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There is a downside to all this recent upside in the market, I’m afraid: The performance pushers are crawling back out of the woodwork, armed with dazzling numbers and whispering of magic.
Despite the choppiness in the stock market over the past week, large cap stocks are still up more than 50% since the market bottom in March, and small stocks have gained north of 70%. That means a money manager who made some well-timed, risky bets earlier in the year could easily be sporting year-to-date investment performance approaching triple digits. Sales reps fairly fall all over themselves when they come across managers that have those kinds of gaudy gains, knowing they can attract droves of assets by just selling the numbers.
Recently, one of my clients forwarded me an email from a broker who was doing just that. He claimed to have found a new money manager who had generated huge returns this year by:
“…focusing on short-term returns from stocks in beaten down sectors by buying the top 8-10 stocks in the sector when a signal is given, then managing the risk by exiting the position in 4 days if not profitable but holding for as long as 5 days if profitable. The year-to-date return is 70%.”
I love the part about holding for four days if not profitable and as long as five days if profitable. I guess the 24-hour interim is the manager’s idea of “The Long Term.”
I also couldn’t help but notice this “advisor” is a Certified Financial Planner. I wonder what his financial plans looks like for his clients if five days is the long side of his holding period? If you put that kind of trading activity into your financial planning software it would have about the same effect as putting a fork in a wall socket.
It’s been so long since we had a run of big gains in the market – second quarter ’09 was the first positive quarter in two years – that it’s easy to forget the tactics that the performance hawkers use when times are good. It’s always about the numbers, and it’s always a trap. Remember that these are the same folks who were shilling dot.com stocks a decade ago.
The bottom line is that it’s definitely caveat emptor time in the market again…
This summer I joined the cool crowd and purchased an iPhone. (My daughter Georgia says this doesn’t automatically gain me admittance to the cool crowd, but I guess it’s a start. It’s got to be cooler than my old bag phone.)
Anyway, the iPhone came with an app (FYI, this is what cool people say when they mean “application,” becoz we R busy and don’t have time for 4 syllables) that tracks the performance of the major stock indices. At the bottom of the screen are links to a variety of news stories related to the market and finance, and after a few weeks I began to notice a curious thing about the headlines I was seeing.
Most of the stories were links to generic, market-related articles from well-regarded news sources such as Reuters, Associated Press, etc. But sandwiched in between, I kept seeing headlines scroll by that were both dire and sensationalistic:
Are We On The Verge of Another Black Monday?
Welcome to History’s Biggest Sucker Rally
Why the Dow Won’t Close Over 10,000
(Ha-ha on that last one, BTW.)
These links always went to obscure web sites that I didn’t recognize. Initially I assumed they were just opinion pieces written by news sites I wasn’t familiar with, and I didn’t pay any attention to them. But one day curiosity got the better of me and I followed the link to the story about how the market was about to take a 90% swan dive. And as soon as I started reading I felt like “History’s Biggest Sucker” myself, because three paragraphs into this “article” about how Armageddon was upon us there was the pitch:
“At my XYZ Fund Timing Newsletter we correctly called the 2008 market crash. Subscribe for just $149 a year and learn how to protect yourself from the even bigger crash to come!”
It wasn’t an article at all – it was an infomercial for a market-timing newsletter. It never ceases to amaze me that people fork over good money for these things, because of the gaping hole in the logic: If the guy knows what the market is going to do and knows how to profit from it, he should be able to make a couple billion dollars just by flipping stocks, right? So why does he need your measly $149?
I assume these are paid-placement links in the stock-market app, but I really don’t know. Maybe the people who compile the links are just gullible enough to think these web sites are legitimate news sources instead of charlatans in journalists clothing. Whatever the case, it was sandwiched right in there with all the legitimate market news of the day from the mainline media.
That is the problem for investors today: In the cyberworld the lines between real media and faux media are fuzzier than a Congressman’s expense report. At traditional media outlets you have editors who double as gatekeepers, but there are no editors on the Internet – only compilers, aggregators and advertisers.
Investors have never had access to more information than they do today, and they have never been more on their own to sleuth out the real news from the faux news. And that is a very precarious situation, because one of the great ironies of successful investing is that too much information is often a bad thing, because investors become overwhelmed and can’t sort out fact from fiction. Real articles from fake advertorials. So they fall victim to the one guy who claims he absolutely knows what to do and where to be. Alas, that is the absolute last guy you want to listen to.
And that’s the way it is in today’s world of mixed media. We miss you, Walter Cronkite.
Some times, I must confess, I worry that I will run out of things to proselytize about.
What if retail fund companies suddenly find a conscience and start actually lowering fund fees? I ask myself, wringing my hands.
What if all those active managers who get paid high fees to beat the market actually start beating the market?
What will I do if I have no more windmills to tilt at? No more demagogues to, um, debunk?
And then I open the paper, and I realize everything is going to be okay because, in fact, I’ll never run out of material. Thanks, Wall Street!
Yesterday was one such day, because two different articles crossed my desk within an hour of each other that were so serendipitous – from a writing perspective – that I fairly chortled (i.e., chuckled and ortled simultaneously) at the timing.
First to come to my attention was the latest “SPIVA” report from Standard & Poor’s comparing the performance of actively managed mutual funds to their market benchmarks (click here to see it). According to the report, 72% of large cap U.S. stock funds failed to beat the S&P 500 for the five-year period ending 2008. Seventy-two percent!
Ah, but what about the other segments, like midcap and small cap and international and emerging markets? It is in these less-efficient areas of the market, the active managers tell us, that they really add their value!
Which, according to the SPIVA report, is true – if, by “value”, you mean “charged even more to perform even worse”:
Fund Category Percentage of Funds That Underperformed Index
Midcap 79%
Small Cap 85%
International 84%
Emerging Markets 90%
Given that the fees for the average actively managed stock fund run about seven times those of the typical S&P 500 index fund, one has to wonder what, exactly, one is paying up for? It apparently wasn’t to avoid the worst bear market in a century, because the vast majority of funds actually made things worse for their investors than the market. Perhaps it was for their managers’ nice suits. (This is what we call a “segue”.)
Those suits (see?) sure must be expensive, because the very next article I read an hour later was from an investment industry trade publication that said – and I am not making this up – that fund expense ratios are expected to go up this year. Up!
It’s all very simple, a fund industry spokesman in the article opined. It costs money to run a fund, so when assets decline, the expense ratio goes up.
This is where Mr. Fund Industry Spokesman wants you to take off your thinking cap and go back to watching American Idol. But I would like you to keep it on for a second and ask yourself this:
What is it about actively managed funds that make them so much more expensive to operate than index funds?
Right – the fund manager and his research staff. MBA’s one and all, each with MBA-like salary requirements.
These are, of course, the very same folks who are underperforming those index funds in markets both good and bad. And then, when you hit one of those bad markets – just when you want those active managers to really help you out – their expense ratios go up, which makes your performance even worse!
Kind of reminds me of the fraternity initiation scene in “Animal House”:
“Thank you Wall Street! May I have another!”
Yet another article I ran across in the financial press yesterday contained lots of quotes from investment types warning us that this is yet another “head fake rally” (there goes another cliché, by the way) for stocks on our way back down to new market lows that are JUST ABOUT TO BEGIN ANY MINUTE NOW! Never mind that this is the same crowd that was telling us this four weeks ago, when the market was 20% lower than it is today.
Now, far be it from me to predict short-term market movements. That is one of the fundamental keys to investment success – realizing no one knows where the market is heading in the short term. I don’t know any more than you do about whether we are in a true bull market or a, um, fake bull market, nor does anyone else. So when people go on record with emphatic statements about what the market is going to do in the weeks and months ahead, I think it is only fair to examine their motivations.
For example, one of the naysayers in the article was a money manager who presently has 100% of his clients’ assets in bonds. I don’t know about you, but I would not exactly consider him to be the Voice of Objectivity right now about the stock market, because if we are indeed in a new bull market, then he is, to put it succinctly, up poo creek without a paddle. Imagine the market gains another 20% in the weeks ahead, and he’s still sitting there with an all-bond portfolio. Is he going to get in the market then, and tell his clients not to worry about the 40% gain in the market he missed out on? Not to mention the fact that if inflation starts building as many expect, his all-bond portfolio is going to get clobbered.
So if you ask that man right now his thoughts about the stock market, he is going to look you in the eye and tell you with complete conviction that you would have to be a fool to be in stocks, because he desperately wants to believe it. Otherwise he will soon be out of a job.
I would imagine his bedtime prayer goes something like this:
“OhpleaseohpleaseohpleaseohPUHLEEEEZ don’t let the stock market keep going up! PLEASE! If you make it go back down I PROMISE I’ll get back in! I PROMISE!”
Such is the fate of those who try to predict the short-term direction of the market – amateur or professional. You end up consigned to hope, conjecture and prayer about things that are beyond all of our control.
Far better to bet on the long term success story that is the stock market and leave the guesswork to those who have backed themselves into such a corner that guessing is all they can do.
An article in today’s Wall Street Journal entitled “More Investors Say Bye-Bye to Buy-and-Hold“ gives us a glimpse into the mindset of many individual investors in today’s market environment.
It is not a pretty sight.
The history of the stock market is, of course, an inexorable upward climb punctuated by temporary downturns. Sometimes those downturns are protracted, deep and scary, and those are the especially dangerous times.
These deep declines are so dangerous for one very specific reason: They lead investors to believe that the temporary downturn is, in fact, permanent. They lead them to believe it is “different this time.” And they open the door for all manner of charlatans and carnival barkers to convince them to deviate from the straight path and begin speculating on things that seem inevitable but always prove wrong.
The WSJ article is full of quotes attesting to this fact:
• ”I just got tired of putting money away and losing it.”
• ”The long-term market gains that we’ve had in the past will not occur until that reverts and we get back free enterprise.”
• ”Nobody can time the market 100% correctly 100% of the time. However, that doesn’t mean you can’t get lucky now and then.”
Consider those quotes, and now consider the following chart:
It is no coincidence that individual investors – and these are stock-fund investors, for pete’s sake – end up trailing the returns even of cash investments over the long-term. When times get tough, individuals convince themselves that it is different this time, or the political administration is going to destroy us all, or that they just need to “take control” over their assets and start trading more. And they end up turning paper losses into real losses, and then they manage to miss out on the ensuing recovery.
This is how the market separates out the real investors from the pretenders. As J.P. Morgan famously observed a century ago:
“In bear markets, stocks return to their rightful owners.”
“With 2009’s first quarter ending at the closing bell, traders said
Tuesday’s gains have been driven largely by money managers
engaging in “window dressing,” or selling losers and
purchasing strong performers so that those
names show up on clients’ quarterly statements.”
~ “Stocks Rise As Quarter Ends”
Wall Street Journal online edition, March 31, 2009
Welcome to the Bizarro World of active management, where it is not so important what you did, as it is how you look. (Which, of course, makes me think of Billy Crystal’s classic takeoff on Fernando Lamas: “It is better to look good than to feel good!”)
Active managers – those who charge their clients high fees on the premise that they can beat the market – soon learn what more than 90% of their peers learn: They can’t actually beat the market. Doh!
So, since their performance isn’t going to cut it, many active managers decide at the end of the quarter to go on a “window dressing” spree, in which they ditch their losing stock picks and add some of the market’s high flyers from recent weeks to their composite portfolios so that maybe they will at least look like they’re just about to start beating the market. Such is active management, a never ending triumph of hope over experience.
Alas, there is a loser in this that the manager seems to be forgetting about: The client. The person who is paying them high fees in hopes that they can pick the winners – here’s the important part – in advance. Buying them after the fact doesn’t do them any good, Mr. Manager! It’s like paying someone to give you yesterday’s winning lottery ticket.
Oh, to be a fly on the wall that glorious day when one of our window-dressing managers gets confronted by a savvy client:
CLIENT: “So I see you added Google and Cisco to my portfolio.”
MANAGER: “Yes, indeed! Great companies, both!”
CLIENT: “So how come they showed up the last day of the quarter?”
MANAGER: “Oh, well, we wanted to get them in the portfolios!”
CLIENT: “Why now?”
MANAGER: “Um, because they have done so well?”
CLIENT: “Not for me they didn’t. And what did you sell to raise the cash to buy these with?”
MANAGER: “Oh. Uh, Citigroup and General Motors.”
CLIENT: “Great companies, both?”
MANAGER: “Uh, not so much anymore. That’s why we sold them!”
CLIENT: “And need I point out you sold them at a 90% loss?”
MANAGER: “No need – I already knew that!”
CLIENT: “And now they aren’t on your books any more, but these high flyers like Google and Cisco suddenly are. So you get to claim that you ‘picked them’ and act like you were there on the front end for your future prospects, only you were piling on at the end. And in the meantime, I’ve experienced all the downside and none of the upside, plus you generated pointless transaction costs for me.”
MANAGER: “That about sums it up!”
CLIENT: “How much am I paying you again?”
Alas, that conversation will likely never happen because window dressing goes on quietly, behind the curtain, where most clients don’t notice it. And so this uber-expensive interior decorating goes on and on.
Only instead of new drapes, the only thing the client gets is lousy performance and a higher tax bill at year end.
