Secrets Of Success: Why professionals are full of the joys of spring

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The Independent Online

One of the key ideas that lies behind the science of behavioural finance is the observation that investors tend to place far more credence on recent data than they do on longer-term trends that may be of greater significance. This is a phenomenon analysts have discovered applies in almost the same measure to professional investors as it does to gifted amateurs.

One of the key ideas that lies behind the science of behavioural finance is the observation that investors tend to place far more credence on recent data than they do on longer-term trends that may be of greater significance. This is a phenomenon analysts have discovered applies in almost the same measure to professional investors as it does to gifted amateurs.

The strong market rally during April, with most stock markets rising by more than 10 per cent, seems to have had a significant impact on investor confidence. Suddenly, most professional investors seem to be full of the joys of spring, and that enthusiasm is even beginning to make inroads into the private investor market.

A seminar for IFAs in London this week, organised by the fund-of-funds experts at Jupiter Asset Management, offered interesting evidence on this point. Most of those present said they expected the UK stock market to finish the year higher than it started 2003. One IFA present said there was evidence of private investors venturing back into the market for equity funds, after a long period during which bond and cash funds have largely swept all before them. .

Most of the five professional fund managers present shared an optimistic outlook. One, Anthony Bolton of Fidelity, went so far as to say without equivocation: "I think we are in a bull market which started in March." He is not the kind of fund manager who normally sticks his head over the parapet, least of all with general market predictions; his reputation rests on his ability as a stockpicker, not as a reader of the market runes.

The first point he made is that you cannot expect to know why the market has turned at the time it turns. It is only subsequently that the supporting evidence appears.

The market, we all know, is a lead indicator: it predicts rather than follows future turns in the economic cycles, including several turns that do not then happen. So if you are scouring the data for signs of an important upturn in corporate profits, or economic growth, you will usually fail to find them, at the time.

So if you want to take a view about the market overall, you have to rely on a mixture of experience, intuition and technical signals. One of the pieces of evidence that Mr Bolton referred to was the number of share-price charts that were showing clear signs of bottoming out in recent weeks.

If those trends continue, it provides further evidence that the worst of the bear market may finally be over. Mr Bolton's conclusion was that "it feels like the start of a bull market to me". In other words, the kind of things we are seeing at present, including the private investors' retreat from the equity market, are those you normally tend to see at turning points in the market.

But surely, he was asked, as a well-known contrarian investor, would he not expect to find much less bullishness amongst the professional advisers in his audience at this point? His answer, which I found a convincing one, was that the bullishness of professionals would be a more convincing reverse indicator if the bullishness was actually reflected in the portfolios of their clients as well as in their public utterances.

In practice, few IFA clients have been anywhere near the equity market for months; and not one, according to a show hands at the seminar, had any clients with more than 70 per cent of their portfolios in the stock market. If the market continues to show strength through the summer, not only will it defy the tired old market wisdom "sell in May and go away", it will also force many institutional investors to scramble to catch up with a market that suddenly seems to be going away from them.

As noted here before, it is in the late stages of a bear market that active professional investors are most at risk of underperforming the rest of the market.

Brian Ashford-Russell, the technology fund specialist at Polar Capital Partners, speaking at the same seminar, said there is unlikely to be any sudden resurgence in the technology sector. If history is any guide, he said, it normally takes about five years for the full effects of a preceding bubble to work their way through.

We are still only three years into the workout stage of the technology sector cycle, though historical precedent again suggests that the next two years will continue the bottoming-out process rather than see further sharp price falls.

Edward Bonham Carter, Jupiter Asset Management's joint chief executive, pointed to the long-term trends in interest rates and yields on equities as evidence that some kind of turning point might now have been reached.

The ratio between the two suggests quite strongly, he said, that if investors are overlooking a specific risk to the present environment, it is likely to be renewed inflation rather than the spectre of deflation, at least in the United States and the UK.

The other encouraging feature of the market, he thought, is that there are still, despite the recent recovery in prices, several companies that trade on high multiples of cash flow. Something like 40 per cent of UK stocks have a cash flow yield at present more than 11 per cent. Few of the fund manager panellists at the seminar reckoned there would be many companies showing top line revenue growth at this point.

The most recent survey of professional investors in my newsletter Intelligent Investor, conducted a few days ago, also showed signs of renewed confidence amongst top professional investors.

I would not say there was as much optimism in this elite group as there has been in the professional community as a whole. But it does all show how sentiment may be beginning to turn, and how contagious that mood can be when it follows a period of striking market gains.

davisbiz@aol.com

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