Sorry!! The article you are trying to read is not available now.
Thank you very much;
you're only a step away from
downloading your reports.

'Distance' From Stocks, Focus on Negative Headlines Led Advisors to Miss the Rally


By outsourcing the investment process to ETF and mutual funds, your advisor may have missed bargains.

Hundreds of billions of client dollars have been pulled from domestic equity mutual funds since the Dow Jones Industrial Average (INDEXDJX:.DJI) bottomed in March 2009, meaning thousands of Wall Street's clients have not participated in the equity market's rebound. Many of them are only now being encouraged by their accountants and financial advisors to put money back into the stock market, as the DJIA hits all-time highs. How does this happen?

One example might be the shifting trends in the advisor-client relationship. In a recent article in Financial Planning, John Bowen notes that financial advisors have largely shifted their focus from investing, towards client relationship building. In 2001, 86% of his clients surveyed said they spent more time "maximizing investment returns" than on client relationships. A decade later that has flipped, with almost 90% of advisors spending less time on investing, and more time on client relationships. A better client relationship means a "stickier" client relationship, one that will be around longer, and make the advisor more money. It is wise from an advisor's revenue standpoint, but I'll point out how this shift in priorities can be damaging for the client.

As advisors outsource the investing portion of their daily work to ETFs and actively-managed mutual funds, they put further "distance" between the advisor and the actual stocks that are owned on the client's behalf in outsourced mutual funds or ETFs. Advisors that outsource the investment portion of their business spend little time reading annual reports, speaking to company managements, and other research efforts critical to evaluating stocks on a company-specific basis, and especially critical to knowing which companies are well-managed enough to own and buy during periods of economic stress. In times of market turmoil like spring 2009, the advisor doesn't know the underlying securities well enough to make a decision to buy or sell – he relies on frightening headlines such as the unemployment rate, worries about Fed actions, and Congressional gridlock, rather than noticing that the companies he owns are selling at "generational low" prices, to quote Doug Kass at the time. This "distance" between the advisor and the actual stocks that create wealth for the client is a major problem, and one that the client ought to be aware of. An advisor outsources the stock-picking process because either (a) he is not very good at it, or (b) he wants more time to go after new clients. Neither scenario is beneficial to you, the client.

Missed the Rally? Blame the Fed.

Opinions abound for the move in the DJIA to all-time highs. ES Browning wrote in the Wall Street Journal:

More than any other time in history, this bull market owes its strength to the Fed.

Or for a more "colorful" take, here's a quote from Jonathan Trugman's piece in the New York Post titled "A bull(sh#t) market":

Truth is, the stock market is setting new highs daily, extending what is now the sixth-largest bull market move since the Great Depression, only because of master matador Ben Bernanke.

I won't disagree that Bernanke has made it a goal of his to boost the stock market, though that is a goal that is not specifically part of his duties as Fed Chief. What I'll point out though, is that the DJIA's gain since March 2009 has more to do with the profitability of the underlying stocks than it does with Bernanke activities such as asset purchases and the fed funds rate. The reason I point out the difference between a Fed-driven rally and an earnings-driven rally, is that the former is a favorite excuse of financial professionals who have not done their job in the past four years, and are responsible for inexcusable pain for their clients. A favorite excuse of theirs is that the markets separated from reality when the Fed got involved with quantitative easing, so all bets were off! A perfect example is David Rosenberg, who commented in Barron's on March 6:

Based on our analysis, the Fed's repeated actions since QE1 have been responsible for roughly 300-500 points of expansion (not trivial) in the [Standard & Poor's] 500 index...

I wonder where that math accounts for S&P 500 (INDEXSP:.INX) component Apple's (NASDAQ:AAPL) 456% rise in share price over this period, and the of hundreds of other stocks that rose not because the Fed is buying bonds, but because they sold more product.

IBM (NYSE:IBM), currently 11% of the DJIA, is a clear example of the earnings-driven growth in the stock market. The shares changed hands at 77.76 on March 9, 2009, roughly 8.4 times the 2009 estimated EPS guidance of $9.40 it had announced a couple weeks prior. It also had several dollars in cash per share, net of which the company had an earnings and Free Cash Flow Yield of over 11%. Today, it expects EPS of $16.77 in the current year, an increase of 82% from the 8.92 per share earned in 2008. And while a frightened market valued the shares at 9x those 2009 estimates, IBM investors breathe a bit easier these days and value upcoming earnings at 12 times, also not an expensive number. So how exactly is that a Fed-driven rally in IBM, which is up 166% since March 9, simply from earnings growth and a slightly richer PE multiple? The lazy-bear answer to that is that the Fed actions have increased stocks' PE multiples, but from what – the panic-induced lows of early 2009? The Fed should not be blamed for a four-point PE multiple expansion off of decade lows, coming out of a recession

Market bears also blame the Fed because they cannot wrap their heads around the rallying stock market in the face of still-dismal economic headlines, such as 14.3% unemployment at the more comprehensive U-6 level. Entire job categories have changed dramatically – how many mortgage brokers do you know now, versus the number in 2007? Income inequality is worse than ever, and the current post-recession expansion is the slowest recovery on record. Bad news is everywhere, but the stock market has hit new highs. I point this out because you didn't have to ignore awful news in order to do well in the market the past few years. If you were absolutely petrified that undercapitalized US banks would see their common stock wiped out, fine! You could do great from 2009-2013 without owning a single financial stock.

Finally, some market professionals stayed bearish during entire rally because they relied on the flawed Shiller PE ratio to determine the market's attractiveness. I explained in March 2010 why this faulty metric made the market appear more expensive than it was, and people still use it today to the detriment of their portfolios. The Shiller PE is based on a 10-year average of a company's earnings per share, rather than a single current-year number. Using this metric is supposed to correct for peak and trough earnings that might cause one to buy a company at peak, unsustainable earnings. Apple and IBM prove this metric to be nearly useless, with 10-year average EPS numbers 75% and 50% below what they will actually earn this year:

My intention is not to insult other advisors, but rather to point out some serious and lazy errors that market professionals are making with other people's hard-earned money. Outsourcing the investment process to mutual fund teams might make sense on paper – they are exclusively focused on stock-picking and research, rather than handling tax, estate, account-opening, and other details that advisors must deal with daily. But this outsourcing of the process runs into trouble in times of severe stress, and led many advisors to remain underinvested or sell at the bottom, because they did not know enough about the underlying equities they owned for their clients. I hope the owners of this capital – clients – take a critical look at how their funds have been invested on their behalf over the past four years, especially if they have underperformed to a large degree.

Also see: 12 Cognitive Biases That Endanger Investors
< Previous
  • 1
Next >
No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Featured Videos