Wall St. And Business Wednesdays: Book Review, The Mind Of Wall Street
It was an unusual feeling to be sure, to learn that the author of the book that I had just begun had died. Already impressed with what I was reading, my attention to the rest of the book, The Mind Of Wall St., was heightened when I learned in April that the principal human being responsible for writing it, Leon Levy, was no longer among us. As I re-read a the obituary of Leon Levy, I can not help but think over the verse in the book of Hebrews (9:16-17) that reads, "For where a testament is, there must also of necessity be the death of the testator. For a testament is of force after men are dead: otherwise it is of no strength at all while the testator liveth." Every story that I have come across regarding Oppenheimer Mutual Funds (which Mr. Levy founded) since his death, seems to have greater context than it normally would. While The Mind Of Wall Street is not an exhaustive biography of its author; it certainly is a testament to, and of, his market genius.
The Mind Of Wall Street is an extraordinary book in its ability to use plain words to tell a complex story. That accomplishment alone is a testament to not only the co-author, Eugene Linden, but the manner in which Leon Levy looked at the world. In sum, the book is an account of how Wall St. (its nature, process, individuals and institutions) works, according to the cumulative lifetime perspective of one man, told through the power of personal anecdotes. The Mind Of Wall Street is not a how-to book but rather a how-does book making plain just how Wall St. works, for better and worse.
Written with a healthy skepticism for dogma and theoreticians Leon Levy is at his best in the book, playing the role of critic, calling into question the thinking and most popular of Wall St. traditions, theories, and practices. This ability, dripping with wit, is most vividly on display when the author takes on such sacred cows as 1) the theory of efficient markets (He writes: "For an astute investor, the worst situation is an "efficient market," in which all information is known and understood by all players and in which prices accurately reflect that information. Not to worry - none of us will ever see that. Instead, the factors that create opportunity are emotions such as fear, which can drive prices far below fair value, and changes that create unknowns, which can flummox those players trying to outfox the market. In the latter case, investors have a great ally in government, whose attempts to legislate fairness or improve the workings of the markets almost always create opportunities and special situations for investors....Typically, analysts evaluating the future prospects of a company look at its past. Where else can they look, after all? And yet, even if they had a perfect snapshot of the past, they would be mistaken to assume that the conditions that held in the past will hold in the present or future. Perhaps this is why the more recent notion of a perfect market - an "efficient market" - in which current prices reflect all available information, is so seductive. A perfect market assumes that prices reflect all prior research at that point. Those who believe in an efficient market, and I am not one of them, believe that stocks can never be underpriced or markets overvalued. They say you can't beat an efficient market - all you need to do is put your money into an index fund. The problem is that all the stocks may be reasonably priced compared to one another, but the whole market may be too high or too low. The market may not be efficient, but over time it is pretty efficient, especially at grinding down the egos of those who succumb to the temptation of seeing profits as certification of their own genius. In an uncertain world, governed by probabilities rather than rules, the only constant may be that the more time that passes, the more probable it becomes that you will at some point encounter an improbable event") and 2) the theory of the rational investor (Levy states: "Most people are extremely uncomfortable when investing in unconventional ways. Although economic theorists offer an idealized image of investors as rational beings who calmly assess opportunities, the typical investor I've met is idiosyncratic, superstitious, and, perhaps most important, prey to fears of the unknown. In short, he or she likes company. But the unconventional is what often creates opportunity. Investing probably is not played best as a group sport.") and 3) the notion that stocks outperform all other investments over time ("The mid-1970s were not a productive time for the markets, which stagnated between 1964 and 1982; the Dow closed at 874 in 1964 and at 875 in 1981, racking up a magnificent gain of one point in seven-teen years. Anybody who began investing in the 1990s, and had the expectation that stocks regularly outperform all other investments, should spend a moment pondering those two numbers and two dates. For example, say you were forty-eight years old in 1964 and put $100,000 into the Dow on the last day of 1964 with instructions that dividends be reinvested, confident that you would have a nice nest egg when you retired at age sixty-five. When the last day of 1981 rolled around, your money would be worth statistically less than your initial investment because of the moribund market and the depredations of inflation.")
The author displays excellence and humility in using analogies and instructive examples to describe how the stock market functions, crediting others as the source of creative insights. He recounts the thinking of one of his employees who used professional sports to help him think about market activity, "He viewed the market as a football game in which there were only 22 players on the field and 80,000 in the stands. Although only the players on the field were moving, everyone had a stake in what they did. Moreover, the action on the field affected the mood in the stands, and the mood in the stands affected the action on the field." In similar fashion Mr. Levy recalls the thinking of a former customer and analyst about a "metaphysical" investor custom on Wall St., "He was one of the first analysts I knew to realize that certain numbers have a mystique in the stock market. Once a stock rises above $10 a share, he argued, it had a better chance to continue rising than if it remained below $10. This principle has nothing to do with the number, of course, but everything to do with psychology. Prices above $10 seem to reassure investors about the stability of the stock and the solidity of the company. Many institutions have rules prohibiting them from buying stocks below $10, the premise being that stocks selling below $10 are highly speculative. We know today that the price of the stock has nothing to do with the fundamental business or its risk, but somehow in the minds of investors, $10 was chosen as the arbitrary figure for stability."
An especially illuminating analogy, provided by the author, that any inner-city resident could relate to is an interesting comparison between how the purchase of an undervalued railroad company (Milwaukee Road) in particular, and stock market investing, in general, relates to the process of gentrification. Leon Levy explains:
Management executives looked to the past in their assessment of the railroad. They saw its wretched history of bankruptcy and losses, the thousands of miles of useless track, and the years of failed attempts at regulatory reform; from this they could only conclude that the Milwaukee Road was a failed railroad that could never be profitable. We looked at the same railroad and instead saw vast assets in real estate and machinery that could be sold. Where management saw endless regulation, rate restrictions, and union rules, we felt there was now the promise of change that would enable the railroad to prosper once again.
...This same clash of worldviews occurs during periods of gentrification. In slums and ghettos, residents associate the neighborhood with crime and privation and can't wait to leave. The architect or builder buying the brownstone sees a valuable, once proud building that can be had for a song. This buyer has no memory of the area's unhappiness and instead focuses on its glorious future. The same principle applies to every transaction on the stock exchange: The buyer is looking to the future; the seller often is burdened by knowledge of the stock's history.
It is Leon Levy's consistent attention to the psychology of Wall St. practitioners that makes The Mind Of Wall Street stand out among other works that advertise their explanatory powers regarding the world of high finance and stock market movements. For Levy, the subject is never theories, techniques and methods devoid of their origin or context in the mind of human beings. More than just an interesting topic of discussion, human psychology was not only a way of viewing the marketplace for Leon Levy, but also a way of doing business. Of his decision-making process when hiring employees he writes "I had the responsibility of assembling a research department and early on made the decision not to hire anyone who remembered the Depression. This move was cost-effective, since those who remembered the Depression tended to be older and more highly paid. But to some degree, this decision was driven by my feelings about the role of psychology in markets. I reasoned that memories of that devastating market would breed caution where we needed boldness."
Leon Levy's own thinking as an investor has been influenced by his own interests and personal studies which include archaeology and the history of taxation. In one section of the book Leon Levy deftly moves from an interesting historical tidbit about ancient Egypt's economy into an entrepreneurial and pragmatic argument against the flat tax.
Four of the book's concluding chapters are a tour de force with the author walking the reader through the principles and practices of investing as they relate to purchasing companies that sell at a discount to their business value; how mood and emotion are beyond the realm of the best mathematical probability models and arbitrage methods; how confidence and arrogance create good and bad markets; and how the concept and investment method of using derivatives as a form of market insurance requires an understanding of economics.
The Mind Of Wall Street is an easy read on a subject that is intimidating to most. While no investment experience is needed in order to understand the book; knowledge of a few financial terms will help with comprehension. As long as the reader is genuinely interested in understanding how U.S. financial markets work, all they need do is allow the author to take them by the hand, for a walk in and out of the minds of market practitioners. The Mind Of Wall Street demonstrates that Leon Levy's life story and world view is sufficient as a market primer for the novice, as well as continuing education for financial and economic professionals.
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Wednesday, June 25, 2003
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