Big Broker - asset allocation011409

“Few people are capable of expressing with equanimity opinions which differ from the prejudices of their social environment.”
-Albert Einstein

Groupthink is not good, particularly when it becomes your culture. If you are not allowed to challenge the received wisdom of your bosses, and you are a financial services firm living in The New Reality, you are going to have a serious problem. Yesterday while I was taking Q&A on a panel at the AQR conference in New York City, I couldn’t shake these thoughts out of my head.

While I was on yesterday’s panel, Barry Hurewitz, whose title is “COO of Investment Research” at Morgan Stanley, made a statement, then asked me a question. Sorry Barry – you’re getting You Tubed. I will paraphrase his statement because it was a bit long winded, but Barry proclaimed the mystery of his “clients” faith in saying “what our clients really want from our analysts is insights – you know, like the conversations.”

Herein lies THE difference between the horse and buggy whip brokerage model that is going away and my vision of the future. Having been a Morgan Stanley prime brokerage client, I think THE client has always expected “insights”, but what they really want today is for your research calls to be right. That’s it Barry – make the call, put a time stamp on it and a price – and be accountable. If the accuracy rates of your compromised and conflicted “calls” are too low to show the world, then I guess the only thing to conclude is that clients want you to talk to your analysts on the phone and have you set up conference meetings for them.

The pundit patrol is going to be all over the manic media today with their view of Barry’s firm merging its brokerage unit with Smith Barney. Now it’s going to be called “Morgan Stanley Smith Barney” and there is nothing that scares me more than Merrill’s “thundering herd” than a team of consensus that’s even larger! Instead of 16,000 Bank of Americans strong, the client gets a 20,000 man team of brokers selling “Investment Research” tied to a groupthink culture.  This is The New Reality – if you dont think THE client wants you to have a process and stand up every morning and make a call that’s grounded in that process, I’ll be standing on the other side of that Trade.

Suffice to say, the US stock market has weakened in the last week in the face of a hard earned “Crisis In Credibility” (see Early Look from 1/7/09). The US brokerage stocks don’t lie, people do. With 3-month LIBOR hitting a new low this morning at 1.09% and the TED Spread (3mth LIBOR minus 3mth Treasuries) as narrow as it has been in well over 3 months, many a supermarket brokerage house strategist is confusing last year’s liquidity crisis with the crisis in the credibility of their employer. We do not have anything in the area code of the liquidity crisis we had in October-November. What we have is a crisis in the structure of the US brokerage model – like Big Auto… Big Broker is creatively self destructing in painfully slow motion.

Brokerage businesses are still ran by starting with a revenue number and trying to understand the cost structure needed to support those revenues. These are compensation structures, not businesses that can stand the test of economic cycles. There are great talents at Morgan Stanley (I have hired 3 of their former horses). Today, this is how they attempt to compensate their best people: 1. with cash bonuses (begging the government for that cash if need be), 2. with options that have ultimately proved worthless, and 3. by promising their “smartest” group thinkers titles, like “COO of Investment Research”.

No one at Morgan Stanley is empowered to be a capitalist right here and now. As I said, they have some great people working there, but they are afraid. I guess that begs the question as to whether you can empower people with fear of economic insecurity.  Where I come from, that creates situations where colleagues start looking after themselves instead of the team. There are two T’s in Morgan Stanley Smith Barney. Neither of them stand for Team. Its sad.

So are Deutsche Bank’s numbers this morning  - they printed a loss of over $6 Billion and shook European equity markets to the core of the matter, the credibility crisis at hand. The #1 and #2 stories on Bloomberg this morning are about Deutsche and Citigroup. This isn’t a surprise – it’s just really all turning out to be what it is – sad.

It is sad to think that the people running these firms tell the client what they need them to want. Let me tell you what they don’t want: THE client doesn’t want you trading prop ahead of them; THE client doesn’t want an investment banking disclosure on your “Overweight” recommendation; and THE client doesn’t want you to lose their money. THE client simply wants to be put ahead of house’s revenue “expectation”, and for THE house to be right.

Both Asian and European stock markets are breaking down now, and they probably should. Their crisis in confidence has no clear path of resolution. In America, the SP500 has broken it’s 889 support line, and while hope is not an investment process, at least we have a catalyst of change in Obama.

The only change I can hope for in the brokerage model of accepted compromises past, is for it to go away in as orderly a fashion as Americans can tolerate. It’s time for change. It’s time for Big Government to manage Big Broker, and let American Capitalists rebuild THE client’s trust.

Best of luck out there today.

Big Broker - etfs011409