Stock Pickers Get Turn To Shine; New that markets are no longer moving in lock step, corporate fundamentals, and the ability to pick stocks, are becoming more important
Stock Pickers Get Turn To Shine
FRANCESCO GUERRERA
Updated April 14, 2014 11:11 p.m. ET
First it was Gwyneth Paltrow and Chris Martin. Now it is markets and the Federal Reserve that are engaged in “conscious uncoupling.”
The recent fall in U.S. equities has highlighted their gradual untethering from the one big driver of performance since the financial crisis: the central bank’s easy-money policies.
The process—a direct result of the Fed’s scaling back, or “tapering,” of its stimulus measures—won’t be easy. But it won’t necessarily spell the end of stocks’ strong run, and not just because the Fed has vowed to keep interest rates low for the foreseeable future.
“I don’t think this is the end of the bull market but we are probably in the sixth or seventh inning,” says James McCaughan, chief executive of Principal Global InvestorsPFG +1.78%
LLC, which manages $312 billion.
Welcome to the complicated life of a late-stage bull market.
Ever since the Fed unleashed its unconventional policies, investors have lived in a binary world where risky investments were either in vogue or out of fashion, often shifting on a daily basis. Now, fund managers will have to rediscover the pleasures, and pains, of picking stocks and other assets.
Since the current rally began in 2009, investors toggled between “risk on” and “risk off” stances. They bought stocks and junk bonds when they felt confident the Fed would continue to stimulate the economy. And they moved toward havens such as Treasurys when they feared a withdrawal of the monetary punch bowl.
Throughout that period, different sectors and assets moved in lock step. Market watchers measure such movements in percentages of correlation, where 100% represents perfect “synchrony.”
Since 2009, the 10 industry sectors in the S&P 500 have averaged an 85% correlation to the index, according to Nicholas Colas, chief market strategist at ConvergEx Group, a provider of brokerage and trading services. That number should have been closer to 50% based on long-term history, he wrote in a recent note.
But in the past 30 days or so, correlations within the S&P 500 have fallen to 77.5%, a substantial decline. Only one sector—industrial stocks—strengthened its ties to the index. Other assets, from European and emerging-market equities to the euro and the Australian dollar, also are going their own way.
The breakdown in these long-held relationships will force fund managers to work harder to pick winners and losers. Aping an index, as so-called passive funds do, or even a sector, like many exchange-traded funds, will be less viable options.
At the same time, corporate fundamentals, such as earnings, will become more important.
“This is creating a stock-picking environment,” says Matthew Rubin, director of investment strategy at Neuberger Berman Group LLC, which manages $242 billion.
That means that clients will have to pay higher fees for the advice and judgment of professionals like Mr. Rubin and hope the advisers they choose will be among the minority who beat the market.
As Mr. Colas told me, fund managers will have to “search through the dumpster for a playbook they had discarded long ago.” Even if they find it, they will have problems following it.
The traditional distinction between “defensive” and “offensive” sectors is being challenged. Take health care. Traditionally, it has been considered a haven in times of trouble on the assumption that people need drugs whether the economy and markets expand or contract. But the emergence of a new breed of “hot” biotechnology companies is undermining that classification.
Over the past month, for example, Gilead Sciences Inc., GILD +1.15% a biotech group, has lost nearly 15% of its value. But Merck MRK -0.63% & Co., a giant drug maker, is slightly higher. The same is true in technology, a “growth” sector where Microsoft Corp.MSFT -0.07% , an old stalwart, has done better than Facebook Inc. FB +0.62% during the recent turbulence.
That is an example of how “passive” management or sector-mirroring can be problematic in a falling market.
Microsoft and Facebook should belong to different sectors, yet they are both included in many technology funds and ETFs.
Some stock pickers aren’t rejoicing in their newfound relevance. Charles de Vaulx, for one, can’t seem to find the right place to put his money. As a “value” investor, Mr. de Vaulx, chief investment officer at International Value Advisers LLC, looks for cheap stocks.
But after a record-breaking run in equities, he isn’t finding much value and has placed only about half of the $20.2 billion he manages in stocks. (The rest is in cash and bonds.)
“We have never been this defensive,” he told me. “We refuse to play the game of the greater fool.” Sometimes, stock-picking means not picking.
As markets detach from their federal big brother, investors and their clients will have to ensure that they join up with the right partners.
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