A Positive Step by Regulators
Thursday, May 1, 2014

The Financial Industry Regulatory Authority (FINRA) took a positive step last week by proposing mandatory background checks on brokers. The proposal requires firms to verify the accuracy and completeness of the information contained in an applicant’s Form U4 (the Uniform Application for Securities Industry Registration or Transfer). Firms would also be required to search public records to ensure the data is correct.

In essence, when a person applies to work for a brokerage firm, either as a new employee or as a transfer from another firm, the hiring company would have to confirm that the job candidate is not misrepresenting himself. This confirmation process would include checking to see if the candidate is hiding any past criminal activity.

FINRA further proposes searching all publicly available criminal records for any registered individuals who have not been fingerprinted in the last five years. The regulatory body then intends to conduct periodic reviews to ensure the information provided to the public is accurate. FINRA operates the BrokerCheck website, which allows individuals to do a background check of a broker. The database has been the subject of criticism for omitting red flags about brokers.

The majority of brokers and advisers are honest, but, as is the case with any field, there are also some who are malfeasant. The difference between a fraudulent broker and, say, a fraudulent car mechanic is the magnitude of the financial damage they can inflict. A mechanic out to rip off his customers might cost you hundreds or perhaps even a few thousand dollars. A broker out to rip off his clients can cost you a far larger sum. In both cases, the bad apples are in the minority, but it does not take a very large percentage of unethical professionals to give an industry a bad name or to create a long list of unfortunate victims. Thus, it is important that you ask questions and do background research.

A mechanic may have reviews from customers online. A broker requires a closer look. FINRA’s BrokerCheck is a good place to start a background search. Check with your state’s securities regulator. Then do an online search (e.g. Google) on the broker’s name. Also ask direct questions to the broker (or adviser or planner) about his credentials, professional background and how he will be compensated. Then ask how easy it will be to withdraw your money and what kind of communication you can expect. If you don’t get direct answers, go elsewhere. It may be even helpful to “interview” a few brokers or advisers to get a comparison.

As far as whether you should employ a financial professional (be it a broker, adviser or planner), there is not a straight answer. About 30% of AAII members do. The biggest benefit a good financial professional provides is to keep you focused on your long-term goals and help you avoid big mistakes. Though it may seem ironic for a representative of an organization devoted to educating and empowering individual investors to bring up the topic of hiring somebody to manage your portfolio, you will get far more benefit from a financial professional if you have a good understanding of investing. Being educated about investing can also help you identify the bad apples in the financial services industry—just as knowing the difference between a bad battery and bad starter motor can help you identify the fraudulent mechanics.

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The Week Ahead

I will speak to our Portland chapter this Saturday and our Puget Sound chapter on Wednesday. Not in the Northwest? Visit our local chapters page to find a meeting near you.

Earnings season continues, with over 75 members of the S&P 500 scheduled to report. Included in this group are Dow components Pfizer Inc. (PFE) on Monday and The Walt Disney Company (DIS) on Tuesday.

April’s ISM non-manufacturing index figures will be released on Monday. Tuesday will feature international trade figures for March. The first estimate of first-quarter productivity and costs will be released on Wednesday, along with the weekly oil inventories report. U.S. jobless claims for the week ending April 26 will be released on Thursday. No major economic figures are scheduled to be released on Friday.

The Treasury Department will auction $29 billion of three-year notes on Tuesday, $24 billion of 10-year notes on Wednesday, and $16 billion of 30-year bonds on Thursday.

Local Chapter Meetings

AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!


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AAII Sentiment Survey

The percentage of individual investors describing their sentiment about the direction of stock prices as “neutral” rose to its highest level since April 14, 2005, in the latest AAII Sentiment Survey. This is occurring as both bullish and bearish sentiment remain below 30%.

Bullish sentiment, expectations that stock prices will rise over the next six months, declined 4.7 percentage points to 29.8%. This is the third time in four weeks that optimism is below 30%. It is also the seventh consecutive week with a bullish sentiment reading below its historical average of 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 1.3 percentage points to 40.8%. This is just the second neutral sentiment reading above 40% in the past nine years, and, as noted above, the highest reading since April 14, 2005. The historical average is 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, rebounded by 3.4 percentage points to 29.4%. The historical average is 30.5%.

The streak of consecutive above-average neutral sentiment survey readings now stands at 17 weeks. This is longest such streak since a since a 24-week stretch between January 28, 1999 and July 8, 1999. Bullish sentiment’s current streak of seven consecutive weeks of below-average reading is the longest since a 13 week stretch between August 30 and November 22, 2012. Bearish sentiment is below its historical average for the 40th time out of 52 weeks.

Neutral sentiment remains at an unusually high level, or more than one standard deviation above its historical average. Even though the Dow Jones industrial average set a new record high yesterday, uncertainty about the short-term direction of stock prices continues to exist. Keeping some individual investors optimistic is the market’s resilience, economic expansion, the Federal Reserve’s tapering of bond purchases and low interest rates. Keeping some individual investors pessimistic are the events in Ukraine, the slow rate of economic expansion, Federal Reserve tapering and frustration with Washington politics.

This week’s special question asked AAII members what factor or catalyst is creating the biggest amount of uncertainty for how the stock market will perform over the next six months. The Ukrainian crisis was mentioned the most, named by more than 24% of respondents. Geopolitics was cited by an additional 13% of respondents. On the domestic front, U.S. politics (particularly the upcoming November elections) were named by 14% of respondents, while Federal Reserve policy and the state of the U.S. economy were each cited by 14% of respondents.

Here is a sampling of the responses:

  • “Much improved, but a ways to go.”
  • “Housing prices are moving up and sales activity is increasing.”
  • “Slowly getting better, depending on the market location.”
  • “It’s bubbly in a few areas, but not nationally.”
  • “Sellers are inching up to prices they commanded years ago, but income has stagnated for many buyers. Not a great scenario.”

This week’s Sentiment Survey results:

Bullish: 29.8%, down 4.7 points
Neutral: 40.8%, up 1.3 points
Bearish: 29.4%, up 3.4 points

Historical averages:

Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%

Take the Sentiment Survey.
AAII Asset Allocation Survey

Investors kept their portfolio holdings essentially unchanged for the third consecutive month, according to the April AAII Asset Allocation Survey. Equity allocations remained above average, while fixed-income allocations stayed below 16% for just the third time in five years.

Stock and stock fund allocations declined 0.2 percentage points to 67.0%. April was just the third month since September 2007 when equity allocations were at or above 67.0%. Last month was also the 13th consecutive month and the 15th out of the past 16 with equity allocations above their historical average of 60%.

Bond and bond fund allocations declined 0.1 percentage points to 15.6%. This is just the third time since 2009 that fixed-income allocations are below their historical average of 16%.

Cash allocations increased by 0.3 percentage points to 17.4%. April was the 29th consecutive month with cash allocations below their historical average of 24%.

The lack of change in portfolio allocations is occurring at a time when a high percentage of individual investors describe their six-month expectations for stock prices as “neutral.” While many AAII members are predicting stocks to neither rise nor fall over the next six months, many are also not viewing bonds or cash as more attractive alternatives.

This month’s special question asked AAII members whether a correction in stock prices (a drop of at least 10%) or a one percentage point rise in bond yields would cause a bigger loss in their portfolio. Nearly 80% of all respondents said a correction in stock prices would cause a bigger loss. The primary reason given as to why was a bigger allocation to stocks than to bonds (34% of all respondents). About 17% of respondents said they didn’t own bonds, while 10% of respondents said their bond holdings were short-term or are had less sensitivity to interest rate fluctuations. Just 3% of respondents said a one percentage point rise in bond yields would hurt their portfolios more than a correction in stock prices would.

April Asset Allocation Survey results:

Stocks/Stock Funds: 67.0%, down 0.2 points
Bonds/Bond Funds: 15.6%, down 0.1 points
Cash: 17.4%, up 0.3 points

April Asset Allocation Survey details:

Stocks: 32.7%, up 1.7 points
Stock Funds: 34.3%, down 1.9 points
Bonds: 3.0%, down 0.2 points
Bond Funds: 12.6%, up 0.1 percentage points

Take the Asset Allocation Survey.

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