AAII Investor Update: CFA Institute Conference—Fix the Financial Industry

I spent the first half of this week at the CFA Institute’s annual conference. I think one of the most encouraging themes at the conference for individual investors was the awareness from within the financial industry that problems exist and need to be fixed.

CFA Institute President and CEO John Rogers made a demand to restore trust in the financial industry. Specifically, he asked for CFA charterholders to be a bolder voice for ethics, focus on financial activities that enable economic progress and share their knowledge and skills with others in the field of finance.

Though Rogers issued a direct call for action, other speakers discussed how the financial industry has erred or can be improved. James Montier, a member of GMO UK Ltd.’s asset allocation team, honed in on how the financial industry likes complexity and warned that the industry’s innovations should be treated with skepticism. Mike Mayo, managing director of the banks group at CLSA, said that his peers need to understand that good ethics is good business, even though adhering to good ethics may take more effort. University of Chicago professor Eugene Fama criticized “too big to fail” policies, opining that it would have been better if banks were required to raise even more capital. Gary Brinson, president of GP Brinson Investments, told attendees that “things outside of this room” need to be fixed.

Notably, the most spirited discussion I attended was about whether high-frequency trading hurts long-term investors. Manoj Narang of Tradeworx, argued that high-frequency traders create liquidity and hold less capital than a mid-size hedge fund. Joe Saluzzi, the co-head of equity trading of Themis Trading LLC, countered that while high-frequency traders do create liquidity, they can also create a “drain during a drought.” The exchange developed into a very technical discussion, with regulations blamed for fragmenting the market into many exchanges. The narrowing of spreads between the bid and the ask price was also cited as driving market makers out of business, which in turn has made it more difficult for smaller companies to go public. (The lack of an orderly market was cited as not facilitating better volume for such stocks.)

The current state of the markets and the global economies were another common topic. Mellody Hobson, the president of Ariel Investments, observed that many individual investors are still bearish. Anatole Kaletsky, the editor-at-large at The Times of London, quipped that everyone is worried about sovereign economies other than their own. Sam Zell, the chairman of Equity Group Investments, opined that Europe faces problems stemming from both its sovereign bureaucracies and its aging population.

As far as investment strategies, the discussions I heard mostly focused at the portfolio level. Eugene Fama claimed that only 3% of active managers beat the markets once expenses are factored in. (His efficient market hypothesis is a big argument against active management.) Jason Hsu of Research Affiliates claimed that higher rates of return can be achieved if indexes are weighted on the basis of fundamental criteria instead of market capitalization. (Note that Hsu’s firm offers ETFs based on these alternative type of weightings.) Both talked about capturing a value premium as a means of boosting performance. Nobel Laureate and Princeton University professor Daniel Kahneman warned the audience that investors often think they created alpha (“excess returns”), even when they didn’t.

The one sector-specific speaker I heard was Donald Coxe, a strategy adviser for BMO Financial Group, who discussed commodity stocks. He advised paying attention to the amount and duration of a company’s reserves. Using gold mines as an example, he said when you buy shares in the company, you also receive a free, long-term call option on gold. He further discussed the need for patience when investing in commodity stocks.

One of the most interesting discussions unexpectedly occurred during a session titled “Celebrating 50 Years of the CFA Charter: The Evolution of a Profession.” Gary Brinson cautioned that there is “no magic elixir” that will get us back to positive rates of inflation-adjusted returns. Charles Ellis, chairman of the Whitehead Institute for Biomedical Research, instructed the audience to help investors make more sensible decisions going forward. David Darst, the chief investment strategist at Morgan Stanley Smith Barney, emphasized the need to understand human behavior. Finally, in responding to a question about what she reads to stay current, Abby Joseph Cohen, the senior investment strategist for Goldman Sachs, said she just finished “The Hunger Games.” Why? Because she wanted to find out what the kids were so interested in. (It’s good to see a market strategist looking beyond the numbers for an understanding of what is going on.)

One trend I noticed among the attendees was the use of iPads. Though most attendees simply used smartphones and pads of paper, I saw more attendees using iPads than laptop computers—a sign of the influence Apple is having. (I’ve heard others notice a similar trend at conferences they’ve attended.) Another trend was the use of Twitter. Many attendees were actively tweeting throughout the conference, and it helped to both to confirm my meeting notes and to see what was being discussed in concurrent sessions. You can see the conference tweets on Twitter, even if you don’t have a Twitter account.

It’s difficult to share three days of presentations in a newsletter, but this gives you an overview. I spoke with some of the aforementioned speakers at, or just after, the conference, and will publish transcripts of the interviews in upcoming issues of the AAII Journal. I think you’ll find the conversations interesting.

More on AAII.com

I looked to see if we had previously published articles from the aforementioned speakers, and we haven’t. We do have a few articles on subjects that are similar to the conference’s presentations, however.

• Gold’s Investment Attributes – Thomas Winmill, the manager of the Midas Fund, discusses the role gold plays in a portfolio and why gold mining companies should be considered as investments.
• How Your Buy and Sell Orders Get Filled – Chris Nagy of TD Ameritrade gave a behind-the-scenes look at how orders to buy and sell stocks get executed.
• Stock Price Movements Are Unpredictable – Both Eugene Fama and Daniel Kahneman are advocates of passive investing strategies, as is Princeton University professor Burton Malkiel, who shares his viewpoints on the subject.
• What Do You Read to Stay Current? – I’m going to pose the same question asked at the CFA Conference. Answer it on the AAII.com discussion boards.
• Don’t forget to take the Sentiment Survey.

The Week Ahead

My colleague, Joe Lan, will speak to our Columbus, Ohio, chapter on Thursday. We have local chapters and groups across the country and you can see a list of upcoming meetings on the AAII Local Chapters page. (I will speak to our Sacramento chapter on June 7 and our Silicon Valley chapter on June 9.)

Dow components Home Depot (HD) and Wal-Mart (WMT) will report on Tuesday and Thursday, respectively. Joining them will be approximately 15 members of the S&P 500, including fellow retailer Target (TGT), which reports on Wednesday.

The first economic reports will be released on Tuesday when the April Consumer Price Index (CPI), April retail sales, the May Empire State manufacturing survey, March business inventories and the May National Association of Home Builders (NAHB) housing market index are published. Wednesday will feature April housing starts, April industrial production and capacity utilization, and the minutes from the April Federal Open Market Committee meeting. The May Philadelphia Fed survey will be published on Thursday.

No Treasury notes or bonds are scheduled to be auctioned next week.

No Federal Reserve officials are currently scheduled to speak.

May stock options will expire on Friday.

AAII Sentiment Survey

Bearish sentiment rose to a seven-month high, while bullish sentiment fell to an eight-month low in the latest AAII Sentiment Survey.

Bullish sentiment, expectations that stock prices will rise over the next six months, plunged 10.0 percentage points to 25.4%. This is the lowest level of optimism recorded by the survey since September 22, 2011. This is also the sixth consecutive week that bullish sentiment has been below its historical average of 39%.

Neutral sentiment, expectations that stock prices will fall over the next six months, fell 3.6 percentage points to 32.5%. This is a four-week low. Nonetheless, neutral sentiment is above its historical average of 31% for the fourth consecutive week and the sixth out of the past seven weeks.

Bearish sentiment, expectations that stock prices will fall over the next six months, jumped 13.6 percentage points to 42.1%. This is the highest level of pessimism recorded by the survey since October 6, 2011. It is also the fourth time in the past five weeks that bearish sentiment has been above its historical average of 30%.

Bullish sentiment is at an unusually low level, and bearish sentiment is at an unusually high level. In quantitative terms, both readings are more than one standard deviation from their historical norms. Last year, bearish sentiment exceeded 44% five times between August and October. Thus, though pessimism is unusually high, it is not high enough to be correlated with a forthcoming market reversal. A bearish sentiment reading above 50% would be a stronger contrarian signal.

Disappointing April employment data, the French presidential election, and a return of downside market volatility combined to fray individual investors' nerves. The continuing above-average level of neutral sentiment, however, shows that there is an ongoing push and pull of bullish factors (e.g., improved corporate profits, U.S. economic growth) and bearish factors (concerns about the pace of growth, Europe, high gas prices, etc.).

This week’s special question asked AAII members what, if any, impact the current uncertainty about 2013 tax rates is having on their outlook for stocks. The majority of respondents said it was not impacting their outlook. Several members, however, thought the possibility of higher taxes next year is a negative factor.

Here is a sampling of the responses:

• “I don’t expect taxes to change much, and there will be little impact on the economy.”
• “None. Huge tax increases are politically unlikely.”
• “None. I’m reasonably certain the dysfunctional idiots in Congress will agree on a fix at two minutes to midnight, as they usually do.”
• “A very big uncertainty. It will drive decisions in the near-term to best take advantage of taxes.”
• “The perceived outcome of the election will have a sizeable impact on the market because of its implications for tax policy.”

» Take the sentiment survey