The Economic Roots Of Beta Climates

May 30, 2009

The Economic Roots of Beta Climates. Expect a W!

How does Mr. Market know more than blue-chip economists and Wall Street experts? Before answering this question, we must make a distinction between big bank/broker research findings (Wall Street), which tend to err on the side of Ms. Rosy Scenario, and research that is independent of Wall Street. After that, we will address how independence can tell you if the beta climate is too hot, too cold or comfortable.

Six years ago, Wall Street and the Securities & Exchange Commission (SEC) reached a settlement on correcting conflicts of their client interest between their investment banking activities and investment research. This deal was supposed to clean up the Street. To a degree, it did, but it did not enhance the quality of Street macro and micro research.

The settlement required the funding of "independent research." It was an attempt to mend the losses had by investors who were "done in" from following the advice given by Wall Street firms during the late 1990s and the early 2000s. Around 1997, the Street began to wrap its equity recommendations around pro forma forecasts. Their make believe resulted in the Nothing but Nasdaq Bubble and then the Tech/Telecom Wreck, which precipitated the bear market of 2000-2002.

If you want good advice, leave the Street and hit the alleyways. Figure 5 ranks the top 15 equity (micro) research firms in 2008. Market Profile Theorems (MPT) was the to- ranked firm. MPT is a quantitative shop (quants). It provided more than 21,000 buy/sell recommendations last year.


Figure 5. Equity Research Rankings for 2008


Quants often foster high turnover rates that cut into their client returns, but with a 38.4% gross return in 2008, MPT clients have a lot to churn away before the No. 2 shop catches up. That said, American Tech Research's 206 recommendations are more executable and appealing to investors. Their 10.2% result was fantastic in a year with most equity indices down about 40%. You need to find a style/integrity fit before buying research. For me, firms ranked No. 2 through No. 10 are a better fit. Avoid outliers.

Small/independent shops dominated 2008 because they had great sell recommendations, which provided 100% of their positive results. Large shops tend to be too close to the views of Wall Street's biggest client firms. This culture hinders their ability to provide top-performing contrarian sell lists. The SEC cannot enforce away bias. Investors should avoid firms that provide very limited and low-quality sell lists.



Find your next ETF

Reset All