Perhaps the most striking perception we entertain is how inexperienced and uneducated most market participants are. The average age for investors is likely over 35 but perhaps not by much, and the average age for money managers is probably less. Active managements have learned over the years that fraidy cat managers and other conservative types do not "sell" as well as the young, agressive and relatively less brainy types who are capable of racking up enormous gains when stocks are in favor. Young equates to risk taking, which translates to potential for gain (and of course, eventual loss). A perfect example of this behavior is seen in Newsday's 2004 Stock Market Game of over 2000 "teams" particpating in a ten-week competition. The leaders of the College/Teacher division advanced by 8.4%, but the first place team of Grades 10-12 racked up profits of 49.1% and the winners of the Grade 7-9 category advanced by 24.3%. The greatest gains were made in the Grade 4-6 category as the Willam T. Rogers Middle School weighed in with a phenomenal 83.4% gain and the average for the top ten teams amongst those aged only nine to eleven years of age far surpassed any other category. One wonders whether bulletin board stocks were on their list.
Is experience a bad thing? In her book, "Bull," Maggie Mahar recounts the experience of Jean-Marie Eveillard, one of the great value investors of the last twenty-odd years. Despite a 19-year period in which his his fund returned on average 16.5% per year, the mania took its toll and clients fled for more aggressive pastures. Mahar quotes Eveillard, "It was warmer in the herd; it is terribly lonely to be a value investor. Eveillard realistically appraised that, "At least we lost half of our shareholders - rather than half of our shareholders money." Finally, Mahar reminds us that "In 2002, Morningstar reviewed the performance of some 372 diversified foreign stock funds, Morningstar named Jean-Marie Eveillard, along with co-manager Charles de Vaulx, International Fund Managers of the year." Eveillard was 62 years old old.
In fact, the last cadre of managers that witnessed a period comparable to 1999 to date were those that bought every "nifty-fifty" share they could get their hands on in 1972, claiming that the group were "one decision" stocks - just buy 'em and forget about 'em. When the market headed south in 1973 and two years of 45% losses in the S&P 500 were followed by another 7 years and change of sideways performance, managers learned an important lesson. But 1972 was 32 years ago and many of those running the big funds are now retired or otherwise engaged. Their lessons are lost upon the new breed of active manager. And as we have shown many times, given the tremendous competition from index funds and ETFs, active managers have had no choice but to place their funds in a position of increased exposure to risk and have cut cash-to-assets ratios to the quick. Worst of all, as we have pointed out on numerous occasions, funds have established credit lines to combat market declines and will buy additional shares when prices fall, rather than sell to preserve remaining assets. This is yet another reason why cash-to-assets levels have contracted so precipitously of late. No old timer we know would take those kinds of risks with investor's money. One subscriber, a Wall Street professional, pointed out that over the past few years, some of the larger mutual open end funds set up lines of credit. Our anonymous source used AIM's $2 billion Aggressive Growth Fund AAGFX as an example, showing that the fund can borrow money from other AIM funds, from $125 million line of credit from State Street Bank and a $500 million line of credit from Citibank. So, if the market and presumably the fund decline by a modest percentage, we have the potential for the fund to be as much as 25% margined. One wonders if these lines have already been tapped in the past, say October 2002 or March 2003, when the going became very rough. Of course, the principle fear is that someday the strategy backfires and prices continue to fall. And then, if the banks call their loans....we could see the worst panic in decades.
In the week ending May 7th, Program Trading comprised a record 52.3% of all volume on the New York Stock Exchange, the fourth time programs accounted for a majority of NYSE volume. The next week, Programs accounted for more than 50%, the first time Programs were over 50% two wweks in a row. Something to be proud of? Hardly. The impact of the individual investor—other than on the Bulletin Board—is now minimal, if not zero. The trend is frightful. A substantial fraction of all shares are now held by indexed entities and a substantial fraction of fresh money that enters the market is from those very entities - buying shares of the constituents without regard to any fundamentals or corporate prospects, buying shares solely because they are listed as constituents of the index. Prices no longer function as they used to and do not represent the combined opinions of investors about individual corporate prospects. Prices are driven primarily by the index entities. Since active managers are forced to compete by buying the very same issues, the index effect is multiplied. As discussed earlier, the May 7th action on Nasdaq was solid evidence that programs were in force, as only 18 stocks of the 832 advancers accounted for 347 million shares of the 587 million that comprised the day's up volume. Of course, all 18 issues were constituents of the NDX, which is tracked by the immensely popular QQQs. A significant portion of the volume may have been generated by so-called "statistical arbitrage." See Mike Santoli's column in the May 17th issue of Barron's for explanations. We have reached a singularly unique point in time, where investments in individual companies per se are quite meaningless. Only the indexes count. If this what the future look like, tomorrow will arrive way too soon.
