A: When I started, the three of us who started together had analytic backgrounds. Due to that, we started with a bottoms-up approach to markets. We were all analysts and all had stocks.

 

Q: You were looking at individual stocks rather than the macro view?

A: Yes, individual stocks. Before too long, it became clear that all of us doing that did not entirely make sense. So, I shifted away from individual stocks mostly and became more of a trader and a top-down thinker, although I had no background in that. That was my first experience in being a trader and thinking about market direction, etc.

 

So, early into the firm's experience, I began to pay attention to what we called exposure. Each day, I would in a more and more refined way measure how our capital was exposed. It certainly did it by taking the total dollars on our long side and subtracting the total dollars on our short side and relating that to our capital.

 

It may not be a simple calculation because we could use leverage. So, if we had capital of USD 100, we might have had a USD 110 on the long side and USD 40 on the short side for an exposure of USD 70. That is the sort of thing I did and I guided the ship in terms of asset allocation.

 

Q: You were still young in your career. How do you go against the established wisdom and have the courage of that conviction?

 

A: It was very trying and difficult psychically because you were really going against all the brokerage house reports, institutional wisdom and all the philosophy of the day. That was very different than it is today.

 

At that point, people wrote 20 group reports that extended out for 20 years and they talked about per share earnings of some of these Nifty 50 companies, assuming that they will continue these superior rates of growth for periods as long as 20 years.

 

Q: But you knew better?

 

A: It did not make sense to me. That was the philosophy of the day and the philosophy was growth. If you could find a growth company for a baby blue chip company that was just beginning to have a superior competitive position, it did not matter so much.

 

Q: The price you paid?

 

A: Exactly. You could pay a fancy multiple because the earnings would bail you out and that was the philosophy of the day. But if you have an earnings disappointment, what happens then?

 

And I tried to find companies that would have earnings disappointment because you in a certain sense get the double whammy of the disappointing earnings and the multiple collapse, and that is what we tried to do. Our timing was not perfect but it was okay.

 

So, we had the single best performance of anybody in 1973 and 1974, and then we turned in 1975 and got bullish early. I was really helped by one of my then newer partners, a fellow named Tony Cilluffo, who seemed at that time to have a direct line to the God I don't believe in. He was great.