Random Roger had some interesting thoughts in his recent post titled “Monday Musings:”
This may come off as an unpleasant rant. Between a couple of articles I found over the weekend and watching the Consuelo Mack show on PBS I came away with a very low regard for the way some folks do things.
First up was an article from Morningstar about what they got wrong in 2008. I have been writing about how worthless the analysis is for as long as I have been writing. They are a bottom up shop and from what I can tell it is a rare day when bottoms up warns of a bear market. Low PEs and other ratios don’t matter when the market is going to rollover into a bear. When the market is going up most stocks go up so a good bottoms up might find stocks that go up more than market but being right about the market would seem to be more important. So with that backdrop Morningstar says the learned a bunch of things in 2008. I would wonder what they learned in 2001 and why that seemingly did not help in 2008.
I have mentioned before that Morningstar’s ratings are one of the most useless tools in an investor’s arsenal yet millions follow them blindly. Whatever approach they use to determine the rankings does not really matter, what matters is that it simply represents a different twist of the buy and hold mentality, which will subject its followers again and again to bear market disasters. Yes, I agree, Morningstar has not learned a thing since the last bear market in 2001, which caused their followers huge portfolios haircuts in 2008.
This article from Seeking Alpha contributor Marc Gerstein posits that collectively the crew at Morningstar is just too young. He believes that experience matters a lot when it comes to navigating the market. I find his take interesting because at 42 I am probably in between his definition of too young and experienced. One reader commented that Morningstar has a bullish bias which hurts them. I don’t know if that is true or not but there might be something to the youth angle but I do think it is bigger than that. Look at Larry Kudlow who must be close to 60 either way or Art Laffer or even Brian Westbury (I think Brian is older than me) they are all experienced and all missed this coming in hideous fashion, bizarre really.
No, age has nothing to do with it; it’s the insistence on using a bullish stance in a bearish environment come hell or high water that is the problem.
This gets me to the Connie Mack show which this week featured Brian Rogers from T Rowe Price and Chris Davis from the Davis funds. Brian’s fund the T Rowe Price Equity Income Fund lost 35.8% in 2008 which was the worst year for the fund going back to 1985 “by a lot.” He said that when there is a severe credit contraction there are very few places to hide. Even safe areas like utilities were “traumatic.” Consuelo asked if there was anything he would have done differently or could have done differently and he answered “no I don’t think there is.” He said they would continue to focus on good quality companies that have struggled, with good balance sheets and valuations. He then said there are things he would have done differently but he didn’t say what.
So I guess the next time the market drops 38% his fund will be pretty close either way? Did he really not know that credit contractions cause problems in the markets? That is the entire idea behind the inverted yield curve.
In past posts I have mentioned that mutual fund managers are not the asset allocators. It is reasonable for a fund manager to invest all of the money in his fund so this post is a bit of a contradiction but I was dismayed by Rogers’ comments and to a lesser extent Davis’. So an active fund manager might be all in but these funds can invest at the sector level in any manner they want so they could have underweighted or avoided financial stocks (financials clearly hurt Davis, not sure about Rogers but JPM, GE and WFC show up in his top ten).
In a bear market there a few places to hide. Since the brokerage industry as a whole has itself dedicated to always being invested in something (so product can be sold continuously) under various disguises of asset allocation, bottom up or top down investing and MPT (Modern Portfolio Theory), they have to pay to price when the bear strikes. All of these themes never look at trends and major market turning points to assess whether ones ideas are still valid.
I am so critical here because I think well if I saw something bad coming (but did not correctly guess the magnitude) how did these guys miss it so badly? They both are smarter than I am and that is not false modesty. Davis might say something about the capital gains embedded in the positions (a point made on past episodes of the show) so maybe no one should buy the fund going forward but that would also mean he made taxes the priority which will lead to tears more often then not. Taxes should never be the first priority.
2008 was not a matter of “seeing something bad coming,” because it assumes that you have the special gift of foresight. It was simply a matter of following major trends in the market place and acting at the turning points.
That’s it; no more no less—no smarts required.
What was required was the realization and experience (from previous bear markets) that senseless holding of any investment, no matter what the economic circumstances or the Morningstar rankings, will have negative consequences when the trends turn south.
A bear market takes no prisoners and even the stock prices of the most bluest of all companies will go down—no exceptions. When the trends change, you simply act and get out. When we went to all cash on October 13, 2000, we had no idea about the magnitude of the following bear market nor did we last year when we exited on June 23, 2008. Trying to assess fundamental reasons when trends head south is simply an exercise in futility.