I had a mentor when I first started on Wall Street who told me early in my tenure “no one cares more about your business than you.” He was saying that I could get all the advice I wanted from the elder statesmen in the office but at the end of the day, the only person in the world that truly cared, deep down about whether I succeeded or not, was going to be myself. I read something last week that made this timeless advice percolate back to the forefront of my brain.
I’m here this week to pass this advice on to you. No one will ever care more about your investment portfolio than you do. No one.
Please don’t take this advice to mean that you should enter into every conversation with your financial advisor, insurance agent or banker with a supreme level of distrust and skepticism. However, I do want you to repeat that phrase to yourself before any meeting as a reminder that you are in control and if you don’t hold them accountable to putting your best interests first, then no one else is going to do it.
What passes for research and advice on Wall Street these days is a joke. The sad truth is that Wall Street research looks, feels and smells the same as it did when I started my career almost 20 years ago. Case in point, Wall Street firms love an asset allocation model.
It’s not the concept of an asset allocation model that I rebuff. It’s the execution of these models that leaves me wanting to stab myself in the eye with a slightly dull pencil.
It never ceases to amaze me that firms with unlimited resources and unlimited intellectual capital can be so inept at a basic service to clients. It’s your job to raise your family, spend time with your significant other and make a living. It’s the job of the firm handling your money to spend all day slicing and dicing the markets so that they can deliver you the very best recommendations to help you profit and most importantly avoid danger. The problem is that most of the time, you uphold your end of the bargain, but your firm does not.
Last week, I received a copy of the latest “Tactical Strategy Update” from Wells Fargo Investment Institute, the research arm of Wells Fargo Bank. My executive summary of the “Update” is that it was 6 pages of garbage. I take that back, it was 4 pages of garbage followed by 2 pages of “risk disclosures” meant to cover their keister if you happen to actually follow this advice and get hurt in the process.
The first “action” that Wells was taking in their model was to reduce US small cap exposure by 2%. Someday I’m going to write a white paper on the fact that allocating 2-4% of your account to any 1 investment is absolutely meaningless. Wells Fargo’s long-term allocation to US small caps is 4%. Based on this call to action, they are cutting that allocation to 2%. What does that actually accomplish?
If US Small Caps were to fall 30% from now, the account that chose not to reduce their exposure would lose just 60 basis points more than the account that took the advice. A crash in small caps and we are talking about 60 basis points of difference! Are you kidding me? Is that really advice? The advice, in dollar terms, is negligible. Well’s main goal is to purposefully not make a distinct recommendation.
They hedge their bets and don’t advise anything that will help you for fear that they’ll hurt your account and you’ll leave. Wells isn’t alone. All firms have this predisposition towards managing career risk over actually helping clients. But I digress, maybe a white paper won’t be enough.
More important than their meaningless shift in target allocation is the rationale behind the shift, here in early May 2016. “We expect under performance from small cap equities as uncertainties resume this year and as the cycle ages.” Please read that sentence again. Somehow, they manage to write 17 words in a correct sentence structure that provided absolutely no information.
I’m going to undress that statement in a moment but first a disclosure. I have not cherry picked this sentence. The remaining 93 words of their rationale is equally uninformative and is the literary equivalent of Ambien. I’d like you to stay awake for what I have left to say.
Let’s start with, “…as uncertainties resume this year…” I hate to break it to the “Investment Strategy Team” at Wells Fargo Investment Institute but if you are in the business of financial markets, hell for that matter life itself, uncertainties don’t start and stop. Uncertainties are always in play.
OK, now let’s deal with the heavy lifting because the first part of the call to action takes the cake, “We expect underperformance from small cap equities…” I’m sorry, but when I read that I thought I was literally in a Hotels.com commercial, listening to Captain Obvious.
This is where the rhetoric ends and we dissect this market like a cardio-thoracic surgeon using my 3 pronged approach to determining how to trade a particular market: fundamental gravity, quantitative and behavioral aspects.
First and foremost, I always start with the fundamental gravity of a market. The fundamental gravity of a market is determined by evaluating the economic conditions and the monetary policy to see if the current environment is bullish or bearish for the market in question.
Our fundamental gravity bias for US small caps turned bearish in Q2 2015 and has remained bearish ever since. It only took Wells Fargo 10 months to figure out what we already know and relay that information to their clients. I’ll be the first to admit that markets can often times become disconnected from their underlying fundamental gravity. But make no mistake, markets never outrun their fundamental gravity, bullish or bearish, for very long.
While US small caps have had 2 multi-month rallies of 10% or more over the last year, they remain very much in a bear market and tied to their fundamental gravity.
From a quantitative perspective, I’m not sure what else I need to say other than look at a chart of US small cap equities. Small caps peaked, shockingly, right along with our US fundamental gravity model back in June 2015. Since then, small caps have declined 14% and any rallies have simply been to lower highs, which confirms that small caps are already in a bear market and have been since November 2015.
So thank you to Wells Fargo, to finally advise that clients cut their exposure after this market has clearly been in a bear market for 6 months and is just 6% away from officially being in crash mode, which means a total peak-to-valley decline of 20% or more.
From a behavioral perspective, we track all fund flows for both the futures contracts and the ETF of the Russell 2000 index, which is the index that tracks US Small cap stocks. The futures contract open interest and total volume has fallen about 60% since last June. The investors who have been trading in small caps aren’t willing to lean one way or the other.
I know this because the number of outstanding long and short contracts is very close to their long run average. Investors have also been yanking money out of IWM, the ETF tracking the Russell 2000 index. The ETF has seen net outflows in half the weeks this year so far. In fact, trading volume in both instruments has been drying up since February, which also happens to coincide with the latest bear market rally in small caps.
For almost a year, the economic conditions have not been favorable for small caps and the markets have been confirming this in real time. Small caps have been making lower highs and the volume on rallies has been markedly less than the volume on subsequent declines. The conviction in this market has been and remains to the downside. What took Wells Fargo so long?
With advice like that, it’s no wonder it was published under the “Investment Strategy Team.” Would you have the big kahunas to put their name on that type of “research?” I certainly wouldn’t. Real change will occur when Wells Fargo is no longer willing to put the FIRM’S name on Wall Street melatonin or refuse to employ the people who published it in the first place.
A quick note, there are 2 other “calls to action” in the Wells Fargo Tactical Report that I’m going to treat like a red headed step child this week. Follow me on Twitter HERE, to receive this Twitter-only content.
The sad reality is that if your investments underperform their potential and leave you with a lesser lifestyle or less security for your family, then no one is going to feel the pain more than you.
Certainly not the money manager or advisor that collected ridiculous advisory fees to pass along shoddy research recommendations.
Most of the guys calling themselves “advisors” just want to babysit your account for another year and hope you don’t ask too many probing questions. They're terrified that you will realize that they are nothing more than glorified salesmen and their only real talent is reading the latest “tactical report” from the firm and regurgitating it as their own thoughts on the market.
You don’t need to know enough about financial markets to be invited to Davos in order to properly manage both your investments and your advisors, should you choose to outsource. It's incumbent upon you to ask enough questions about your advisor’s decision making process to give your BS meter time to work. I promise that if you ask the right questions, you’ll leave the meeting either knowing that you found one of the rare good guys or feeling like you need a shower.
Either way, you’ve done your job.
Your family will thank you and more importantly, you’ll thank yourself.
Part of my mission with The Whaley Report each week is to provide you with enough knowledge to accomplish 2 critical things with your investments. I want you armed with enough knowledge of markets to be able to make great investment decisions if you’re a do it yourselfer.
I also want you to be knowledgeable enough to ask probing questions of your financial professional. I cover only the critical developments in financial markets. If your advisor can’t carry on a coherent conversation about the topics in TWR, especially the trade commentary, then it’s time to find a new advisor. And let me insist that you start the talent search by looking in the mirror. Who better to advise you than the one person who cares the most about the results?