Analysis: Stock-picking makes a comeback as macro tides fade
Tuesday, 07 February 2012 | 00:00
Stock-picking once again matters on Wall Street.After a year in which stocks moved in near-lockstep regardless of individual merit, the herd mentality is crumbling away.
The move away from a frenzied rush in and then back out of the market is a welcome sign for stressed-out fund managers and lay investors alike.
"If I think something looks cheap I'm more prepared to own it because I think that will matter. Before, I would throw up my hands and say, 'So what? If it's perceived as a higher risk asset then it's going to crater with any nasty news out of Europe,'" said Art Steinmetz, chief investment officer at OppenheimerFunds in New York.
The change reaffirms the diversification strategies that underpin trillions of dollars worth of savings meant for college tuition and retirement. When just about everything is moving in the same direction, investors have fewer ways to cushion market swoons.
In 2011, daily activity in individual stocks was less dependent on company reports than on action in European government debt markets, and the equity, currency and commodities markets traded in tandem.
Now that stocks are going their own way, it's been good for so-called active fund managers, those who decide what individual stocks are best to hold rather than follow an index.
In January, about 70 percent of active managers outperformed the S&P 500, compared with just 23 percent in 2011, according to Bank of America/Merrill Lynch data.
"Our traders have had their best month since 2009 because of the fall-off in correlation," said Don Bright, a director and trader at Bright Trading in Chicago. "We're doing a lot of homework on earnings since fundamentals are driving individual stocks again."
Correlations, a measure of how tight a relationship individual securities or entire markets have with each other, have fallen sharply since the volatile trading days of last summer, according to Marko Kolanovic, head of equity derivatives at JPMorgan Chase & Co.
"We are currently witnessing the largest drop in realized correlation in the recent history of the U.S. stock market," he wrote in a recent note to clients. The rolling 10-day correlation of S&P 500 stocks had reached 80 percent in the fourth quarter of 2011, and fell to around 10 percent in early January, according to the bank.
Rob McIver, co-portfolio manager for the $3.8 billion Jensen Quality Growth fund (JENSX), said he grew increasingly frustrated over the second half of last year as he watched the companies in his portfolio increase earnings and yet suffer with the broad stock market.
McIver finished the year with a loss of 1 percent after dividends, compared with a 2 percent gain for the S&P 500.
One of his holdings was Emerson Electric (EMR.N), which sagged throughout the spring and summer as the euro zone crisis worsened. Strong second-quarter results didn't interrupt the trend.
"Emerson was almost like the canary in the coal mine," he said. The stock lost 18 percent in 2011; it is up more than 12 percent so far this year.
ALL IN VS. ALL OUT
For their part, individual investors aren't yet convinced. Despite a 4.3 percent increase in the S&P 500 in January - the second-best month since the end of 2010 - trading volume is down 15 percent from a year ago.
Volatile, correlated trading amplifies the post-flash crash suspicions of many retail investors who see markets as the playthings of big money with the resources to hire legions of PhDs and use expensive technology to keep up with high-speed trading.
Cliff Downing, 53, a small business owner in Wilburton, Oklahoma and a stock picker since the age of 10, has sold most of his stocks and closed out his brokerage accounts since 2008.
"On top of working in the major markets I used to like the (over-the-counter) Pink Sheets but I don't do any of it anymore. I've liquidated everything and moved things to other places," he said.
Since the financial crisis began to get a grip at the start of 2008, investors have pulled more than $400 billion from U.S. equity funds, and the figure keeps growing, with $7 billion withdrawn so far this year, according to the Investment Company Institute.
"Prior to the financial crisis, it was easy to have the view that you could focus more on the micro and individual companies and be fine," said John Roth, the manager of the $6.5 billion Fidelity Mid-Cap Stock fund (FMCSX) and the $1.8 billion Fidelity New Millennium Fund (FMILX). "But the last four years have shook the system."
For now, those worries have abated, and stockpickers are in a position to thrive if Europe's debt talks proceed and U.S. economic figures continue to improve.
"The market is starting to trade stocks based on underlying fundamentals," said Sudhir Nanda, portfolio manager of the $189 million T. Rowe Price Diversified Small Cap Growth fund (PRDSX).
"Autos and the auto sector were improving all the time last year, but the stocks were getting punished because people were so worried about risk," said Nanda. His fund has positions in auto suppliers TRW Automotive (TRW.N) and Tenneco (TEN.N), which were both hit hard in 2011 on global economic concerns.
So far, 2012 has been better for them. TRW and Tenneco are both up 24 percent after losing 38 percent and 27 percent in 2011.
Some analysts caution that the return to profitable stock-picking could be short-lived.
"The sense of real panic about some kind of meltdown in Europe has abated," said Jonathan Golub, chief U.S. equity strategist at UBS. "But I think at the end of the day that this is going to be another year where the macro is going to matter."
Fund managers looking to distinguish themselves from others now have to contend with this quarter's earnings trends, which show a lot of companies suffering declining revenue and a reduced number of companies beating earnings forecasts.
Derivatives strategists at JPMorgan Chase note that implied correlation - expectations for how tight the relationships between stocks will be in coming months - has only declined modestly.
That suggests investors are still hedging against a flare-up of troubles, likely from Europe.
"The European crisis, which is by no means resolved, is a pot that is at least not boiling at this point. It's a pot that's simmering," said OppenheimerFunds' Steinmetz. "That fear of transmission through the banks was what was keeping risky markets highly correlated. Now we can get back to fundamentals."