'In good times, operate aggressively, but do nothing too risky or arrogant'
Below is a client letter co-authored by Jefferies Chairman and CEO Richard Handler and President Brian Friedman from the July 2014 issue of Jefferies Insights, the firm's quarterly client newsletter - a publication intended to share Jefferies’ perspectives, ideas and insights on the markets.
'To Our Clients:
Let’s Not Dwell, But Let’s Not Forget
It is summer time again, an always personally enjoyable season, yet an often volatile time in the financial markets. We also think it is a good time for a bit of reflection. We continue to put some much appreciated distance from the epic financial crisis that first erupted in 2007, and then overwhelmed the markets and the world in 2008 and 2009. Miraculously, the world today is awash with liquidity, stock market indices are at all-time highs, bond yields remain at all-time lows, volatility is astoundingly subdued, unemployment is approaching pre-crisis levels, and productivity appears to be on the upswing.
However, let’s not completely forget the summer of 2007, which was truly the beginning of the great global de-leveraging and the financial contagion that left virtually nobody and no company unscathed. We do not think it is necessary to remind anyone of the specifics of what happened. We all either experienced losses ourselves or knew someone we cared for whose life was permanently changed. We are talking about the loss of companies, jobs, life savings, personal health and personal relationships. We also sadly lost a bit of innocence when we realized our unshakable belief in our economic system and fundamental way of life was in fact very shakable and far from guaranteed to exist forever.
The purpose of this note is not to sound the alarm that now that we are back to record levels, we should brace ourselves for an imminent crisis. In fact, there are many fundamentals in the world today that we find better underpin the valuations that are now prevalent, relative to the false sense of security many of us felt before the summer of 2007. That said, we do think it is a good time to reflect on three of the factors that we can control and thereby help ourselves avoid the slippery slope of the next real problem: Leverage, Style Drift and Culture.
Leverage can be an amazing tool. While it does an incredible job of amplifying the good, it does not know its master and is equally capable of magnifying the bad. In a world that is starved for yield, it is easy to get lulled into a false sense of purpose that your investors, whether they be shareholders or retirement accounts, can only be satisfied by returns comparable with those achieved in earlier periods, albeit very different times. When the ten-year U.S. Treasury offers a "riskless" return of only 2.69%, it may take a lot of leverage to generate real returns in fixed income. What we are suggesting is that we all may want to have our eyes wide open regarding the risk that is clearly starting to make its way back into our system.
After a few years of relative stability, it is also easier to begin to have “style drift,” whether one is managing a company or a pool of investments. We each tend to have our respective areas of expertise and most of those are highly competitive and not without endless challenge. Outside our respective specialties, the world is a very competitive place and nothing new is ever easy or safe. Clearly, diversification strategies and growing out of your comfort zone are important to create long term value.
That said, a lot of our collective problems occurred when some of us strayed too far from what we knew, relied on people we thought we knew, or just let our guard down and “went for it,” hoping for the best (and hope is not a strategy). We all know when our walls of common sense begin to erode. We each need smart partners around us who are not afraid to speak their mind and who are willing to help us restack the common sense walls on a continual basis.
Our final point is probably the one that is most important for not falling back into some of the bad behaviors that can lead one to be especially vulnerable during a crisis: Culture. A good culture keeps a company transparent, non-bureaucratic, focused on its clients and people, and honest. A good culture is devoid of arrogance that can easily seep in and do damage everywhere it touches. A good culture allows you to minimize (ideally zero tolerance) bad actors in your company. People who take short cuts, are political, prioritize themselves above others, take excessive risks for personal gain, don’t value capital, or are unethical are outright cancers. These types of people will not only flourish in the next crisis, but most probably they will cause it. A good culture enables you to surround yourself with the smartest of partners. The right culture will make sure even the most junior person in the organization is empowered to tell you there might be something you are missing, and that person will not fear retribution if they are wrong (or right!).
We do not want to dwell on the painful years of the worst crisis we have experienced in our business careers. We are pretty sure you do not want to either. We do want to keep first and foremost in our minds the things that we can do internally to make sure we are best positioned for the next (inevitable) market dislocation. There is a very simple rule we try our best to live by: In good times, operate aggressively, but do nothing too risky or arrogant. That way, in bad times, you can take advantage of the more plentiful opportunities. None of this is easy, but if we keep reminding ourselves of the challenges, realities, threats and opportunities, perhaps we can sustain the growth that is inherent in our system.
Enjoy your summer with your friends and family,
Rich and Brian'