How to Make Money Investing in Stock by Arbitraging Wall Street’s Misunderstanding of Public Policy
I’d like to introduce a theme to be developed in future posts: that knowledgeable investors can profit by making investment decisions that benefit from Wall Street’s shortcomings in understanding government policy. The increased role of government in business makes Wall Street nervous. This is partially ideological: many businesspeople and financiers just don’t want the interference and limitations that government participation in the marketplace brings. But some of it is fear of the unfamiliar. The government’s interests are different that the interests of ordinary market participants.
If you think about it, the potential for asset values to be underestimated or overestimated because of Wall Street’s cumulative knowledge gap is enormous. Think about all the political factors driving government policy that can affect the value of an investment. Political ambitions in upcoming elections, international military and political events, and just doing the right thing—making choices that (politicians think) help people and the nation. The list is endless.
Now think about the professional and academic background of the financial community. The standard academic entrée to finance is the Master of Business Administration (MBA), a degree focusing on just that. That’s not to say that the better MBA programs don’t address the interface between public policy and business, but that’s hardly enough to say that the MBA focuses on understanding government. Take also the curriculum for become a Chartered Financial Analyst (CFA). While the CFA curriculum requires a significant understanding of economics, including the effects of government regulation, it doesn’t require any particular study of the reasons behind government policy.1
That’s not to criticize either the MBA degree or the CFA charter. They properly reflect knowledge in the fields used in their names. No doubt many MBA’s and CFA’s have a range of knowledge far beyond their degrees and certifications that they apply to better serve their employers and clients. And concededly the better investment houses make an effort to bring in people familiar with the Washington environment to advise on the government‑business interface; i.e. not just to aid in lobbying efforts to advance their own interests but to integrate political factors into their investment advice. But my contention is that in the final analysis, the degree of rigor that goes into the analysis of political factors affecting market prices is often far less than the analysis of pure business factors like balance sheets, management competence, market position, and product quality.
A story from my own investment experience illustrates the point. Back in 2000, I was considering making an investment in the Lockheed Martin Corporation, a major defense contractor. Lockheed was, at that time, moving forward with a controversial takeover of Comsat, and there were real business reasons to be concerned about whether the combination would work. But underlying public policy assumptions were contributing to the pessimistic outlook. I can still remember reading a stock report from a major rating organization that cited the reduced probability of military conflict due to improvements in international relations as counting against Lockheed because of reduced demand for arms. While the analyst’s review of the management challenges facing Lockheed made sense, this sweeping and seemingly indefinite assumption about the continuation of peace in international affairs had no credibility in my eyes, and that was the moment I decided to purchase Lockheed stock. I purchased the stock in two batches at an average of $17.44 a share. After the events of September 11, 2001 proved the analyst’s political/military assumptions to be tragically wrong, the stock—which had already exceeded expectations since had I purchased it—soared. I eventually sold the shares in 2007 at $96.79 a share.
So keep your eyes open for opportunities when the analysts inject political assumptions into their recommendations—and the market accepts them—but you know better.
(Note: The author does not hold a securities position in the Lockheed Martin Corporation as of the original publication date of this post.)
- See the Topical Outline published by the CFA Institute at http://www.cfainstitute.org/cfaprog/courseofstudy/topic.html. [↩]
