Stock Picking Risky Business in 2009

My 25-year-old daughter demonstrated she was The Master of the Obvious when she told me “The stock market was less than ideal in 2008.”
The collapse in stock prices last year spared no one as share prices fell around the world. All 47 markets tracked by MSCI lost ground, with 23 countries experiencing losses in excess of 50 percent (total return measured in dollar terms). The U.S. finished seventh, with a total return of 37.6 percent.
Among the 10 largest firms in the S&P 500 Index at year-end 2007, there was a wide range of outcomes for 2008: Bank of America and General Electric significantly underperformed the market, with price declines of 65.9 percent and 56.3 percent, respectively; while Johnson & Johnson shares fell only 10.3 percent and Wal-Mart rose 17.9 percent.
Other prominent firms experiencing dramatic losses included American International Group (97.3 percent), Citigroup (77.2 percent), Fannie Mae (98.1 percent), Merrill Lynch (77.6 percent) and Wachovia (85.4 percent). Since all of these firms are constituents of a market portfolio, the easiest way to outperform the market in 2008 was to avoid or underweight these big losers.
It seems plausible that last year’s financial meltdown was so extensive and so well-advertised that investment experts would have found it relatively easy to outperform the broad market by selecting the right stocks or sectors. A review of several widely read sources of advice suggests that, in at least one respect, there was nothing unusual about 2008: it was just as hard as ever to outperform the market.
Here are a few samples from the “where to invest now” articles that were published a year ago:
? For its annual “Where to Invest” issue, SmartMoney scoured the globe for appealing opportunities and identified a dozen companies “likely to increase profits in a world filled with trouble spots.” Outcome: From the recommendation date of Nov. 2, 2007 through Dec. 31, 2008, the average share price decline of the 12 named stocks was 52.4 percent, compared to a drop of 40.2 percent for the S&P 500 Index and 35.4 percent for the Dow Jones Industrial Average. Performance varied widely: Wells Fargo (WFC) shares declined 8.8 percent, while Genworth Financial (GNW) plummeted 88.9 percent. (Pearlman, Russell. “Where to Invest 2008.” SmartMoney, January 2008.)
? A prominent money manager and self-described “contrarian” investor wrote in a January 2008 Forbes column: “You have to choose carefully here, since many financial stocks will not come back for a long time, if ever. … The safest plays are among the big banks.” Outcome: Prices for the seven financial stocks mentioned in the column, including Citigroup, Freddie Mac and Wachovia, declined an average of 74 percent in 2008. (Dreman, David. “Seize the Day.” Forbes, Jan. 8, 2008. Wall Street Journal, New York Stock Exchange 2008 Trading Summary, Jan. 2, 2009.)
? A money manager who applied detailed quantitative analysis to successfully predict the crash of 1987 was expecting a gain of 20 percent for the S&P 500 in 2008: “Our models show the S&P 500 is undervalued by 25 percent. … Our indicators are extremely bullish.” Outcome: Disappointment. (Tergesen, Anne. “What the Pros Are Saying.” Business Week, Dec. 31, 2007.)
? Nvidia was featured in a “Company of the Year” cover story by Forbes, which reported that the firm’s sophisticated graphics chips, the brains inside popular products such as the Sony PS3 game console, were finding new applications in science and industry. Outcome: Nvidia shares fell 76.3 percent in 2008. (Caulfield, Brian. “Shoot to Kill.” Forbes, Jan. 7, 2008. Wall Street Journal, New York Stock Exchange 2008 Trading Summary, Jan. 2, 2009.)
? A successful former hedge fund manager and globetrotting author argued correctly a year ago that a recession in the U.S. was already under way. He was bullish on commodities (“the commodities bull market still has years to go”) and China (“there are gigantic opportunities in China and gigantic changes taking place there”). Outcome: The Dow Jones-AIG Commodity Index declined 37 percent in 2008, the worst year since its inception in 1998, and total return for the S&P GSCI Index was 46.49 percent. China ranked 26th among 47 world stock markets tracked by MSCI, with a total return of 50.83 percent. In fairness to the forecaster, he was making a long-term recommendation, not a prediction for the next 12 months. Investors who overweighted their portfolios in 2008 with commodities or Chinese stocks are hoping he’s right. (Barclays Global Investors., accessed Jan. 7, 2009. Cui, Carolyn. “Commodities: Great—Then Ugly.” Wall Street Journal, Jan. 2, 2009. O’Keefe, Brian. “Hog Wild for China.” Fortune, Dec. 24, 2007.)
? Fortune editors sought to identify the “true artists of today’s mutual fund world” and selected six “standout managers” through a careful selection process. Fortune was sufficiently confident of their efforts that they believed “having even one of these names in your portfolio would reflect a savvy eye.” Outcome: Compared to a passively managed blend consisting of two-thirds DFA U.S. Large Company Portfolio and one-third DFA Large Cap International Portfolio, total return for the six actively managed selections (four U.S., two international) was more than 200 basis points lower for the year ended Dec. 31, 2008. Maybe next year. (Morningstar., accessed Jan. 6, 2009. Rosenburg, Yuval. “Old Masters and New Classics.” Fortune, Dec. 24, 2007.)
It’s obvious that the really smart and well informed stock pickers got mud on their faces in 2008. So, if stock picking didn’t work in 2008, when will it work? The answer is pretty obvious: NEVER. Nobody can consistently pick stocks and nobody can time the market. There will be years when “luck prevails,” so, do you want to depend on “luck” with your financial future?
How do we expect the stock and bond markets to perform in 2009? We have no clue. The markets are the markets, and predicting their short-term outcomes is best left to the village idiots on CNBC and working for Wall Street firms. We do anticipate that the banking crisis will eventually be resolved, credit markets will open up and “Free Enterprise Capitalism” will reward, over the long-haul, those investors willing to bear the risk/volatility of stocks.
It is impossible to ignore the news about the economy and not think about how the stock market is going to perform. In light of this observation, we ask ourselves, “Is all of the bad news about the economy already priced into the market?” We don’t know the answer to this question either. Nobody does.
What we believe makes sense is “Stocks for the Long Haul” and “Bonds for the Short Term.” Utilizing these assets to create A Plan consistent with your financial situation is an imperative.
Regarding “Stocks for the Long Haul,” it may be helpful to consider Warren Buffett’s perspective: “Betting against free enterprise capitalism doesn’t seem to work very well.”
We’ll stick with Warren and put our chips on “Stocks for the Long Haul” without concerning ourselves about 2009 as a definitive statistic. ?′
Tom Warburton is principal of Warburton Capital Management.

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