Why the market is always right (even when it isn't)

The stock market is never to blame for a fund's results.

By Martin Braun
Globe Investor Magazine Online, Dec. 18, 2008

Martin Braun is the president of Adaly Investment Management Corp., a Toronto-based investment counselling firm. mbraun@adalyfunds.com

I have a bone to pick with investment professionals of various stripes who manage other people's money. (And by the way, I'm one of them).

It seems that, not only are their results really poor this year, but more to the point, it's not their fault. That's right, the market is to blame. For if the market weren't so bad, they'd be doing much better. Fancy that.

Now in the interest of full disclosure, our funds are not performing well either - they're down between 14 per cent and 21 per cent - and I feel really lousy about it. It's the first year in nine that our flagship fund is not up, so it seems that a nice winning streak is about to end.

But is the market to blame? Of course not! Not for a second would I even suggest such a thing. We are the culprits, because we are paid generously to know what to do - in both good times and bad - and if we can't tell the difference, then we fail.

There are two types of markets. The first kind is one in which stocks matter. The second is one in which they don't. What do I mean?

Sometimes a market gathers such force that, much like the tide, it lifts all boats or, conversely, lowers them.

The 1999-2001 technology bubble-and-bust is a good example. In that type of environment, investors don't distinguish good companies from bad particularly well, and valuations go out the window. Like most serious investors, I don't like this type of market, because fundamental analysis doesn't work well. The tidal wave of buying, or tsunami of destruction, feeds on itself, and it's almost impossible to know when it will finally be exhausted.

I prefer the other type of market - the one in which analytical stock pickers, burrowing through financial statements and engaged in laborious industry research, discover hidden gems or disasters in the making. It's like detective work, without the electronic surveillance and glossy photos. Here's the point: Our job as those who manage other people's money is not just to pick stocks, it is also to pick markets.

Take another step back: In 2006, the ridiculous multiyear U.S. housing bubble finally burst, and as a result in 2007 the mortgage market (led by the subprime area) collapsed. This had the effect of wiping out the financial sector, resulting in a massive credit contraction, which has brought consumers to their knees in 2008. As a result, demand for goods and services is plummeting, bringing an end to a remarkable commodity cycle - one in which oil approached $150 (U.S.) a barrel and metal prices exploded.

The Canadian stock market is all about energy and metals, and when investors around the globe want to jump on that particular bandwagon, this is where they come. So for five consecutive years, Canadian investors were treated to a display of "brilliant" money management, the likes of which they'd never seen before.

But what we really experienced from 2003 on was simply investment surfboarding, riding that beautiful wave of endless Chinese demand for finite raw materials - a lovely working premise until it turns out that demand was not so endless and supply not that finite.

With the benefit of hindsight, it is true that these things I say are obvious. But you can't buy and sell stocks in hindsight, which makes money managers' jobs so much harder. You see, we have to invest with foresight, and it appears that foresight is not a common virtue in our crowd. So mostly we are trend followers, which is a decent investment strategy as long as you know what the trend is. Lacking that, and foresight - well, dead man walking.

Over the past few months, I have read and heard much righteous indignation spewing from the mouths of professional investment advisers and money managers who strutted like peacocks when the cycle was going in their favour, and now denounce that same market for turning on them. They were more than happy to take credit for their results then, but loath to accept responsibility for their reversal of fortune now. Then, the market had it right. Now, the market has it wrong. Sure, whatever you say.

The intellectual dishonesty is galling, and is tantamount to suggesting that the sun actually rotates around the Earth. As if it is the manager who is the omniscient one, and the market that needs to learn the truth.

Know one thing: The market is always right, even when it isn't.

Special to the Globe and Mail