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A New Leading Indicator Of Stock Market Direction

Click to enlarge I just discovered a new leading indicator of U.S. stock market direction, and I’d like your thoughts on its efficacy. The following graph shows the history of the indicator going back to 1998. It forecast the market declines in 2000 and 2008, and is currently forecasting another market correction. A high indicator precedes a market sell-off. A low indicator signals a recovery, and a flat indicator is a predictor of average returns. The returns shown in the graph are the average quarterly returns over the year following the indicator date. They’re rolling 4-quarter averages. Click to enlarge The Indicator I created and maintain the Surz Style Pure indexes that break the stock market into large, middle and small, and within each of these sizes into value, core and growth. Morningstar style boxes use a similar approach, and were introduced several years after I launched my indexes. My index definition for large companies is the top 65% of the market. I sort the 6000 companies in the U.S. stock market by capitalization and start adding until I get to 65% of the total capitalization. I’ve recently noted that the breakpoint for large companies has recently reached its highest point ever – $22 billion. A large company, by my definition, is currently above $22 billion. There are currently 227 U.S. companies that meet this rule, with total capitalization of $16 trillion, which is 65% of the $25 trillion total market size. This large company breakpoint is the indicator shown in the graph above. It has successfully predicted the last two market cycles, and is signaling that a major market decline started last year with more to come. This supports my prediction for a 19% loss in 2016 based on pure fundamentals. So why does this breakpoint indicator work, and most importantly will it work this time? Here are some possible explanations: Mega cap market domination is cyclical, and the (capitalization-weighted) market goes where the mega caps go. It’s just another measure of overpricing, big companies becoming too expensive. Investors flee to the safety of big companies when they’re worried, and worry ultimately turns into panic. It’s not a leading indicator at all. The apparent correlations are spurious. What do you think? Have I stumbled onto something? What is it telling us about 2016? Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

The New Definition Of Investment Manager Success: How To Tell Who’s Winning

It’s become self-evident recently that peer groups suffer from “loser bias” because the majority of active managers underperform their benchmark. Beating the losers is not a “win.” Peer group comparisons simply don’t work anymore. Beating the benchmark is a good beginning, especially when combined with a statistical test of significance called a “Success Score.”. If intermediaries continue to use peer groups, as is likely the case, investors will continue to be disappointed because they’ll continue to hire losers. In the “good old days,” investment managers had two shots at winning. They could beat their index or they could beat the median manager in their peer group. That peer group thing doesn’t work anymore. Due to the popularity of passive ETFs and the emergence of Robo Advisors, there is only one pertinent yardstick – beating the benchmark. Unfortunately , less than 20% of active managers achieve this measure of success. This active manager failure renders peer groups worse than useless. It is now well-understood that peer groups suffer from “loser bias,” in addition to survivor and classification biases. Loser bias is the reality that more than 80% of the managers in a peer group are losers since they fail to beat their benchmarks. Beating the losers is like winning the prize for best ballerina in Waco. Investors need to demand better. So the new definition of “success” is beating the benchmark, but there’s more to winning than this simple measure. We want to know that success is not just luck, that it is likely to repeat in the future. That’s where statistics and “Success Scores” come in. We call it a “win” if the outperformance of the benchmark is statistically significant. Success Scores are the statistical significance of benchmark outperformance. A facsimile of a peer groups is created by forming all the portfolios that could be formed from the stocks in the index. A ranking against these Success Scores in the top decile is significant at the 90% confidence level – we can be 90% sure that it wasn’t just luck. Success Scores are bias free and available a day or two after quarter end. It’s not enough to beat the benchmark. An investment manager needs to beat his benchmark by a significant amount to be a true winner. Success Scores are especially worthwhile for hedge fund managers since peer groups of hedge funds are just plain silly. The tradition of disappointment in active managers will continue if clients (investors) allow it to continue. Clients deserve better,but they need to know how to get it. Investors need to understand their advisor’s due diligence process and to be concerned if it includes peer group comparisons. In other words, investors should seek out advisors who employee contemporary due diligence tools if they are relying on their advisor to select good investment managers. Here are some facts every investor should know: Based on Dr. William F. Sharpe’s “Arithmetic of Active Management”, 50% of active managres should beat their benchmark. The fact is only 20% beat their benchmark, far below expectations. The search for “alpha” uses regression analysis. “Alpha” is the Greek letter for the intercept. It is well-documented that it takes at least 50 years for a manager with “average” skill to deliver a statistically significant alpha. By contrast, “Success Scores” can provide significance for very short periods, like one year. 70% of managers are active, not passive. Towers Watson, a prestigious investment consulting firm, says this number should be closer to 30%. There are too many active managers. Approximately 40% of funds in a peer group don’t belong because they’re different. This problem is called Classification bias. For hedge fund peer groups, most funds don’t belong because hedge funds are unique, which by definition means without peers. Knowledge is power. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

CFA Institute Study: Disclosing Fees, Conflicts Vital To Adviser-Client Relationship

What do investors want? It’s an issue of critical importance — and concern — to CFA Institute, an organization committed to the highest standards of ethics, education, and professional excellence in the investment profession. And at no time in the history of the investment management industry has this question mattered more. Longstanding business practices are under scrutiny, stoked by acrimonious debates in the United States over the duty owed by the person giving investment advice, and by the availability of low-cost automated financial advice globally. These issues are poised to change the investment industry as we know it. Simply put, understanding the needs of investors is critical to strengthening client satisfaction and loyalty in a rapidly evolving industry. For these reasons, CFA Institute partnered with global PR firm Edelman on From Trust to Loyalty: A Global Survey of What Investors Want . In it, we investigate trust within the investment community, surveying retail investors and institutional investors around the world to examine how much they trust the financial services industry, and comparing this to the general population surveyed in the annual cross-sector Edelman Trust Barometer . While investors have a slightly more positive view than the public, our survey shows there is much more room for improvement. When asked if they trust the financial services industry to do what’s right, 61% of retail investors agreed, 57% of institutional investors agreed, and only 51% of the public agreed. Moreover, the number from the public is up 8% from five years ago — an improvement, but hardly impressive in absolute terms. These findings have practical implications for the investment management profession. The survey also explored what dimensions influence that level of trust by giving respondents actions to rank in importance and satisfaction. The gaps are eye-opening and provide a roadmap for firms who wish to strengthen their value proposition and build loyalty with investors. Paul Smith, CFA, president and CEO of CFA Institute, has argued that shortcomings like these and a lack of trust are factors that hold the investment industry back. “Building trust requires truly demonstrating your commitment to clients’ well-being, not empty performance promises or tick-the-box compliance exercises,” he has said. “Effectively doing so will help advance the investment management profession at a time when the public questions its worth and relevance.” Assessing the Gaps Between What Investors Want and What They Get Both retail and institutional investors share the view that financial professionals are falling short on issues of fees, transparency, and performance. Among retail investors, the most important actions from an investment firm are that it “fully discloses fees and other costs” and “has reliable security measures.” These even surpass protecting their portfolio from losses. Among institutional investors, “acts in an ethical manner” rated as the most important attribute, followed by “fully discloses fees and other costs.” That’s not to say that performance is unimportant — 53% of retail investors and 60% of institutional investors cited “underperformance” as the biggest factor that would lead them to switch firms. This was followed by “increases in fees,” “data/confidentiality breach,” and “lack of communication/responsiveness.” Fee Transparency Even More Important Than Returns The survey reveals that the biggest gaps between investor expectations and what they receive relate to fees and performance. For many investors, understanding fees — how much they are paying and what they are paying for — ranks above returns in their priorities. Seventy-nine percent of retail investors said it was important to them that their investment firm clearly explain all fees before they were charged, and 73% said generating returns similar to or better than other firms was important. Click to enlarge Retail investors say they are prepared to pay fees, even higher fees, if they feel these costs will add value or deepen existing services. In what areas are retail investors willing to pay more? Better protection from portfolio losses (38% say they would pay more for this) Reliable security measures to protect their data (35%) Investors also want more context to understand specific portfolio management strategies, reflecting their increasing desire to be engaged. The top client service action retail investors want is that a firm “helps me understand why my portfolio is positioned the way it is.” This is expected by 70% of retail investors, but only 46% say investment firms are adequately delivering on this — a large gap that firms should close. Disclose Conflicts of Interest Investors surveyed also want upfront conversations about conflicts of interest, with fees structured to align with their interests. They want to be sure that their managers are acting in their best interest at all times, and it is in the best interest of investment managers to clearly communicate their commitment to conflict management and resolution. As regulators and industry professionals alike grapple with the conflicts of interest associated with a variety of investment advice business models, investor preferences are clear: They want the best solutions for their unique needs, and not just the lineup of products that the adviser can receive compensation for selling. Retail investors surveyed prefer to have access to the best product for their unique needs (76%), rather than choosing from a constrained set of products, even if choosing from constrained offerings would lower their out-of-pocket expenses for investment management (24%). Click to enlarge Institutional investors had similar priorities and concerns, and in addition, they identified gaps related to the depth of understanding an investment firm has in helping them solve their problems. For these investors, they expect a firm they hire to think beyond a specific mandate and show they truly understand their organization’s priorities, liability structure, and political dynamics. Rise of Robo-Advising The study reveals key regional and demographic differences in what investors value from financial professionals, with implications for robo-advisors. Looking ahead three years, the majority of investors in Canada (81%), the US (73%), and the UK (69%) say they will still value the guidance of an investment professional to help them versus having the latest technology and tools. However, the majority of retail investors in India (64%) and China (55%) and half of investors in Singapore believe having access to the latest tech platforms and tools will be more important to executing their investment strategies. Younger respondents also strongly preferred technology to human guidance, so this is an important trend for the future. What does this mean for financial professionals? It’s simple: Investors expect more than just performance. While markets may be uncertain, there are many factors that investment professionals can control in how they conduct their business and work with clients — and these are very valuable. From transparency around fees and investment decisions to aligning their interests with their clients’, investment firms have great potential to build greater trust among investors. Show your commitment to advancing ethics and trust: