Debunking the myth of the stock picker’s market

As if trying to time the stock market isn’t hard enough, it’s recently become trendy to try and predict when stock pickers will have their day in the sun again.
Both InvestmentNews and The Wall Street Journal ran articles this week about portfolio managers’ and advisers’ warming up to active managers because a “stock pickers” market is already here or could be right around the corner.
The “stock pickers” market, the legend goes, is driven purely by fundamentals, making it easy to pick winners and thereby kick the pants off an index.
Since the financial crisis, however, stocks have been driven by big macro events, like the eurozone crisis or the debt ceiling, making them all move in unison either up or down. That has largely rendered moot money managers’ ability to pick the companies that will outperform.
At least that’s the most popular excuse for why nearly three out of four large-cap mutual funds underperformed the S&P 500 from 2009 to 2012, according to Standard & Poor’s.
The problem is that correlation, which measures how stocks move in relation to each other, doesn’t actually tell you anything about the opportunities available to portfolio managers.
Even though correlations between stocks historically have been high, meaning stocks generally have moved in one direction — up — since the market bottomed, that doesn’t mean they’re moving at the same speed.
Every year since 2008, more than half the stocks in the S&P 500 have finished the year with a return of 10 percentage points or more or less than the index, according to research by The Vanguard Group Inc.
That means there are at least 250 stocks in any given year that a portfolio manager could choose to overweight or underweight to boost returns versus the index.
This year has been no different. Through Aug. 19, 262 companies have returns that are more than 10 percentage points more or less than the S&P 500’s 15.4% gain, according to Lipper Inc.
For managers looking to make big bets, 165 companies from the S&P 500 have had a return of more than 10 percentage points better than the index, year-to-date. That includes well-known ones such as Netflix Inc. (up 180%), Best Buy Co Inc. (up 162%) and TripAdvisor Inc. (up 65%).
If making big bets isn’t your thing, there has also been 97 companies that have underperformed the S&P 500 by more than 10 percentage points. The list includes household names like of J.C. Penney Co. Inc. (down 32.9%), U.S. Steel Corp. (down 23.9%) and Expedia Inc. (down 23.3%)
Even with the majority of stocks offering managers a way to outperform one way or another, 56% of the 287 large-cap-core mutual funds tracked by Lipper are trailing so far this year, which shouldn’t come as much of a surprise.
Management fees and trading costs, a general unwillingness to make big bets, and the fact that the market is hard to beat without any head winds have always been active managers’ biggest problems. Correlation or lack thereof has nothing to do with those factors.
This isn’t to say that everyone should be all passive all the time, but when it comes to picking an active manager, their process, their fees, and a long-time horizon should be the biggest factors in choosing them, not whether or not it’s a “stock pickers” market. If you believe in active management, the data show it’s always a “stock pickers” market.