Two schools of thought about market

By DAVID MOON, Moon Capital Management, LLC
July 18, 2010

In a recent Wall Street Journal article the research director at Birinyi Associates, Jeffrey Yale, was lamenting how the current stock market is an indexing market, not a stock pickers market. “On good days everything goes up, and on bad days everything goes down. Everyone talks about baskets or sectors.”

There is an old saying that suggests that if the only tool you have in your toolbox is a hammer, all of your problems eventually look like nails. Mr. Yale, and others with his bias, clearly see what they choose to see.

The data set on which Birinyi bases their conclusion is a 50-day moving average correlation between the direction of the S&P 500 and that of the stocks within the index. Well at least I give them credit for using an investment horizon of almost a whopping two months. In Yale’s comments he spoke about investment returns in terms of “good days” and “bad days.”


Small investors are leaving the stock market, for various and predictable reasons. This sort of thing usually happens after periods of poor equity performance. Following a quarter in which the S&P 500 dropped almost 12 percent, it is no surprise that individuals are pulling money from stock mutual funds.

This increases the influence of the purely institutional investors. And this is where some really weird logic begins to occur.

The folks at Harris Private Bank in Chicago, a huge ($57 billion) investment outfit, have moved to the most bearish stance allowed by their guidelines. They have moved from 55 percent stocks to 45 percent stocks.

Big freaking deal. If the stock market drops 20 percent over the next year, that massive shift in investment policy will make a difference of about two percentage points.

Jack Ablin, the chief investment officer at Harris explained their justification for cutting their stock allocation in reaction to their bearish call: it is easier to change the asset allocation than it is to try and pick and choose among stocks.

Institutions are focusing more of their assets into the same group of stocks, making miniscule asset allocation changes and calling it active management.

There are a couple of conclusions you might draw from this phenomenon.

If institutions are redominating the market, and they are increasingly focused on short-term performance and the same stocks, then perhaps an appropriate investment strategy is to buy what the pros are buying – without paying the pros to do it, of course. If these institutional purchases become self-fulfilling prophesies, then all an investor needs to do is buy what the pros are going to buy, before the pros buy it.

The other school of thought is that the institutional investors are no more likely to be right now than they are, in total, any other time they congregate and move more in lock-step. The last time the stocks in the S&P 500 were this highly correlated was October 1987 – just prior to the one-day, 22 percent Crash of ‘87.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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