Secrets Of Success: Big investors play catch-up as rally strengthens

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The Independent Online

The latest stock market rally has caught out some big investors, leaving them scrambling not to miss the revival that is taking place with some vigour.

The latest stock market rally has caught out some big investors, leaving them scrambling not to miss the revival that is taking place with some vigour.

This is what usually happens when bear markets come to an end, as this one may be doing at last. But I have yet to be convinced we are quite out of the secular downtrend that has dragged the world stock market down by 50 per cent from peak to trough over the past three years. (In practical terms, for the medium-term investor, it does not really make much difference any more if we have one more downleg to go from the recent market lows, or not. If the market does fall a further 25 per cent from here, it will come back from there before five years are up).

It is always entertaining to watch the intellectual gyrations that are used to justify the fact that a pundit has changed his mind about what is going to happen next. All the great investors of the past have had the ability to change their mind within 24 hours if they catch a sniff of a market changing its mood. The smartest ones, such as Warren Buffett, whose annual meeting took place last week, also take the precaution of rarely, if ever, saying out loud what they think the markets are going to do next, though this is somewhat at odds with the marketing-driven focus of many fund management firms. For them, all publicity these days seems to be regarded as good publicity.

The remarkable thing is that being wrong more often than not does not appear to be a barrier to retaining a reputation as a guru on Wall Street or in the City: it would be interesting to speculate what might happen if big broking-firm strategists were held directly to account for the accuracy of their predictions. The debate about "rewards for failure" might then extend from corporate boardroom to the investment community. Some of the biggest and best known names in the market forecasting business are lavishly rewarded, despite having records which fail to stand up to serious critical scrutiny.

The only sensible motto a fund manager can adopt at potential turning points like the one we have seen in the past few weeks is that adopted by one of the leaders of the 1848 revolution in Paris. He famously declared about the rampaging mob: "Je suis leur chef: il faut que je les suive" ("I am their leader: I must follow them"). In the short term all investors must be trend followers. Most professional advisers have clients who tend to be furious if they miss out on strong rallies.

For non-professional investors, whose priorities are very different to those of the professionals, the risks come in different forms. In my experience, we all worry too much about changing our opinions or appetite for risk without having a plausible reason. We are uncomfortable taking a bullish stance when the newspapers are full of dire warnings about the risk of being in equities, or the terrible calamities attending our pension providers. Yet these are necessary conditions to profit from an unexpected rally. Intuition and experience are the main guides at this point: the real reasons why it is right to be bullish when markets turn only become apparent some time later.

Given that the market is at what I take to be a potential turning point, I was interested to read the comments this week of David Fuller, the technical analyst whose views I monitor on a regular basis. He said this week: "Every technician knows that stock markets are at a critical juncture," (which can be translated as saying "none of them is confident about which way they are heading next"). He adds: "The medium technical rally does not appear to be over on the basis of any actual market evidence." If it was, we would not still be seeing up-days that are stronger than down-days: or the market failing to go through its previous lows.

Two other indicators suggest to me that the market rally has some staying power. One is the strength of smaller company shares, which usually lead the way out of bear markets, though the fact that they show strength does not infallibly mean that a bear market is over. The latest monthly statistics from Standard & Poor's show that the average UK smaller companies fund was up by nearly 12 per cent in April; and the average European smaller companies fund was up by just over 10 per cent.

Looking at the three and five-year data for fund performance, the performance tables are dominated by gilts, other types of bond and property. It would be astonishing, going on impossible I would say, if the performance tables in either three or five years were to show a similar picture. Quite which category of asset will be on top then I have no idea, but the odds must now favour equities again making a reasonable showing in relative terms.

As for the rest of this year, another well-known phenomenon noted by Mr Fuller is that stock markets rarely do badly in the year before a US presidential election, for reasons that are not hard to find. This one looks like being no exception. At the start of May all the major US market indices were above their end-2002 levels. The old market adage says "sell in May and go away". There will be further bad patches this year, for sure, as no market recovers in a straight line, but this may be one year when even that hoary old chestnut does not hold true either.

The second indicator that has caught my eye in recent months is the number of highly savvy professional investors who are venturing back to the market, having sold their firms, or simply retired from the fray, during the last legs of the great bull market in 1999-2000. I know of at least five professionals I would put in this category who are starting new ventures. The way to judge their real feelings for the market is not by listening to what they say, but by looking at what they are doing to earn a livelihood. The omens on this score are also starting to turn more positive, it seems.

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