Is There A Goldman Sachs' Curse? Quantitative Finance And Newton's Third Law.

S&P has been in a stupor for years. That stupor contributed to quite a mess. Now, as they awaken from the stupor, it appears they will continue to contribute to the mess. This time by actually doing what they should have been doing in the first place to keep this mess from happening. Today S&P downgraded Goldman Sachs and Lehman's credit outlook to negative.

Wasn't it just a few months ago when Goldman was the poster child for skirting this crisis? On the cover of magazines and cover articles on leading financial sites for their brilliance? And, what have we been saying in numerous posts? Not!

I wrote in early 2007 that Goldman Sachs was a great proxy for this cycle. An out take from that post -- 'If ever there was a proxy for this bull market, it would be Goldman Sachs. Basically anything to do with a liquidity induced economic rebound is in Goldman's portfolio of capabilities. Goldman is a money making machine. Commodity trading; mergers & acquisitions; private equity; services to hedge funds, trading groups and mutual funds, etc. Buying into Goldman's stock gives someone access to all of the assets and sectors that are booming this cycle. Goldman's stock itself is almost the perfect asset allocation model for this cycle.'

If you didn't read that post, I would encourage you to click on the text above and read it for the historical economic events and eery Goldman parallels. I obviously don't believe there is a curse per se but there is a history of doom associated with peaks in Goldman's perceived brilliance. From the outside looking in, Goldman Sachs appears to be a special company. One where creativity and individuality are encouraged. Where new ideas and innovation are embraced. There is alot of brainpower within the walls of the company. And? The world is littered with failures associated with brilliant people and brilliant talent. It's the same fallacy the Google supporters are so quick to point out. Before that it was Microsoft. Before that it was IBM.

Goldman management seems to have forgotten the basic concept of entropy. Or maybe their leadership didn't take science classes. Maybe they should have before they hired all of those science majors to create Frankenstein finance. Entropy tells us randomness is always increasing. Therefore markets simply cannot be tamed. Applying significant leverage to this truth is completely invalid. It will lead to ultimate failure. Always. No matter how many smart people a company hires. No matter how great the company is. Financial leverage is a scourge of Wall Street. It may work for years but ultimately the fundamentals will not support their assumptions. Outliers will develop. That is where we are today. We've had leverage for decades. And, that in itself may be manageable under many situations. The problem is when the underlying fundamentals inharmoniously merge with leverage to create a storm.

Here's what I find most interesting about the prognosticators this cycle. Each time we hear of a new problem everyone scurries to do research on what the actual product is and what the impact will be. And, if this means it is now time to back up the truck and buy stocks hand over fist. CDOs, CLOs, SIVs, SPVs, BFDs, auction-rate securities, mark-to-market accounting, other derivatives or what not. I have a new one for you. It's the most important one. It's called 'IDM'. IT DOESN'T MATTER. I don't understand any of these products any better than the people who came up with the ideas for them in the first place. Yet, I have been able to write about the coming train wreck well in advance of it happening. Wall Street still doesn't get it. Their industry is peaking and as we have said they are in a bubble. When that bubble pops, so will their industry. And, so will the employment and business models within that industry. As we have said many on Wall Street will assimilate back into society to become productive assets as employees, new companies, new entrepreneurs, maybe new industries, drivers of new capital formation and the like. Now, it's time to put the economy back together again. But, not yet. Not until all of the elitists recognize what a mess they've made. The majority of the population already understands in their own way.

Back to Goldman. Major cracks are showing in Goldman's stock. For many reasons I believe the May 2006 market top was the true economic top. Into early 2007 we saw a massive volume bubble that completed a blow off in the American equity markets. I'll share my thoughts behind that in another post some time soon. In any event, I expect Goldman's stock to go lower. Much lower. How low? Likely into the mid 80's before this bear market is over. Maybe significantly lower than that. We will just have to see how outcomes unfold.

It will be interesting to see the outcome of this cycle as it pertains to Goldman. Will it be similar to 1929 when they abandoned Goldman Sachs Trading Corporation and returned to their core business in order to survive and restore their reputation? Will their quantitative genius be exposed as faulty science as we have argued? Will Wall Street be forced to abandon much of their proprietary trading and quantitative methods of madness that have contributed to massive profits? And to a massive mess. Obviously, not because they want to but because the market will force them to. In a bout of significant irony, Wall Street is imploding because it achieved exactly what it wanted. The environment they sought to create with lack of transparency and oversight will ultimately lead to an outcome associated with Newton's Third Law: for every action, there is an equal but opposite reaction. In this case, the reaction to lack of oversight and transparency fought so hard to achieve will likely be self destruction.

This gives me a chance to put up one of my favorite commercials again. The Orwellian Apple ad from 1984. In the ad, Wall Street is the mind bending Thought Police on the screen, society is represented by the brainwashed drones in the audience and the economy is represented by the woman throwing the hammer. The grand Orwellian experiment is over. The Age of Enlightenment begins.