“Let Wall Street have a nightmare and the whole country has to help get them back in bed again.” – Will Rogers.
Congratulations to Goldman Sachs for a particularly (un)timely call on Marks & Spencer. The brightest firm on Wall Street (this construction is known in English as an oxymoron), having had the stock as a "Buy" recommendation all the way down from 745p, finally pulled the plug last week at 235p. All things being equal, we can now expect a counter-analytical bounce.
Wall Street’s finest sprint into action – Marks & Spencer share price, 2007-2008
Not to be outdone, rival Investec also snapped into action, and with the stock trading at around 230p also cut its “opinion” from "Buy" to "Hold." Thanks, guys. From the industry that sold you subprime rubbish: subprime research! Market timing is admittedly difficult, but this is ridiculous. (There are more examples of facile Wall Street capitulation here.)
But it shouldn‟t come as too much of a surprise. City “research” has never been uniformly recognised as worth anything other than something to keep the mentally disadvantaged off the streets, just as economics, as J.K. Galbraith once noted, is extremely useful as a form of employment for economists.
For another object lesson in the perils of market timing, I am endebted to Jonathan Escott of TD Global Finance. Having enjoyed a 15-year streak of outperformance versus the S&P 500 Index, Legg Mason's Bill Miller has not only fallen from grace, but his Legg Mason Value Trust fund has now eroded all the gains it has made versus the Index since 1987:
Legg Mason Value Trust vs S&P 500, 1987 to 2008
This prompts at least three suspicions:
- Every Icarus gets his wings clipped eventually;
- Those investors who piled in on the back of Mr Miller‟s well-reported 15 year outperformance will no doubt be ruing their battering at the hands of market timing;
- Fund groups compensated on the basis of growth in assets under management as opposed to value delivered (i.e. more or less all of them) are acutely vulnerable to their own success.
On this last point, one is reminded of the fate of Fidelity's once gargantuan Magellan fund, which peaked out in August 2000 with a value of over $100 billion (!).
Dan Gross of Slate Magazine wrote about the hurdles facing any very large fund in 2005, when the then manager of Magellan, Robert Stansky, resigned:
When you have to buy as much as they do, it's difficult to open and close positions quietly. Hedge funds and other quick-fire traders are constantly trying to suss out which stocks the big dogs are buying and selling and how they can profit by jumping in and out ahead of them. And unless you want to buy hundreds upon hundreds of positions – in which case you're essentially mimicking the broader market – a huge mutual-fund manager has to confine himself to huge stocks. Magellan has 207 positions, and its top 10 holdings are the same giant stocks that everybody owns.
As we said at the time, beyond certain levels, size is an insurmountable barrier to ongoing investment success. (Buy the products of entrepreneurial boutiques.) This facet of the business will continue to haunt the major players in both traditional assets and hedge funds and funds of hedge funds for years (those that survive this bear market, that is).
Now that all asset markets are facing more challenging times, it makes sense to revisit some comments made by Yale endowment CIO David Swensen, in an op-ed piece for the New York Times, again in 2005:
Unfortunately, the track record of individual investors with plain-vanilla mutual funds fails to inspire confidence. Actively managed mutual funds overwhelmingly fail to beat the market. In a well-structured study published in 2000, an investment manager, Robert Arnott, showed that over a two-decade period, excessive management fees and frantic portfolio trading reduce the chance that a mutual fund investor will beat the market to less than one in seven.
Most mutual funds do not produce even minimally acceptable results because of the conflict between the mutual fund company‟s profit motive and the mutual fund manager‟s fiduciary responsibility. Mutual fund companies profit by gathering assets, charging high fees and churning portfolios. Mutual fund managers produce superior investment returns by limiting assets, assessing low fees and trading infrequently. In case after case, profits trump returns. The mutual fund manager abrogates fiduciary responsibility for personal gain.
Not that every fund manager is a greedy incompetent, just most of them. But in such an acutely difficult market environment, if you have to own third party funds, you will probably do significantly better not by buying the biggest, but by thinking small.
The key challenge today is not in accessing the market: plenty of low cost ETFs will enable you to do that at a stroke, with the likelihood of superior performance compared to the average asset manager. The critical challenge now lies in asset allocation, and particularly in moving money away from those areas where it is most vulnerable. The severity and universality of the bear market in stocks can be seen in the following chart, which shows the widescale losses, by sector, incurred within the UK's FTSE All-Share Index since the start of the year.
Note that outside oil equipment services, industrial engineers, miners and industrial metals, not one sector is showing positive returns. The bear has been everywhere. The biggest losers, year-to-date, have not even been the banks: retailers have taken over as the businesses most prone to falling off the ugly tree and hitting every branch on the way down, as Marks and Spencer discovered to its own cost last Wednesday:
Index Group performance for the FTSE All-Share, 2008 to date
So what now ?
- Reconsider one's commitment to the equity market. Particularly, move money away from the more obvious danger zones. Expecting a bounce is all well and good, but so is wishful thinking. The game has changed.
- Cash was never trash, but now it is king.
- Reconsider one's commitment to bonds, particularly government bonds. UK government finances are poorly positioned for tax cuts in the face of this recession. As and when policy rates are poised to move substantially lower (during real economic emergency), it may be time to return to the government bond markets, but inflationary headwinds are too strong for the moment. And GBP increasingly looks like an accident waiting to happen.
- If one has little or no exposure to genuinely high quality "absolute return" vehicles, now might be a good time to start building it.
- The world is calling time on venal banks, and on increasingly worthless paper assets, including currencies. There is a time-honoured safe haven with a 2000+ year history of preserving wealth in real terms. It is called gold.