FSO Editorials: Do Not Fall For Wall Street Hype by Robert B. Gordon 02/09/2004

Do Not Fall For Wall Street Hype
by Robert B. Gordon, Sc. D.
February 9, 2004

There are many very serious problems in our enormous and broad financial industry which are magnified by the ignorance and gullibility of the American public. Our public press has been covering the current SEC investigation into illegal actions in our financial firms, brokers and mutual funds. However, they have not done anything to explain how investors can help themselves do a better job of protecting themselves from a fleecing by the "wolves" of Wall Street. That is what I intend to do in this writing. Please read carefully and get its important message.

I have no idea how much money is spent on advertising by Wall Street firms, but it must be a huge sum. And, I hasten to add, it must be effective in selling their wares to the wealthier segment of our society. Their expertly contrived messages are aimed at the wealthy, but also affect millions of investors with more ordinary means. Is it hype? Do any of these definitions fit?

1. To create interest in by flamboyant or dramatic methods; promote or publicize showily.
2. To intensify or increase, often by questionable methods.
3. A flamboyant or questionable claim used in advertising or publicity.
4. A swindle, deception or trick.

The ads are done with great skill and undoubtedly are effective or they would not be run so many times on TV. Unfortunately, they are very deceptive and give an impression of skills in money handling that may not be as true in a great bear market as it might have been in the great bull market that is now over. Unfortunately for our TV networks, this source of revenue will surely disappear as the bear market deepens. I have lived through and fully experienced the 1972-74 bear market and seen its dramatic effect on Wall Street activity. Along with other experts, I fully expect this current bear to be much, much greater in every respect. The business of Wall Street firms and their advertisers will be very adversely affected.

The Wall Street apparatus thrives on huge bull market profits and has so far been able to survive earlier bear markets that lasted 2 or 3 years. But this huge bear that is just starting to develop will be very different in both length and intensity. Wall Street will probably survive in some form, but will be greatly reduced in size and importance.

Despite their slick professional advertising, Wall Street’s main business is not to advise the wealthy, but to be (1) a wholesale seller of stocks and bonds for corporate and government customers and (2) a retail seller thru regional brokers to the investing masses. Some very nasty secrets about the collusion between mutual funds and brokers will be revealed in the current SEC investigation. The job training at many levels is primarily directed at how to sell stocks and bonds. Very little effort, if any, is spent on teaching the important history of market boom and bust cycles. In my opinion this is a tragic mistake.

I have stressed this importance in many essays. My readers have learned that the lessons of previous bull and bear cycles are the most important lessons of all for an investor or advisor. Without a good knowledge of the great history lessons, no one should be buying or selling stocks and funds. The tiny percentage of knowledgeable investors who enter the market with full awareness of whether it is starting to go down from a peak or starting up from a bottom will have a huge advantage.

One of my strongest essays on the lack of knowledge in Wall Street is in my archive with the title Wall Street’s Greatest Crime. It was translated into Spanish and made required reading in an Economics course in Business Cycles at the Catholic University in Chile. I hope that many readers will visit and enjoy its account of previous boom and bust cycles.

Wall Street endeavors to place its faceless customers into a few fixed categories and then give each group slightly varying advice. In their view, every need can be met by a slightly different mix of stocks and bonds. Important innovations rarely come from the big established firms, but rather from funds like Prudent Bear or the Rydex family. They are mass selling the same old wares decade after decade. They preach their great skills of allocation and diversification, but end up putting their customers in the same old conventional assets.

For more than two years now, I have been trying to fight the hype and conventional thinking coming out of Wall Street and to help individual investors break out of their old habits and learn to think for themselves.

Is it possible to be a "good" fund with a history of excessive fees, manager salaries and profits? Unfortunately, the answer has to be yes because the excesses cover nearly all fund companies. To my knowledge, only #2 Vanguard is organized as a "non-profit" fund company with management fees a small fraction of the industry fees. Despite their heavy advertising of the importance of a low fee structure, they have yet to top #1 Fidelity, which recently was forced to drop its 3% commission on sector funds in order to compete with no loads.

Although the investigation will take many months, if not years, I predict that most of the funds who knowingly permitted a favored few to trade at the expense of all other clients will eventually disappear. The remaining funds will be under heavy pressure to reduce their high fees for small investors to the lower fees charged institutions. However, high fees are not the worst threat to inexperienced investors.

Very aggressive growth funds sold to unsuspecting investors who do not have the ability to go to cash or other protective actions in down markets have lost greatly and will continue to cause the loss of huge sums to investors who cannot make a sell decision. I have just heard from a sad reader who now knows he made a big mistake in not getting out of one such fund.

In the boom years, scores of growth funds were competing with other similar funds in a reckless manner because the manager’s pay was based on relative performance. This was and is a very bad and risky policy, especially when hidden from the fund’s shareholders.

Another long standing practice of many fund companies was to combine a poor acting fund with another, thereby removing its performance from average performance data and from company and industry fund data.

I have never owned or considered owning any loaded fund, regardless of the fee or how it is exacted from most unwary customers. My hope, although it will not happen in my lifetime, is that the current investigation may start a process of first minimizing and ultimately eliminating load fees. Even if this is a wild dream, most of the brokers now selling loaded funds will vanish in this long bear market. Compared to the 9 years of fund redemptions after 1974, I suspect that when this great bear market ends, there will be many decades of net fund redemptions. This would cause a major reduction and consolidation of the mutual fund industry and could possibly lead to some better opportunities for investors.

What is the greatest problem with mutual fund loads? It is not the money involved or who gets it or when it is taken from the buyer. The greatest problem is that it gives the buyer a strong reason to hold on to the fund shares, to become a buy-and-hold investor. It also forces the buyer to forego the option of buying better performing no load funds. Of course, the practical problem is that the broker’s customers never learn about no load funds despite the great amount of no load advertising.

We now have a situation in which some fund companies, including one industry leader, offer a series of ABCD funds in which D denotes a no load fund and the others are loaded. We will continue this subject later under a different heading.

Forgetting the fee structure, which may be improved, what other features should you look for in a very good fund? Here is my list in order of importance:

      1. Historic performance in both up and down markets, net of expenses and fees.
      2 Performance ranked vs. other funds of similar objective.
      3. Managers' names with dates they started with the fund.
      4. Historic performance of fund to its announced objectives.

As an example of a fund I picked for a recent 15-year retrospective study, here are its great credentials:

      1. Fifteen-year straight line historic performance of better than 10% per year.
      2. Morningstar 5 star in Conservative Allocation category whose funds averaged 4%
          lower in the past four years.
      3. Manager 1 started 10/31/82. Manager 2 started 1/10/86.
      4. Many decades of history following its objective of 60% bonds and 40% stocks.

I am currently holding or investigating about 30 funds from numerous fund companies. I have never owned a loaded fund of any type or description in my more than 50 years of fund investing experience. I may have missed owning one or two great funds, but I prefer to do my own investigation and make my own selections.

We have recently rediscovered two reliable old, stable funds, Merger and Permanent Portfolio, and added them to our list of suggestions. Our list of stable funds is still very small and will continue to be so. We always welcome suggestions from our readers. That source gave us the two Hussman funds and we would be happy to receive more names.

From reader suggestions, I have been looking at several very new and potentially exciting funds being offered by Pimco, a large West coast fund company specializing in bonds. These funds are being offered in the ABCD series and are in a category Pimco calls Real Return funds. They include a novel TIP bond fund, a unique commodities fund, a fund of funds and an unusual real estate fund. Unfortunately, they are not yet available in my FastTrack fund price database so I am trying to get them included as soon as possible.

Maybe Pimco’s location in California instead of the East Coast is helping to generate their new product ideas. To my knowledge their new series of funds are very innovative and I am anxious to subject them to a close study.

I recently received a mailing with words of wisdom from an individual with 34 years of investing experience that I deemed very close to what I have been trying to say for many months. It is a powerful statement of what is needed for investment success. Print it out and read it as often as needed to stay on the right track.

"It has always been my contention that the only way to be a successful investor is to avoid the disasters. I say this because it only takes one bear market to wipe out years of hard-earned profits. In essence, stock market participants should realize right from the outset that losses come with the territory. Being wrong is not a weakness but staying wrong is.

Winners in the market will often be wrong. But the one thing that separates the winner from the loser is the fact that the winner has the ability to realize he is wrong and take immediate action. On the other side of the coin there is that class of investor who will insist they are right and the market is wrong all the way down. It takes only one bear market to financially devastate this type of investor.

The other prerequisite to being a successful investor is having a viable plan of attack along with the tenacity to follow it. Investors who can successfully combine a viable strategy with the ability to avoid the disasters are in a position to nail down substantial profits."

I quote a small part of Dr, John Hussman’s report to fund investors dated 2/2/2004:

"Find winning moves. As I've written frequently over the years, the key to success in just about everything is daily action. You find a set of actions that you believe will produce good results if you follow them consistently, and then you follow them consistently. Too many investors put their capital at risk based on beliefs – even hunches – that they have never verified with any sort of historical data or analysis, or that would be impossible to verify at all. For us, it's critical to know both the average result, and the potential range of results, that we can expect from a given action.

For example, one of our most consistent day-to-day actions is the attempt to purchase stocks with some combination of favorable valuation and market action during periods of short-term weakness, and to replace less attractive holdings on short-term strength. By doing that, we're constantly trying to improve the value and market action inherent in our portfolios at points of opportunity.

Very simply, you can't buy low and sell high, on average, if your daily actions aren't designed to force you to buy low and sell high on average."

RBG Comment - Please read his last sentence again. What he is doing in his Growth fund on a daily basis is being duplicated over longer intervals by our periodic portfolio rebalancing. In this process, assets are being taken from the gaining classes (selling at highs) and then being transferred to lower gaining or losing classes (buying at lows). These small gains then continue to compound with time. And, most important, if these gains are not taken by means of the rebalancing step they typically disappear and are lost for good.

With the excellent assistance of a reader I am able to bring to you the overall win/loss record of its 34-year history and the results of its 4 major asset classes over the past 4 years. Please note that the 34-year performance has a logarithmic price scale. A linear chart is smooth and curving upwards.

Note in the table below that the entire portfolio has only 3 minor losing years out of its 34-year history. But this great bear market will give it a severe test and definitely worse than it has had to date. Fortunately in a multi-stable asset portfolio we have suggested, any such losses will probably be made up during rebalancing.

Yearly Permanent Portfolio Results 1970 through 2003
1970	+4.1%	1980	+22.1%	1990	-0.7%	2000	+2.7%
1971	+13.4%	1981	-6.2%	1991	+11.5%	2001	-1.0%
1972	+18.7%	1982	+23.3%	1992	+4.0%	2002	+7.2%
1973	+10.6%	1983	+4.3%	1993	+12.6%	2003	+11.8%
1974	+12.3%	1984	+1.1%	1994	-2.4%
1975	+3.7%	1985	+20.1%	1995	+16.6%
1976	+10.1%	1986	+21.7%	1996	+5.2%
1977	+5.2%	1987	+5.3%	1997	+6.7%
1978	+15.0%	1988	+3.6%	1998	+7.4%
1979	+36.7%	1989	+14.8%	1999	+4.7%

Please note below the losses of the 15% stock category in the first three years of the current bear market fund and the gains in the bear market rally of the last year.

Comparison Among Investments in Recent Years
Year	Portfolio	Stocks	Bonds	Gold	Cash
2000	+2.7%	-8.7%	+21.2%	-6.5%	+6.0%
2001	-1.0%	-11.9%	+1.6%	+1.4%	+5.4%
2002	+7.2%	-21.9%	+17.5%	+23.5%	+1.8%
2003	+11.8%	+26.5%	+5.5%	+19.2%	+1.4%

Stock results are for an S&P 500 Index mutual fund and include reinvestment of dividends. Bond results are for a 30-year T-bond and include interest received. Gold results are for American Eagle 1-ounce coins. Cash results are for Treasury bills, assuming that a 1-year bill was bought at the start of each year.

I am pleased to advise the availability of a free web source for comparing the historic price performance of at least seven funds, or stocks, or indices on a multi-colored chart. Go to www.bigcharts.com, click on charts at the top of the first page, then enter one stock or fund symbol as a standard of comparison. Further down on the page you can enter, with a space between each added symbol, at least six other stock or fund symbols whom you wish to compare on the chart. The graph give a different color to each line on the chart. This quick and easy method is a great tool for comparing stocks, funds or indices, It’s a great do-it-yourself tool. Give it a good try as it should help all investors. And it will certainly answer our reader’s question on "how to find the price peaks and valleys for rebalancing." On FastTrack or BigCharts, the peaks are literally steeper than the Swiss Alps. Check some gold stocks or funds where the price peaks resemble that of the Matterhorn!

There is ample information on hundreds of fund classes and thousands of funds on web sites like Morningstar, Bloomberg, Quicken, Yahoo and Zacks. Most of them offer a fund screener that ranks the fund performance in dozens of stock and bond asset classes. Discount broker Scottrade offers a Value Line mutual fund screener available to both clients and visitors. Individual investors can now access more and better information then ever before so there is no excuse for inaction in doing your own homework. And this process of information gathering is the necessary first step to investing success.

Although we are facing the deepest and longest bear market in world history, literally tens of millions of Americans are totally unaware of this dire fact. Having succumbed to the hype of Wall Street, CNBC and our public press, their investments and retirement plans are at risk of terrible losses. I urge all of our readers, new and old, to review all of their investments right now. Take action and sell potential losers like aggressive stocks and funds that have done so well in the past year. The market climate is about to change dramatically.

Every reader needs to take appropriate steps and adopt one of the many conservative balanced portfolios described in our essays over recent months. We have worked very hard to find a very limited number of stable asset classes that will survive turbulent markets. Send us your questions of a general nature only as we are unable to answer many questions on individual stocks and funds. Remember, in a bear market, it is the asset "class", not the individual security symbol, that determines whether you win or lose.

Bob Prechter is giving an important lecture on socionomics (not the stock markets) at the London School of Economics and Politics on March 18, 2004.

"On Thursday, March 18, 2004 Robert Prechter will present a lecture on socionomics from 1:15 to 4:00 p.m. at the London School of Economics and Political Science. The talk will be held in the New Theatre (E171), Houghton Street, London, WC2A 2AE.

The lecture, "Socionomics: Social Mood Is the Engine of Social Activity," will illuminate how and why the psychological dynamics behind social mood trends shape the financial, economic, political, demographic and sociological forces that make history.

As a radically new paradigm for the social sciences, socionomics offers a new theory about the causal connection between social mood and human behavior. The socionomics paradigm demonstrates how successful anticipation of future events is possible with the knowledge that human social behavior changes as a result not of external forces but of internal psychological ones."

It is not surprising that he is going abroad for this first major presentation to the World’s economists, for American economists have not yet discovered or adopted Ralph Elliott's Wave Principle published in the 1930s. Will they be ready for socionomics in 2070?