Current economic conditions and recent market action has everyone worried, and rightfully so. In the past few months, I have referenced interesting personal indicators such as the LJ indicator, which measures investor sentiment in La Jolla, California, The Target Rate Indicator, which shows relative Market action in relation to the Target Rate of the Fed since the inception of the Target Rate in 1997, and more importantly, The Investment Rate, which is a proprietary measure of consumer liquidity levels since 1900 through 2030.
I am personally glad that a bearish tone has overwhelmed the market. I think it is well deserved. Unfortunately, the people that are making the decision to sell at current levels are well behind the curve; where were they 6 months ago? More unfortunately, most people buy at the top and sell at the bottom. Avoid this!
This blog comments on this bearishness that I see in relation to a new indicator: I'll call this The Industry Indicator. I have countless contacts in the Financial Services industry, ranging from professional traders, to retail brokers, money managers, and hedge fund advisors; there seems to be a resounding theme in all major Financial Institutions. The theme: "Be cautious here, the Market may decline."
Major brokerage firms like Morgan Stanley (MS), Smith Barney, which is run by Citigroup (C), Merrill Lynch (MER), and the other big boys on the street develop the mindset of the financial advisors that work for them, who in turn advise their clients on their personal investment decisions. I was a retail broker for 9 years and I know that these big firms want their brokers to follow the leadership of the firm. In fact, independent thinking is discouraged. A great example: the unwritten law is that you can't short a stock that the firm has a strong buy rating on, nor can you buy a stock that the firm has a sell rating on. In January of 2000, by the way, these firms had strong buy ratings on almost all internet stocks and there was no such thing as a sell rating (hold was the worst you could get). In fact, many of them had strong buy ratings on each other a handful of months ago too.
Unfortunately, and Wall Street has learned this the hard way in the past handful of years, the firms making these leadership decisions have a top priority to make money for their shareholders first, and that conflicts with the decisions and guidance they provide to their registered advisors. These advisors are trained by the firm to depend on the insight f the firm, and that helps them guide the investment decisions of their clients. If the priority of the firm conflicts with the objective of the client, there's a big problem.
Six months ago, almost every major brokerage firm on the street was bullish with respect to equities. They were encouraging their clients to buy, at the top. The reason is simple: these brokerage firms make more money when people buy stocks aggressively, so regardless of timing, the mindset is to teach their Registered Investment Advisors to always encourage their clients to invest, because that keeps the commissions rolling.
Without a doubt, the goal of the retail brokerage offices of these firms is to help their advisors build businesses, and that means gathering assets and generating commissions to help increase the bottom line of the firm. Making money for the client is secondary. Brokers rarely tell their clients to sell, unless there's something else to buy; they're trained this way. Isn't there a conflict of interest there? What happens when the market turns bearish?
Let's be specific to what has happened over the past 6 months. Also, remember what happened in the internet debacle. Either most of these firms just don't get it, or they just don't care.
Most major brokerage firms missed the sell signals in the market six months ago, just like they did in early 2000. Why? Because they were making money hand over fist, and their shareholders were happy. Keep the clients invested, keep the money flowing, and don't mess with the model!
Have you ever heard your broker say, "if it goes down we'll buy more" or "the market always goes up over time so we should be buyers on dips" or "we'll move the money into a conservative fund to reduce risk"?
On the other hand, have you ever heard your broker say: "we should go to cash and wait, things look risky"? More importantly, if the answer is yes, do they suggest going to cash when the market is at a peak, or when the market has already declined significantly? If they are following the guide of the firm, they are always behind the curve. This time is just another great example.
Resoundingly, they tell you to sell, or get conservative when the market has already fallen. Today's market is a great case in point. Almost every major brokerage firm on the street is cautious. They are not bullish like they were 6 months ago, and they are advising their Registered Investment Advisors that declines are possible. Where were they 6 months ago? I know where I was. But now, my mindset has changed.
Forget the past, though; what about now?
This is where the Industry Indicator comes in. I can't find a bullish brokerage firm on the street. I am personally interested in what Goldman Sachs (GS) is doing with their in house investments, and I have a strong gut feeling.
Goldman Sachs has a different mantra. They want to be ahead of the curve and they guide their clients that way, too. Most other firms may take internal action. We saw proof of that with some Blodget emails from Merrill Lynch in the recent past, but their decisions to advise their Registered Advisors are significantly behind the curve. Why? Is it because the commissions wane when they tell their clients to move to cash?
Everyone is cautious, everyone is nervous, and every broker that I know is having a hard time telling his clients to buy anything now.
Could there be a better contrarian indicator?
Investment Strategies are simple: Buy when everyone is selling, and sell when everyone is buying. If you followed the Industry Indicator in 2000, you sold at the top, and bought when they put sell ratings on everything by late 2002. If you followed it again recently, you sold in the middle of 2007 when everyone was bullish and no one wanted to hear anything that suggested otherwise.
The next question pertains to the next leg of direction. Is it time to buy? Are the big boys bearish enough? Well, I can't find anyone that's bullish. I think that's a good sign.
With that in mind, make sure that you reference my prior posts on the Investment Rate, because that tells us to expect substantial declines over time; but the market never goes straight down, so my bullish stance is intended to take advantage of the oscillation back towards resistance, then we'll short again.
The next shorting opportunity might be best reserved for the reversal in the Industry Indicator: i.e: maybe we'll wait to short when the big boys start telling their advisors to buy aggressively again.