I couldn’t believe what I was hearing. I nudged the fellow asset manager sitting next to me, “Did he really just say that?” “Yes,” she whispered and then shook her head slowly from side to side.
Last week, I made my annual pilgrimage down to the Inside ETF Conference in Hollywood, Florida. I love going—and not only for the midwinter chance of three days of warm weather. (It did not disappoint; it was sunny and in the high 70s.) I also enjoy learning about the newest ETF products and hearing views on the state of the markets and the financial-service industry from some of that industry’s leaders.
Onstage Monday morning were the two conference co-founders, Matt Hougan and Dave Nadig. They are both widely respected industry veterans, having written for and been in management at ETF.com, a great source of ETF investment information. I am a longtime fan of them both.
Dave Nadig recently became chief investment officer and director of research at ETF Trends, an ETF.com competitor, run and started by an old active management friend of mine, Tom Lydon. Dave was giving, as he does each year with Matt Hougan, his part of their joint “State of the ETF Union” message.
Dave is the researcher of the duo, and he matter-of-factly stated, “Investing is fundamentally a solved problem. We all know we should be in fairly boring, fairly static portfolios, and that’s probably the right thing.”
One solution for all investors?
I was stunned! Here we were at a conference representing an industry boasting of its 6,500 different ETFs. The mutual-fund industry similarly has about 9,600 funds. And the largest turnkey asset management program (TAMP) in my own industry tops over 9,000 strategy selections.
In total, that’s more than 26,000 possible investment strategy selections without even going into the arcane arena of hedge funds. Given the numbers, it doesn’t sound like a “solved problem.” Nor is it probable that there is only one possible solution for everyone—or even one solution for each type of financial environment.
I know the point Dave and Matt were trying to make. They are part of an industrywide push by the big funds, ETFs, and financial-service providers to get financial planners to focus their time on, as Matt put it, “other things” instead of investing.
They are all pushing a single solution for financial advisors: Instead of investment advice, planners should be providing what they call “real advice.” Matt mentioned taxes, insurance, bill payment, Social Security, college financial aid, and travel planning as the items that required “real advice” from financial advisors.
I can’t disagree that clients need advice on these subjects. However, based on discussions with thousands of advisors over the 39 years since I founded Flexible Plan, I also know that advisors want to be real resources for their clients and that what they like best about their practices is the interaction they have with their clients.
Yes, I can agree with all of that, but I don’t think that the actors pushing this grand solution have got it right when they minimize the advisor’s role in investing. While most do not have the time to actively implement investment solutions, they are normally the most knowledgeable resource on investing that their clients have. Therefore, advisors will continue to have a major role in helping clients choose investment answers.
There is no silver-bullet strategy for investing
I don’t believe in the solution to the “solved problem” that the big guys have for the advisors. As Matt and Dave made clear, their solution is for all investors to have a generically allocated, “fairly static” portfolio of low-cost index funds or ETFs. Since they believe that only the big players in the industry can provide these, there is no need for the financial advisor to spend any time on investment advice. “Just sell our products,” the providers advise financial advisors, “and spend your time on doing other things for your clients!”
Of course, those of us in the trenches know that investors, with good reason, don’t trust the big guys on Wall Street to solely look after their investments. Instead, investors trust financial advisors—those they know personally, who live close by, and who likely have dealt with the same problems that they have—to guide them and help them choose their investments.
In addition, most financial advisors have studied investments their whole professional life and have personally experienced the changeable nature of the financial markets. Some are even escapees from the very institutions that are now telling us all to rely upon them.
These advisors realize that there are at least three problems with the “fairly static portfolios” that most of these institutions are pushing on them:
- The modern portfolio theory on which they are based is out of date (created in the 1950s), and it never truly fit the real world.
- They follow an approach that has not worked in practice, failing to sufficiently manage risk in both the 2000–2002 crash and the financial collapse of 2007–2008.
- They ignore the behavioral realities inherent in most investors, principally their outsized fear of losses that will not allow them to follow the big players’ market orthodoxy and sit still when markets plummet with their life savings at stake.
I think one reason why many industry gurus may think that investing is a “solved problem” is that we have seen superb performances from two of the mainstay asset classes for many years. Stocks are in the middle of an 11-year rally. Bonds have topped even that, rallying for more than 30 years!
It is true that for any given asset class there is one strategy that can be declared a winner each year. But the top performer changes, not only within each asset class but also among all asset classes virtually every year.
These market professionals seem to forget that an investment in three-month Treasury bills held from 1969 to the end of 2008 would have topped an investment held in the S&P 500 over the same period. That’s based on a 40-year history.
Following the same analytical path as today’s financial gurus, I’m sure some investors at the time may have thought that this was solid evidence that investing was a “solved problem”—just invest in T-bills. Yet the place to be for the next 11 years would turn out to be U.S. stocks, while T-bills returned next to nothing.
And what about the “fairly static” allocation process the industry continually thrusts upon us? The actual experience of being in the market up until then caused one market pro to write the book “Buy and Hold is Dead.” And financial-advisor conferences at that time featured advisors wearing pins that said “Buy and Hold” with a line struck through the phrase. Investing was a “solved problem.” Forty years of market history said so!
What I have learned from 50 years of investing is that the financial markets are too variable to be considered a “solved problem” involving one solution that is and will be best for all time. There is no silver-bullet strategy for investing.
Is passive asset allocation the solution to the “investing problem”?
Passive asset allocation is “fairly boring, fairly static,” but it is not the “right thing” for everybody or for every market environment. It is just one strategy. And those of us who have invested for a long time know that “every strategy works until it doesn’t.”
I don’t believe that investing is a “solved problem.” And I don’t believe that the industry’s proffered “fairly static portfolio” is the “right thing” for all investors, all of the time. I think a portfolio that continuously searches through multiple asset classes and strategies to solve the problem is closer to the solution investors are looking for their advisors to deliver.
Dynamically risk-managed portfolios of actively managed strategies using a variety of asset classes are designed to do just that. Rather than relying on a single defense against bear markets (for example, the way “fairly static portfolios” rely on the single defense of diversification), dynamically risk-managed portfolios are designed to bring to bear many tools of modern finance.
Rather than creating “fairly static portfolios” of the same asset classes, my experience tells me that an approach that is responsive to the markets, that stays invested in the top-performing asset classes as they rotate in performance, and that uses many allocation strategies is a better solution.
There—problem solved (at least for the time being)!
The major stock market indexes finished down last week. The Dow Jones Industrial Average lost 2.5%, the S&P 500 Index fell 2.1%, the NASDAQ Composite fell 1.7%, and the Russell 2000 small-capitalization index lost 2.9%. The 10-year Treasury bond yield fell 17 basis points to 1.51%, sending bonds higher. Last week, spot gold closed higher again at $1,589.16, up $17.63 per ounce, or 1.1%.
Stocks tumbled on the news of the spread of the new coronavirus (named “2019-nCov”). Most of the decline occurred Friday (1/31), when 2% losses were common. All of this year’s gains on the Dow and S&P 500 were erased, while the NASDAQ held on to a 2% gain.
This week, however, stock prices rebounded from just above their 50-day moving average. As I write this on February 4, stocks are back above last Wednesday’s (1/29) close, just 0.96% below the record close for the S&P 500 hit only 11 trading days ago. Reported coronavirus infection levels and death rates have not been as high as projected so far, and we’re beginning to see survivors among those hospitalized.
In addition, you may recall that much of the concern about the economy has come from the very weak manufacturing data of the last few months. However, a number of the reports issued recently suggest that production may be turning around. Factory orders rose by 50% more than predicted, and the ISM Manufacturing PMI report rose above the 50 mark, indicating expansionary times in the manufacturing sector.
At the same time, the Fed decided last week to restate its position that it will not be raising rates. This coupled with the economic background has caused the Chicago Fed’s National Financial Conditions Index to fall to the lowest level since February 1994. Credit conditions are about as easy as it gets, and easy money normally begets more economic growth.
Among the economic reports last week, 16 beat expectations and 12 underperformed. The inflation reports were especially positive, taking pressure off the central bank to raise rates. Unfortunately, this also takes away one of the underpinnings of the recent gains in the price of gold. The market’s abandonment of its flight from stocks this week also weakens the gold story.
Earnings and revenue reports continue to pour in as the peak of the filing numbers for the fourth quarter was hit last week. So far we have seen more positive reports than analysts were expecting. According to Bespoke Investment Group, as of Friday (1/31), 69% of reporting companies outperformed analyst earnings projections and revenue predictions were topped by 64.4%. Both of these numbers are up substantially from last quarter.
As the following chart suggests, we entered last week in extreme overbought territory. As you can see, we have been overbought for a while, which has caused me to predict short-term weakness since before Christmas.
Last week’s weakness corrected this condition, and it did not take long for the market to mount a new rally. Of course, that now means that we will probably be back to overbought territory after today’s gains.
Still, sentiment, which had also been extremely high and suggestive of a market tumble, has cooled off as a result of last week’s scare. Both bullish and bearish sentiment numbers are close to normal levels.
I’m short-term neutral on stocks, but I remain long-term bullish.
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