An Interview With Byron R. Wien

BYRON R. WIEN, CHIEF INVESTMENT STRATEGIST at Pequot Capital Management, a Westport, Conn., hedge-fund outfit with $5.5 billion under management, is a big-picture guy. He travels frequently and widely -- most recently to Brazil -- to gain first-hand insights into global markets. A lucid writer, Wien has a knack for distilling a lot of information into concise monthly notes to clients. He started his Wall Street career in 1965 as a securities analyst, then worked as a portfolio manager before becoming U.S. chief investment strategist at Morgan Stanley. He joined Pequot in late 2005. To probe his latest thoughts, Barron's recently spoke with him in his midtown Manhattan office.

Barron's: What's been the biggest surprise for you about the market and the economy so far this year?

Wien: How far things went both up and down. Commodity prices went much higher than I thought they would. I thought oil would go to $115 a barrel, for example.

I was a bull on oil. And I thought it would go down at the beginning of the year, which it did. Then I thought it would go up -- but to $115 -- and it went to nearly $150. All other commodities went to extremes, including corn. I was bullish on agricultural commodities, but their prices went up much further than I thought they would. I certainly didn't expect that Bear Stearns would fail. So the problems in finance turned out to be more severe than I had originally expected.

Anything else?

At the beginning of the year, every strategist thought large-capitalization stocks would outperform small-caps. That hasn't happened. We probably should have known it wasn't going to happen, just because everybody thought it would. The fundamental reason behind that prediction was that large-cap stocks had a higher percentage of foreign earnings. That turned out to be right, but large-capitalization companies just have a tough time being flexible.

Wouldn't you think that in this kind of market, investors would seek more dependable earnings growth?

Investors look for companies that do something new that's going to have a big impact. A big company does something new, and it just makes up for something that's going bad somewhere else.

How do you compare this market with others you've seen in your career?

This market is different because globalization has changed the nature of investing. When I started as a securities analyst, I was focused on U.S. equities alone, and I didn't know much about what was going on around the world, and I could do my job very well; today, you can't.

In 1965, the United States was the unquestioned economic, political and military leader of the world, a position it achieved in 1945 and maintained until 1980. But in 1980, Japan started to become a factor and Europe was back on its feet. I don't think, I or most other American investors, globalized enough. And then in 1990, after Communism failed and China became a factor and India entered the world economy, we didn't understand fully enough that these were not only potential customers of the United States -- but very real competitors.

As a global strategist, you spend a lot of time visiting other countries. What's caught your eye lately?

The biggest new thought I have related to my travels is that the United States and Europe are going to have a tough time showing real gross-domestic-product growth in excess of 3% in the next five years, maybe the next 10. That means that the market, which did so well from 1982 to 1999, may be slow in coming back.

In January, you wrote, "I worry that the problems in housing and credit are more significant and longer-lasting than the usual market-adjusting events." What raised those concerns?

An idea was evolving: that we didn't get into this mess in the usual way.

Usually when we are in a recession, the Fed eases and then we come out of the recession. Business gets good. Inflation picks up. The Fed tightens. And then we go back into recession. But this wasn't anything like that. Interest rates weren't high. Inflation wasn't a problem. We got into this because of an excess of credit, both in the financial system and in housing. There was too much leverage in the financial system, and housing had gotten out of control.

Is there a sign of a bottom in financials?

The leverage in the financial-service industry is going to be wound down a lot, and I don't think the return on equity for these companies is going to be as great as it has been in the past. So the earnings for these companies in the next up-cycle aren't going to be as good. Maybe the financials have gone down as far as they are going to go down, but I don't think they are going up with any verve.

And it sounds as if you see the business model changing for these firms, and becoming less profitable in the post-credit-crunch world.

When I came into this business in the mid-1960s, what a doctor made or what I made as a securities analyst or what a lawyer made working at a big firm was all the same. Five years out, our compensation had increased -- pretty much in parallel.

But in the period from 1982 to 1999, the compensation in financial services expanded much more rapidly than it did in any other field. I don't know that a securities analyst is a whole lot smarter than a lawyer at a major law firm, and I don't see why securities analysts or investment bankers should be paid so much more. So I think there's going to be a convergence of compensation.

One of the topics you've written about in your notes to clients is the possibility that stagflation, which combines inflation and stagnant growth, will rear its head again as it did in the mid-1970s. What's your assessment of that possibility?

I'm probably not as worried about it as I was in the beginning of the year. In other words, I understood the "stag" part of it better than I did the "flation" part of it. So I was more worried about inflation at the beginning of the year than I am now. I'm buying into the idea that maybe the slowdown around the world is going to take pressure off inflation. But I'm concerned that growth is going to be harder to come by.

What's your take on the U.S. recession?

We are in a recession, but there are two parts of it that you haven't seen yet.

The first part is an increase in unemployment, and the second is a collapse in consumer credit.

You've seen it in housing, which is a form of consumer credit, and in finance. But we are in a recession, and we are not going to come out of it until sometime next year at the earliest. The market will discount that by six to nine months. I have said that the market low on July 15 was a very significant low. I am not saying it won't be tested, but I don't think it will be severely penetrated.