Figure 1-1

The Dart Board Beats The Pros

How Mutual Funds Fared 1987 - 1997*

Aggressive Asset Equity- Growth & SmaU

Growtli Allocation Income Grewtli Income Company

•Returns measured to September 30, 1997

Sources of data: Upper Analytical Services and Momingstar

prices in periods of panic, when the public sells them with no regard to value. The portfolio manager, the legend continues, sells stocks in periods when the public is enamored with them, pushing prices to mania levels.

Evidence compiled by the Securities and Exchange Commission suggests otherwise. The much abused and supposedly emotional individual investor sold securities near the 1968 market top and bought at the market bottoms of both 1970 and 1974. The institutional investor, on the other hand, bought near market tops and sold at the bottoms. In the 1987 crash, the individual investor was scarcely involved. According to SEC records of the crash, almost all of the selling was done by professionals. The market panic in the third quarter of 1990, following the Iraqi invasion of Kuwait, demonstrated once again that professional, not individual, investors were the largest, and often most desperate, sellers.

The same pattem shows clearly with mutual funds. These funds should be fully invested near market bottoms-with low cash reserves-after snapping up bargains dumped on the market by panicky individual investors. Conversely, near market tops, they should sell heavily, accumulating large cash reserves by taking advantage of the speculative whims of an excited public. Again, theory and practice diverge widely. Rather than supporting stocks when prices plummet, they get trampled at the exit. When prices soar, they buy aggressively. The pros seem to judge market direction poorly.

Are investment advisory services that sell advice to the public by subscription any better? Many of these services, as they readily advertise, aim to get you in near the market bottom and out near the top. Would you have profited by subscribing to such services? Again no. For years, pundits, myself included, have publicly charted an almost perfect correlation between the investment advice given and the future direction of the market.

Unfortunately, it is almost perfectly wrong. When advisors go one way, markets go the other. As the averages approach their highs, larger and larger numbers of advisors become bullish, and as they move toward their lows, an increasing number stampede for the exits. The fact is so well known on Wall Street that many of us now use the advisory services as a contrarian indicator. If over 70% of services wax bullish- look out-markets are approaching a high. Conversely, if 70% are terrified of the bear, its time to buy. This was tme at the market high in 1972, when 71% of the services were bullish, at the bottom of the worst market break since the war in late 1974, when 70% thought the market was heading south, andjust before the Great Bull Market began in the spring of 1982. Instead of the market following the advisors, the advisors seem to unerringly follow the market.

What then do we make of these statistics? Some skeptics and financial writers (the two being often difficult to distinguish) beheve the figures indicate professional money management is inept. The most important service investment management could perform for clients, they might say, would be to walk their dogs or perhaps advise them on their business attire. Other skeptics have cheerfully suggested that blindfolded chimpanzees heavily fortified with margaritas could outperform the experts by throwing darts at the stock pages.

But humor aside, the knowledge that professionals do not outperform the market has been widely known for a generation. This is before considering the effects of the investment revolution. Adjusting for the new financial order, the results only get worse, putting the investor even fur-

The New Conquistadors

Some of the countrys best academic minds looked at this problem soon after it was recognized in the early sixties. The financial professors found a radical new explanation of why professionals do not perform better. For a while, at least, this seemed to be the stock markets equivalent of the theory of relativity, the smashing of the atom, or maybe even the fountain of youth.

Using enormous computer power, by the standard of the day, they put forward an all-encompassing theory. Markets, they said, are efficient. That meant that stock prices are determined by the thorough and diligent work of the brightest analysts, money managers, and other investors. The combined knowledge of thousands of these experts kept prices exactly where they should be. No one can beat the market consistently. It might be hard to accept what the professors said, but they had proven this truth overwhelmingly. Besides, there were benefits. You no longer had to waste endless time and energy trying to outguess the market. No reason to get stressed out; it just couldnt be done. But you could still get higher retums. All you had to do was to take more risk.*

So there it was. Forget the sweating, studying, and tossing and tuming you used to do at night trying to buy the right stocks. It didnt help a hoot. Investing had been promoted to a science with the mathematical precision of quantum physics. Just sit back and enjoy the ride.

* As they defined it, which well look at in chapter 3.

ther behind the eight ball. No, the odds of winning big do not appear to lie with this group, regardless of how much media attention they get or advertising they churn out.

I opened this chapter by assuring you that investors have an excellent chance of bearing the market. Now we see even the experts cannot keep up with it. Something obviously is out of whack here, as financial academics began to realize several decades back.

A new world has since been discovered and mapped. The ivory tower explorers went sailing over seas of data, rather than uncharted oceans, but the attitude was similar. They were conquering new intellectual realms for the greater glory of academe, making sweeping pronouncements in the process, and coming up with unbeatable odds-or so they said. Natives-money managers, analysts, investors-beware. You are about to be conquered.