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MMM-054: Henry Blodget Interview + Stop That Picking!

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Interview with Henry Blodget. Transcript below. Buy his book! Read his new blog http://www.investmentintelligencer.com/

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Complete transcript of my interview with Henry Blodget.

Henry Blodget is president of Cherry Hill Research, an Internet industry analysis and consulting firm. He is a frequent contributor to Slate, Newsweek International, New York magazine, and other publications, and an occasional guest on CNBC, CNN, MSNBC, and NPR. Henry writes and edits Internet Outsider, a business blog, which was recently voted one of the “Best of the Web” in a BusinessWeek reader poll. The Wall Street Self-Defense Manual is his first book.
A former top-ranked Wall Street analyst, Henry worked in corporate finance and equity research at Prudential Securities, Oppenheimer & Co., and Merrill Lynch. From 1999-2001, Henry was Managing Director and head of global Internet research at Merrill, where was voted the top Internet Analyst on Wall Street by Institutional Investor, Greenwich Associates, and other third-party organizations. After leaving Wall Street, Henry was a party to an industry-wide regulatory complaint about conflicts of interest between the research and banking divisions of brokerage firms. He participated in the global settlement of the complaint and is precluded from working in the securities industry.

Boyer: I was going to ask you, “What are you doing these days?” But I can tell that you are indeed busy with a number of web sites. You’ve got the InternetOutsider.com, which was recently voted “Best of the Web” in a Business Week reader poll. You’ve got WallStreetSelfDefenseManual.com and the book. And you’ve got a column at Slate called “Bad Advice” and you are President of Cherry Hill Research. So, are you doing anything else?

Blodget: Well first Paul, let me just say thank you for having me on the show. I think your site, from what I’ve read, is excellent. And it’s a pleasure to do this. So thank you. I think you listed that I’m working on a bunch of things. I’m also developing a new blog that I’ll be focused on investing. [InvestmentIntelligencer.com] The current one you mentioned, WallStreetSelfDefenseManual.com is definitely related to the book. Hopefully the new blog will allow me to talk about just different topics in investing in a lot more detail without relating it to the book.

Boyer: OK. I see, great. So what really keeps you busy during the days?

Blodget: Well everything that you listed. Blogging sounds like it is a very easy, quick thing you do between meetings and I think some people can do it that way. But certainly if you want to try to say something intelligent, or add value, it’s not something that you can just knock off very quickly. But obviously the writing does as does the research for the book. And I’m continuing to do that sort of research. And also with Cherry Hill Research do a fair amount of consulting for the Internet sector. So still a very full schedule.

Boyer: OK. In talking about the book, I have read it a couple of times now. And, you know I think it really has one of the clearest explanations of why passive investing is best. And it is written so that my parents, I think, can read it and understand what’s going on in investing. What motivated you to write this book?
Blodget: Well first, thanks. If it has done that then it’s definitely set out to do one of the things I was aiming for. Because I think the distinction between active and passive, and the distinction between trading and investing is something that even people who are very much experts in the business and I think its something that one really has to step back and understand the difference… We’ll talk about that a little bit. But I think it’s an easy distinction to miss but it’s absolutely critical that people understand it. Especially if they are to actually embrace the idea that passive investing is intelligent instead of just settling for mediocrity, which a lot of people who don’t what they’re talking about, think.

Certainly when I was on Wall Street I obviously saw the, not only the way people invest from the institutional side and so forth, but saw a huge amount of media on Wall Street… I was working on Wall Street in a time when the stock market became sort of a national pastime. And I watched the media cover that and I think what I was struck by was the gulf of understanding between Wall Street and the media and how the media often portrays what goes on in Wall Street to investors. I just wanted to simplify as much as I could, concepts that are pretty complex and ultimately have teams of academics doing incredibly detailed research on pieces of them. But just simplify the concepts so that people understood what Wall Street could do for you, which is some things, and what it definitely cannot do for you, and ultimately what to look out for. And hopefully the book does that.

Boyer: You’re certainly right in talking about those times. I remember going into restaurants and instead of having sports on TV they had CNBC on TV. And you would look and watch the stock charts go up and up and up. And talking about all the .COM stocks and so forth. Those were times we will never forget I’m sure.

Blodget: That’s right. And we’re getting right back into it now. Maybe the correction will remind people that the stock market doesn’t always go up.

Boyer: At that time, back in those times, were you an active investor?

Blodget: I wasn’t active in the sense that I was trading frequently. I’ve never been a particularly active trader because I don’t think it’s a smart way to invest. It certainly doesn’t fit my personality. But I was buying and holding [individual] stocks and I actually still have some stocks that I owned in that period. I own them as much for sentimental purposes as anything else. I’m not thinking I’m going to beat the market or what have you. To the extent that I was buying individual stocks, as opposed to just passive funds, I did do some active investing, yes.

Boyer: At that time, what did you think of passive investing and of index funds?

Blodget: I was certainly aware of the indexing movement and I was aware of John Bogle and others who had written about it intelligently. I didn’t realize until I left Wall Street and really took a look at the industry as a whole and the actual performance records of mutual funds versus passive funds… I didn’t realize it until then just how much the odds favor passive and just how dangerous active investing is to most people who pursue it. I had the sense that index funds were a smart way to go, but I didn’t realize how overwhelming the odds were that it was a smarter strategy for everybody. So that’s something that I came to by doing a lot of research after I left Wall Street.

Boyer: So that was the conversion process, that after leaving Wall Street is…

Blodget: I wouldn’t… it’s funny. A lot of people have said that this is a conversion. I think that the being an analyst on Wall Street and speaking primarily to active investors and then being an investor on the outside… I don’t think the two are necessarily mutually exclusive. You still have trillions of dollars and many, many mutual funds and other companies that are pursuing active management, whether or not that is the smartest strategy, and Wall Street exists in large part to serve that community. I would say it is just what I have had is a different perspective now that I’m off Wall Street and I look at the whole business from the perspective of the smartest way for an individual to invest. I just thinks that’s very different from the way the media portrays it or people off Wall Street normally think of as, quote, smart investing.

Boyer: Now if CNBC was a channel for individual investors that [told] the best possible message that they could get out, what would it look like?

Blodget: That’s a tough question. I think that one has to bear in mind that CNBC is a business. And ultimately CNBC will fail unless it makes smart business decisions. And it turns out that when one is trying to program a television based investing channel, the way to make the best business decisions is to focus on the market in a minute-by-minute basis and to have lots of prognostication and lots of opinions and lots of experts. CNBC does a superb job of that. It is very difficult not to watch, it is always interesting, I find.

But from the perspective of an individual who does not want to be a day trader and is trying to give themselves the best odds of the highest rate of return over the long haul, CNBC should probably be turned off. And what would it look like if it were actually catering to people and trying to encourage them to invest as intelligently as possible? Ultimately, it would talk a lots about the advantages of passive investing. It would use a lot of the academic research that has been done. It would be far less personality-driven. It would be far less focused on what the market is doing. But in CNBC’s defense, all of that would be a death knell for CNBC as a television channel. Everyone there would be fired. The company would probably go out of business. So it is no mystery why CNBC is focused on what it is. And again, if one is trading actively or works on Wall Street, it’s great entertainment and often very informative and interesting.

Boyer: Thus, the reason why the Mad Money Machine podcast does not have a million subscribers!

Blodget: [laughs] Probably the case. Harder to make a living in the media on passive investing, that’s for sure.

Boyer: Why doesn’t your book have an index?

Blodget: Index… meaning… just a list of topics at the end?

Boyer: Right.

Blodget: You know, I don’t even know. I didn’t even think about it. I figured the notes would be enough.

Boyer: I wanted to look up “Cramer” for example and see if he was mentioned in the book…

Blodget: He is not in it.

Boyer: Yeah, I can see that. You know, having said there’s no index, I did go into Amazon and “Search Inside the Book.” It acts as my index in that sense.

Blodget: Oh, that’s good.

Boyer: Yeah. Did a search for “Cramer” and you’re right, he’s not in there. Why not?

Blodget: I think that I’ve obviously had some exchanges indirectly with Jim since writing the book. I wrote a couple of columns about the whole Mad Money show and what Jim’s doing now and so forth on Slate since then. But in the book I was very much just interested in concepts and using those concepts as a way… taking some examples as a way of illustrating those concepts. I tried not to focus on specific individuals or what have you.

Boyer: OK. I think it makes sense for your book to live a good, long time on the shelves to not get caught up in too many fads. And one might argue that certain TV shows that are on TV now might be fads. And we can go through that cycle.

So, I wish you had written these columns a year and a half ago when I was becoming obsessed with Mad Money, not that I would have listened. But for anyone who hasn’t really read the articles yet out at Slate.com, here’s an open ended question: “What do you really think about Jim Cramer?”

Blodget: I think Jim is an amazing entertainer. I’ve always been impressed with the breadth of his knowledge, the ability to talk about almost any topic market-related under the sun. He’s phenomenally impressive in that way. As I argued in the Slate article, anyone who thinks that the overall strategy and the advice that he gives is “intelligent investing,” for an individual, is likely to be incredibly disappointed. When you step back and you look at the performance of professionals who do this all day long and nothing but and yet you still have at least 4 out of 5 of them underperforming an unmanaged index, and then you take the next step which is that an individual who is watching the TV show in the evening and gathering some stock picks or stock advice from that and then going out and doing a little bit of research on the side is at an extreme disadvantage to hedge funds and mutual funds and other professionals. And there are tens of thousands of them who do this 24 hours a day, 365 days a year. One of the strongest messages that I would have for any individual is just, you have to do everything possible not to fall for this idea that with an E*Trade account and a Yahoo! Finance page and a little bit of CNBC, that you are actually making choices that are informed relative to the professionals that you are competing against. If the idea is that Jim is going to help give you an edge that you can then use to beat the professionals who do this all day long, I think that is a huge recipe for disappointment.

Boyer: I loved that chapter in your book talking about who are we up against, “Who is Your Competition” and you talk about an analogy of sitting at the poker table and you might be the third best player at the poker table, but you’re still going to lose. Or talking about baseball players and you’re going up against professional athletes when you’re trying to go out and hit a home run. Even the professional athletes get strikes. I really like the analogies in the book in that sense.

Do you think Jim Cramer, after running a hedge fund and doing all this trading, trading, trading, for 14 years, in this mindset of picking stocks, looking at companies, trying to trade and speculate on what’s hot today… Do you think he’s even aware of the works of Markowitz, Fama, French and these other great academics and either chooses to ignore them or genuinely believes they are wrong, or do you think that because he is obsessed with how companies and stocks perform, he’s really just unaware of them because he’s never had the need to absorb their ideas of the efficient frontier.

Blodget: I don’t know the answer to that. I should probably talk generally just because I don’t know what Jim Cramer knows and what he doesn’t about the academic research and whether he’s really stepped back. Generally, and I get this question a lot, “What do people on Wall Street think about indexing?” And what do they think about the academic work and so forth. The general attitude is that academics don’t get it. And/or that, “Yes, we understand that a minority of investors beat the market. And we are that minority!” Everybody tends to be overconfident. There have been a lot of studies showing that 80 percent of people think that they are above average in driving. And 80 percent of kids in a class think they are going to finish in the top half of the class. People tend to be overconfident. This is an area of investing where it is extremely easy to be overconfident. Primarily because when you decide to buy or sell a stock, you have a fifty-fifty chance of being correct. Those odds tend to fuel people’s sense that they really have insight. People don’t generally tend to step back and say, “I had fifty-fifty odds” when in fact in a bull market I had much better odds than that. So how much did I make versus how much would I have made if I had done nothing. The answer is that most people on Wall Street, it’s just not in their interest to step back and study the academic work. That’s not what they are paid to do. Ultimately, they can always default — I’m sure Jim Cramer can always default — to the idea that he is just telling people how it works. This is a trading show. It’s not an investing show. Certainly there is a defense for that. The distinction that the average viewer should draw is that he is talking about trading and speculating which is a negative sum game. If you do that, the expectation is that you will lose. Versus investing, which is a positive sum game. If you invest and hold for the long haul the expectation is that you will win. That is a distinction that a lot of people miss.

Boyer: Now I have read in some of your blogs and even in your book that you have said the stock market as a whole is currently overvalued. And I read this before last Tuesday’s 416-point decline on the DOW. So, are you once again a prophet? How do you consider the stock market overvalued?

Blodget: That’s a good question. I think that the only method of valuing the stock market as a whole that stands up to rigorous analytical scrutiny is what is referred to as a cyclically-adjusted price-to-earnings ratio. That is where an analyst is not simply taking the current year’s earnings and taking the current market price and looking at that ratio, but is actually looking at the current year earnings in the context of the business cycle. In other words, today we have record high profit margins. And if you just take a straight PE of the S&P 500 for example, it looks like it’s about average for the century. But the reason it’s average, in my opinion, is that the earnings are so incredibly strong right now. If you actually go back to normalized earnings, say you take the middle of the range that earnings tend to migrate around, then the stock market looks extremely expensive. It has been that way for years. Making investment decisions and changing your investment strategy relative to what you think the market is going to do on a near-term basis is not intelligent because it is so hard to predict it. I do think that… and this is where I have not completely jumped into the passive camp, I do think that it makes sense to adjust your target asset allocations slightly based on whether the asset class that you’re looking at is particularly expensive or particularly cheap. I have not gotten to the point where I have found a lot of work that can really demonstrate that that is the most intelligent way to go. But I think, certainly looking at a couple of centuries of asset class performance it makes sense to say that we are still, at this date, trending around particular means. When you get way above a particular mean, there’s probably more risk and less upside than normal.

Boyer: Well I’ll take the bait then and ask you which particular asset classes now are overvalued or undervalued?

Blodget: Well unfortunately [laughs] that’s an extremely depressing question because basically what happened in the last five to ten years is that just about every financial asset class has gotten bid up well beyond its historical mean. Certainly there are many people who think that it’s different this time, that the old averages don’t apply, that we’re in a new world where the S&P average PE multiple is going to be, say, 20 as opposed to the 15 or 16 times that we’ve always had. That is always possible. It’s one of the hazards of ever trying to invest based on valuation. I tend to think that it is yet another example of people assuming that it is different because it has been a particular way for so long. But the bad news is unfortunately that most equities and most bonds are very historically expensive at this point. Not so much that one shouldn’t have any money invested in them. At most what we are talking about is a small tweak of the asset allocation. The only asset class that is not overpriced, that is very easy to invest in right now, is cash. Cash is a very depressing thing to have to invest in. I wouldn’t think that somebody who had an above normal cash allocation was being stupid, let’s put it that way.

Boyer: What’s next for you?

Blodget: I want to continue to try to do what I’ve done in the book and what I’m doing a little bit in the blogs. I hope to do more coming up in the Slate articles. Basically, act as an intermediary between Wall Street, the academic community, and individual investors. Given my experience on Wall Street, and now several years of getting deeply acquainted with the academic research, combined with the journalism that I’ve done, I feel like where I can help to bridge and help to educate people is by really sitting in the middle and trying to take some of the concepts that have been studied and proven in academia and make them very accessible to individuals. Similarly, on Wall Street, my hope is that you will see more and more active managers over time really start to focus on the fact that what drives investment performance over the long haul is reduction of costs and reduction of expenses and less and less effort and money devoted to trying to beat the market and more and more devoted to things like the value effect and the small stock effect and others that have been shown to drive most of the market beating returns over time. My hope is that there is a way to synthesize that and make it as interesting as it really is to people. And ultimately it would be nice to actually make it interesting from a television perspective as well. One of the things that a lot of people don’t realize when you talk about indexing is that there are violent wars about the best way to construct an index fund, what is an index and what isn’t, and what is the difference between as S&P index fund versus a Dimensional Fund Advisors passive fund that’s more of an actively managed index fund. These are intensely interesting controversies. There probably is, I hope, a way to make them accessible and interesting to average individual investors as well.

Boyer: Well, what about a podcast?

Blodget: [laughs] You mean on Mad Money Machine? Anytime! [laughs]

Boyer: In fact I would love that, if you could come on my show and have a segment every show. But what about [doing] your own podcast?

Blodget: It’s an interesting idea. I think that’s certainly one of the things I’ll consider with the blog I’m working on now, which is getting close. It should be in a week or two I should be able to actually start publishing on there.

Boyer: Well since we can’t pick stocks, who do you like for American Idol this year?

Blodget: [laughs] I have made every effort, after wasting countless hours with a couple of members of my household who very much enjoy the show, I’ve made every effort… in past year’s I’ve wasted a lot of time… so I’ve made every effort to stay away from it this year. But I gather that somebody already has it locked up. At least that’s what I read in the papers.

Boyer: Oh really? [laughs]

Blodget: I think there’s a Jennifer Hudson-like person who has been tipped to sweep it.

Boyer: OK. Well I hope you’re talking about Melinda Doolittle. She’s the one I wanted from the very beginning.

Blodget: I don’t know, but could be.