Jeff Saut: Performance Pressure Weighing on Wall Street
Is this the beginning of a decent correction?
Editor's Note: The following article was written by Raymond James Chief Investment Strategist Jeff Saut. It has been reproduced with permission for the benefit of the Minyanville community.
According to Acorn Fund's founder, and portfolio manager, Ralph Wanger:
"Zebras have the same problem as institutional portfolio managers. First, both seek profits. For portfolio managers, above average performance; for zebras, fresh grass. Secondly, both dislike risk. Portfolio managers can get fired; zebras can get eaten by lions. Third, both move in herds. They look alike, think alike and stick close together.
"If you are a zebra, and live in a herd, the key decision you have to make is where to stand in relation to the rest of the herd. When you think that conditions are safe, the outside of the herd is the best, for there the grass is fresh, while the middle see only grass which is half-eaten or trampled down. The aggressive zebras, on the outside of the herd, eat much better. On the other hand – or other hoof – there comes a time when lions approach. The outside zebras end up as lion lunch, and the skinny zebras in the middle of the pack may eat less well but they are still alive."
We saw many "outside zebras" gorging themselves on stocks in late 2007 as the Dow Jones Industrial Average registered a new all-time high in October of that year (at 14164). Those outside zebras ended up as "lion lunch" when the senior index shed an eye-popping 53% over the ensuing 17 months. By then, many of those outside zebras had moved to the inside of the herd just in time to miss the March 2009 bottom (at 6627).
Since those lows, more and more zebras have ventured back toward the "outside" of the herd driven by performance pressures. I've repeatedly commented that given the immense amount of cash still on the sidelines, as the equity markets continue to rally the performance pressure, subsequent bonus pressures and ultimately job pressure, become just too great, causing portfolio managers to "pay up" for stocks. And that, ladies and gentlemen, is why the corrections have been short and shallow since the anticipated March "lows." As the sagacious Jeremy Grantham writes:
"In markets, where investors hand over their money to professionals, the major inefficiency becomes career risk. Everyone's ultimate job description becomes 'keep your job.' Career risk-reduction takes precedence over maximizing the client's (portfolio) return. Efficient career-risk management means never being wrong on your own; so herding, perhaps for different reasons, also characterizes professional investing. Herding produces momentum in prices, pushing them further away from their fair value as people buy because others are buying."
Clearly, this "performance pressure" is currently playing on the "street of dreams" as the DJIA tagged another new reaction "high" last Wednesday at 9918. Since then, however, it has surrendered roughly 277 points, causing one market maven to ask, "What sparked the late week wilt; and, is this finally the beginning of a decent correction?"
Speaking to the first question, my guess is the "stock sag" was sparked by last Wednesday's FOMC policy statement. As my firm's economist, Dr. Scott Brown, wrote: "As many had speculated, the FOMC also decided to slow the pace of its purchases of agency debt and mortgage-backed securities, tapering them off by the end of 1Q10. This is meant to provide a smooth transition in the markets (similar to the exit plan for the plan to purchase long-term Treasury securities)."
To me, that statement isn't particularly pleasant reading. And then there was this from Fed Governor Kevin Warsh: "And our policy judgments will ultimately prove worthy of the accolades, and tender the ultimate rejoinder to our critics, if we rise to meet this heightened responsibility. I am confident we will. . . . That outcome will require that policy makers have equal parts capability, clairvoyance and courage – perhaps the most important of which is courage."
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