Taking Stock / The Oracle From Brouhaha

Israel's portfolio managers can't stop the music. Almost every day, hundreds of new customers barge into their offices brandishing checkbooks.

What are the customers telling the portfolio managers? That they want to make money too, obviously. "We see the market rising day after day, that stocks do in a week what our deposits do in a year, and want to make money without undertaking too much risk," they say.

What are the portfolio managers advising the hordes pounding on their doors? Only they know. Most probably do their duty and remind them that stocks are a risky business. But we may assume that most of the conversation is devoted to etching the usual market myths into customer's consciousness.

If you've forgotten the myths, you got a reminder Wednesday from investments manager Shmuel Frenkel's interview in Ma'ariv. He estimated that the current wave of gains on the Tel Aviv Stock Exchange would persist for two or three years, and called on the people to leap into the frothing waters. What prescience.

Frenkel:"All the economic data justify the market's strength... I would like to remind people that in 1993, the economy was posting record growth. Suddenly in 1994, the stock market crashed and nobody realized that the market was presaging a recession."

This is a common myth that purports to prove the stock market's function as economic barometer. Ostensibly, the horrible 1994 crash had presaged the recession that arrived immediately afterward. Since everybody estimates that 2004 will be a year of economic rally, the barometer ostensibly justifies entering the market now.

We beg to offer a different reality. Even though the market collapsed in February 1994, the two years that followed were among the best the Israeli economy had ever known. The 1994 crash had nothing to do with any economic downturn. It was caused by the preceding financial bubble, which was caused by low interest rates and the banks' penchant for aggressively lending customers money to invest in the banks' own mutual funds. It was also caused by all those junky IPOs by companies that have mostly disappeared since.

When touting "low interest" or "absence of alternatives," remember that low interest is sometimes a recipe for a financial bubble.

Frenkel: "That's the way it is. When people get practically zero interest on deposits, they see they have to go to the capital market."

That's a key myth in portfolio management, but it also tends to conflict with reality. History teaches that when interest rates are very low, stocks become very expensive. The best timing would be to buy stocks when interest rates are in the sky and are likely to fall. Anybody who thinks Israeli interest rates have room to fall further may want to get into the market. Anybody who figures they don't, might prefer to err on the side of caution.

Frenkel: "The market is fundamentally different today than it was 10 years ago."

A lot of people say that. Sure it is; it has evolved, matured, become more sophisticated and has also grown together with the economy and the access to international markets. But if our memory serves us, 10 years ago Shmuel Frenkel and his cronies were telling us, right before the market crashed, that it had changed and was very different from the early 1980s.

Maybe the market changed, but people haven't.

Frenkel: "Over time, customers discovered that stocks are the best investment for them. People sticking with good stocks such as Teva Pharmaceuticals, over the years, earned a great deal of money, even after hard times of drops on the market."

Define "over time." For instance, if you were "sticking," as Frenkel put it, to stocks over the last 10 years, you took a terrific chance because of the terrible fluctuations, and at the end of the day, you got maybe 3-4 percent a year. Shekel deposits would have offered much the same at far less risk.

Investors entering the market in a boom will find it takes a great deal of time to get their investment back, with reward compensating them for the risk, if they get it at all. That long-term theory works for investors who really do come in for the long-term, not who join in the boom and flee in the bust.

As for Teva, Frenkel knows perfectly well that it is the exception that proves the rule. There is only one Teva. Most of the market consists of companies like Koor, Clal, Elron Electronic Industries, Industrial Building Corp., Israel Discount Bank, The Israel Corp., Supersol and Bank Leumi, companies that generated roughly zero or negative real yields over the last decade.

Frenkel, on himself: "I believe in long-term investment, like in Teva. But why talk about too long a term? We're looking ahead, and we know we're witnessing the start of a period of growth. What will happen in two or three years' time? If we see, heaven forbid, a change for the worse, we can always reduce our exposure to shares."

Yup, that's the biggest baddest myth in the industry of managing other people's money: We, the experts, know what will happen 2-3 years down the line, thanks to our clever models. We will lead you into the market at the right time, and if we see things deteriorate, we'll lead you out right on time.

But Frenkel, a seasoned war-horse, knows that nobody really knows when to get in or leave. If he knew when to get in and out, then the "flexible" mutual fund he runs, Epsilon Gmisha, wouldn't have generated a pitiful 22 percent yield in 2003, a year in which the stock market rose 50 percent.

Of course Frenkel's forecast for 2004 might come true; it might prove to be a great year for stocks. But by the same token, it could disappoint. The Americans have laid out a safety net for Israel's deficits, but they can't protect us from a downturn on Wall Street.

It might be better for Frenkel & Friends to tell their customers the simple truth that investors on Wall Street and on the TASE learned time and again in the last decade: stocks are an excellent investment for people prepared to take big risks, or for people who really do get in for the long run.