Bank of America & Merrill Lynch fines, those deceits, manipulations and frauds that we know about totaled $101 billion for the last 15 years. Of course, this behavior would be largely impossible for firms without giant sized budgets for buying congressional influence with lobbying and campaign contributions. My favorite Merrill fraud: "settling with FINRA for overcharging more than 47,000 retirement accounts & charities that invested in mutual funds--fined $97 million." Click below for corporate settlement table for BOA/ML. For entire table on corporate deceit, manipulation and fraud see https://goo.gl/JegFgd h/t Anonymous
Co-authored by Ron Granberg, CFA & John Lombardo, CFA of Bluewater Capital Management LLC
It has been said that there are multiple stages leading to the acceptance of a great truth. It may initially be dismissed as absurd, then violently opposed, and finally accepted as though it were never in doubt. Warnings of investment bubbles follow a similar pattern. Because valuations correlate poorly with returns over the subsequent one-to-two years, early warnings that valuations are becoming stretched are often dismissed as stocks surge higher. As valuations rise further into the stratosphere, such warnings draw the ire of most investment professionals, whose counterattack typically relies on new valuation criteria, arguments that historically sound valuation metrics are no longer valid, and talk of “new eras.” When the bubble collapses, investors are left with steep losses and self-recrimination as they realize the market was indeed seriously overvalued.
Currently, we appear to be in the second stage of truth regarding the bubble in US equities, the third in just the last 15 years. The current narrative rests largely on the fallacy that you “can’t fight the Fed,” its corollary that investors must buy equities due to absurdly low bond yields, and that price-to-earnings ratios remain reasonable. The problem with this narrative is that easy monetary policy is not prophylactic against bear market declines and simple trailing and forward price-to-earnings multiples are not reliable indicators of subsequent equity market returns.
First, let’s address the argument that you “can’t fight the Fed.” Simply put, you could have followed that mantra down the rabbit’s hole in each of the last two bear markets. During 2001, the Fed cut the Fed Funds rate from 6.50% to 1.75%, where it remained until a 0.50% cut in November 2002. From January 2001 through September 2002 the S&P 500 declined 36.71%. Similarly, the central bank lowered its benchmark rate from 5.25% to just 2% from September 2007 through April 2008, at which point, what turned out to be one of the worst bear markets in history was still being called a correction. By December 2008 the Fed had cut the rate to 0-0.25%, where it remains today. For those keeping score, from the Fed’s first rate cut in September 2007 through the market lows in March 2009, the S&P 500 fell more than 50%. In short, “fighting the Fed” can be challenging, but failing to do so in the aftermath of one of their liquidity driven bubbles can be damaging to your financial health. While Fed largesse can induce complacency and provide fuel for a bubble, it’s of no consequence whatsoever once investors begin to re-price risk.
Second, those suggesting market valuations are reasonable are either misinformed or disingenuous. We have often heard investment professional’s state that “valuations are not demanding,” yet such statements reference price relative to either trailing or forecasted earnings, neither of which correlate strongly with returns over the subsequent seven to 10-years. Lacking organic revenue growth, corporations have driven per share earnings higher through massive stock buyback programs (while the ratio of insiders buying to those selling is among the lowest in the last 15 years). Additionally, earnings have benefited from new all-time highs in profit margins despite weak revenue growth due to significant declines in labor and interest expense. Revenue will only be driven higher if consumer incomes begin to rise and that will likely be accompanied by rate normalization. Any further reduction in interest and labor expense would likely only occur if the economy returns to recession, further reducing revenue. In short, investors would be wise to remember that profit margins, among the most mean reverting statistics in finance, are likely to revert yet again. As such, today’s valuations are far more excessive that simple price/earnings ratios suggest. Meanwhile, valuation metrics such as Robert Shiller’s cyclically adjusted price-to-earnings ratio, i.e. CAPE, the ratio of company assets to their replacement cost, i.e. Tobin’s Q, or non-financial market capitalization-to-gross domestic product, are among their highest levels in history. Each is flashing serious warning signals and each correlates strongly with future returns.
In light of the aforementioned, one would expect investment professionals to be cautioning clients about the risk of a bear market in US equities. Why then are the vast majority screaming “you can’t fight the Fed” and telling clients that valuations are reasonable? The answer likely resides in self-interest and career risk. As Keynes noted, “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.” Additionally, there is the self-interest of the mutual fund industry, which collects enormous fees from the equity funds it manages. Simply put, their chief strategists are loathe to suggest significant reductions in client equity allocations and they likely wouldn’t have their jobs very long if they did. As a result, the investment industry’s response to each of the last two bear markets has essentially been “Who could have known? You can’t time the markets.” While not an advocate of market timing, the great Ben Graham noted that there are valuation levels as which investors “certainly should refrain from buying and probably would be wise to sell.” Today, if you aren’t concerned about valuations, you aren’t looking at the right metrics or simply don’t care to acknowledge them. Those that correlate strongly with long-term returns are at levels that in each and every instance have been followed by bear markets.
There are no valuation metrics that we know of that correlate well with returns over the subsequent 12-24 months. Yet market internals have deteriorated measurably this year. Nearly half of the stocks in the NASDAQ Composite are down 20% from their 52-week highs with the average stock in the index down 24%. Simply put, the benchmark’s solid year-to-date return is a function of the performance of a rather small number of its largest components. Similarly, about 40% of the stocks in the Russell 2000 are down at least 20%. Given the significant deterioration in market internals coupled with the excessive valuation exhibited by metrics that correlate well with long-term returns, prudent investors should aggressively reduce their exposure to US equity markets. Doing so will enable them to preserve capital and deploy additional money into equity markets when risk is far lower and potential returns much higher.
Barclays Advisers' New Performance Metric: Their Behavior
Bank Could Dock Compensation in U.S. Wealth-Management Unit for Misconduct
Updated Feb. 12, 2014 10:34 p.m. ET
The new pay model is part of Barclays's broad effort to clean its image. Associated Press
BarclaysBARC.LN -2.90% PLC is shaking up the way it pays its U.S. financial advisers, breaking with industry practice as the British bank seeks to clean up its image.
Advisers at the Barclays Wealth & Investment Management division in the Americas will no longer get paid solely on how much money they bring in. Going forward, their compensation could be docked for misconduct.
While the size of any such cuts remains to be seen, the new policy already has spurred some of the firm's roughly 275 U.S.-based advisers to look for jobs elsewhere, according to recruiters, and could make it harder for the firm to find new brokers.
Tom Lee, who heads the adviser unit, defended the compensation model that went into effect Jan. 1, saying the firm "remains competitive as it rewards talent and continues to pay for performance." He called the changes "industry-leading and an important step toward aligning our remuneration practices with our clients and shareholders."
The change is a small part of a global reshaping of London-based Barclays's business and practices, with the aim of polishing a reputation tainted in recent years by scandals, including involvement in efforts to rig benchmark interest rates and improper sales of insurance and other financial products. It also follows regulatory and internal criticism of the U.S. wealth-management unit's culture for allegedly putting boosting profits ahead of following rules.
Barclays's adviser network is tiny in comparison with those at big U.S. banks such asMorgan Stanley, MS -1.69% which has more than 16,400 advisers, and recruiters say they don't expect other brokerages to follow suit.
But it is still causing something of a buzz in an industry in which advisers typically can—and routinely do—calculate their own pay almost to the penny, based on a percentage of the commissions and fees they generate. At the largest retail brokerages, that payout ranges from around 40% to 50%.
Barclays advisers will receive about half of their pay in the form of a monthly payment; the other half will be paid out every three months, according to people familiar with the new arrangement. While both payments will be based on a production formula similar to that at other firms, the quarterly payment also takes into account values-based criteria that include professional conduct and customer complaints. Poor performance in these areas could lead to a reduced payout.
Mr. Lee said the new pay model was "well received." But Andrew Parish, managing director at Axiom Consulting Group LLC, says he has fielded calls from at least 10 Barclays advisers in New York, Los Angeles and Chicago, among other places, since they learned of the new arrangement late last year. So far, none has decided to move elsewhere, he said.
As part of his campaign to improve the Barclays image, Chief Executive Antony Jenkins announced last year that bonuses to employees will be based in part on how they uphold the bank's values. He said that employees unhappy with the changes could leave.
Barclays added about 200 U.S.-based financial advisers in its purchase of Lehman Brothers' North American operations in the 2008 financial crisis. Barclays's chief executive at the time, Robert Diamond, set out on an aggressive plan to build up the franchise but the unit has faced costs of increasing regulation and of paying a stable of well-connected wealth managers.
In 2012, the U.S. Securities and Exchange Commission said it found cultural "deficiencies" at Barclays Wealth, as did a subsequent independent report which the bank acknowledged was suppressed by an executive. Leadership of the wealth-management division was later replaced. The bank has since presented plans to cut its physical presence across the globe and refocus on key clients.
Since the first quarterly variable payments to U.S. advisers won't be made until April, it is unclear exactly how much pay could be affected by the new criteria. Scott Smith, an analyst at research firm Cerulli Associates, believes the change could help Barclays and wouldn't cause many advisers to flee—if pay is docked only rarely.
Deep pay cuts for anything less than serious misconduct wouldn't make sense, Mr. Smith said. "I don't think anyone's going to be docked 20% of their pay because grandma had a complaint," he said.
—Max Colchester contributed to this article.
The large investment firms, the ones that advertise and everyone knows well, as well as many others, pay their advisors a percentage of revenue they have generated from their clients. In addition to, a fixed percentage of assets, revenues come from commissions, product fees, transaction fees, and revenue sharing agreements and these bias the large firm advisors to place their clients’ wealth in their proprietary investment funds, or in funds with clandestine revenue sharing arrangements. Because they get paid out of revenue, their incentive is to use the high revenue generating products and they’re pressured by management to that end. But, no individual firm has a monopoly on the best investment talent. In fact the best investment talent leaves these firms, because they can’t stomach the politics.
These large firms love to hire ex-teachers and ex-military because teachers have a large network of children they’ve gotten to know, as well as, their parents. Teachers are generally liked and trusted, so naturally clients will trust them with their wealth. And of course, children grow up to become investors, too. Ex-military are very diligent in going out and raising money. They take orders well and are unquestioning by prior career training. That’s a super fit for the firms that want to push high profit margin funds. Can it be worse than this? You bet. These advisors that you’ll meet are good looking and tall and come from wealthy families. That’s right, good looking, tall, and a superior talent or access to collect clients, that’s the wire-house formula. And it works. None of this, however, gives them an edge on advising you and managing your money. A few might be smart, but not by design. By design, they want unquestioning advisors that believe they are best serving their clients, while unknowingly using inferior and high profit margin mutual fund products.
But the greatest disadvantage of using these firms is they never go to cash in anticipation of a market crash. They can’t, because it’s equivalent to dialing down their profits. It is calendar year earnings that are the most important focus of these large firms, not your long term investment performance. Instead they tell their clients, “You can’t time the market.” These firms don’t even share the same institutional research with their retail advisors that they share with their institutional clients. They have a whole other set of worthless research. And that’s by design as well. First, the retail advisor base will have difficulty understanding the institutional research, and second, you can’t have everyone getting out of the market at the same time. These are big firms with trillions of dollars under management. It’s more profitable for them to treat their more valuable untrusting clients better and use the less valuable trusting clients as a source of liquidity for when the valuable clients want to get out.
It is best to hire an investment advisor and insurance professional separately. Insurance by itself is extremely complicated. You’ll end up with an investment advisor who has to spend a lot of time keeping up with the insurance industry regulations, pricing, performance, and new product bells and whistles. You want him focused on markets, risks, and investments. And you don’t want him dealing with the second regulator, when the market is melting down. Don’t settle on an advisor who does both. It’s likely he/she will do both poorly. If you find an advisor or insurance professional you like and are comfortable with, ask for a referral for the other. They won’t want to take reputational risk by referring someone who’s not competent or has integrity issues.
Visit the FINRA’s (Financial Industry Regulatory Authority) website to see if the advisor has complaints or been convicted of fraud etc. These advisors can stay in business well beyond their usefulness to society by giving good lawyers lots of business.
Be aware of the various compensation structures that advisors have. These can be fee only, or commissions, or both. That’s right, many advisors collect both. Commissions are bad because of the incentive is not aligned with putting you in the best mutual funds. And be careful, many firms say they are fee based only, but aren’t. A recent study found that ~25% of a large sample of advisors who said in their marketing materials that they are fee based only, actually also collect commissions. These advisors are liars.
Regarding fee based advisors, fees are a percentage of assets under management. Merrill in 2014 will charge: 1.6% of the 1st $250,000, 1.3% for amounts over $250K up to $2,000,000 and 1% above that. Morgan Stanley fees are similar. Independents charge significantly less than that, because they are not sharing the fee with their boss and their boss’s boss and with the firm.
There’s a large exodus of advisors from these large firm, many are going independent as technology and research has become widely available and affordable in the last few years. Large firms account for 60% of private clients, down from 80%, ten years ago.
In short, go with a fee based firm that does not collect commissions, nor has revenue sharing agreements. A truly fee based advisor can get you in a mutual fund with an upfront load without you having to pay that commission. In this case, you don’t pay it and the advisor won’t collect it. That’s what fee based only, means. By the way, you’ll pay that commission if you do it yourself online.
Finally, make sure that the advisor has a third party custodian. You don’t want to invest with future Bernie Madoffs. Every other week, I read about another advisor absconding with their clients’ lifetime savings. If your money is housed at a third party custodian, you won’t be robbed. The custodian will send out monthly statements and year-end tax information directly to you. The advisor should only be developing a customized asset allocation based on your risk tolerance and executing transactions to populate that strategy for you. He should not be preparing your monthly statements and year-end tax information. He should also be knowledgeable about the investment environment and protect you portfolio from going over the cliff. Ideally, he’ll be moving you to cash before that. That’s what the great investors do.
But the greatest disadvantage of using these large investment firms is they never go to cash in anticipation of a market crash. They can’t, because it’s equivalent to dialing down their profits. It is calendar year earnings that are the most important focus of these large firms, not your long term investment performance. Instead they tell their clients, “You can’t time the market.” These firms don’t even share the same institutional research with their retail advisors that they share with their institutional clients. They have a whole other set of worthless research. And that’s by design as well. First, the retail advisor base will have difficulty understanding the institutional research, and second, you can’t have everyone getting out of the market at the same time. These are big firms with trillions of dollars under management. It’s more profitable for them to treat their more valuable untrusting clients better and use the less valuable trusting clients as a source of liquidity for when the valuable clients want to get out.
Ignore most of what’s on CNBC, Bloomberg and other media business programs. On these shows, the “Chief Global Equity Strategist” from Merrill or Morgan is really a highly paid sales person, and he is there to market the firm and enhance the firms trading positions. There’s also more than one “Chief” at these firms—there’s too many venues and TV show for just one “Chief”. Never take their free advice, it’s really not free. Understand they are given access to the program’s audience because they spend enormous amount of money on advertising. This access to the millions who watch these programs enable them to drum up interest in specific securities that they want to unload at better prices. Also, the program format is remarkably similar to sports news, it is entertainment. The format focuses too much attention on the recent past and the short term. What’s hot and what’s not, rather than well thought out long term strategies based on fundamentals and valuation—that’s boring and alienates advertisers who want to drive the investment themes themselves. Also, ignore Jim Cramer. A recent independent study of his advice has him wrong 54% of the time.
At a networking breakfast event on Thursday, I spoke briefly about the QE Taper and risk to investors. The owner of a competing financial advisory spoke to group moments later, “investors should be in the market at all times,” he said. This is the worst financial advice I ever heard spoken.
On Friday, the Dow Jones Industrial Average finally climbed to a new all-time inflation adjusted record. It took 14 years and the broader indices the S&P 500 and NASDAQ aren’t even close. So if you had your money in the stock markets before the crash in 2000 you’re likely still not back to breakeven.
A bit of history first. The 2000 crash was easily anticipated, no earnings and enormous valuation. The crash of 2008 was less easily anticipated. With mortgage fraud and Lehman Brother’s solvency/liquidity problems concealed, and no insight from policy makers, main stream media, and banking executives denying that a problem even exists, investors complacency can be understood. Yet, when Lehman imploded a sensible response was to get out. And if you did you would have saved yourself from a further 50% fall, from 1250 to 666 (S&P 500.)
I see investing much like poker. When the right hand comes along you can bet it all. The risk with this, of course, is that if another player"calls" you and you lose – you’re busted. In investing when you have the opportunistic set of conditions in your favor such as an extreme oversold market condition, panic and fear from investors, deep discounts in valuations, etc. these are times to invest more heavily into equities as the "risk" of loss is outweighed by the potential for reward because the "hand" you are holding is a strong one.
The single biggest mistake that investors make today is they continue to be "all in" on every hand regardless of market conditions. "Risk" is only a function of how much money you will lose "when", not "if", you are wrong.
The advisor community too often abdicates the most important aspect of fiduciary duty, risk management. If you are all-in at market tops you can lose everything on one hand. If you are patient and adjust your risk appetite for the investment environment, you’ll do much better in the long run.
Here is my advice: If you haven’t already, sell equities and let the cash sit un-invested. Cash provides ultimate optionality, all other investments assume price and liquidity risk.
“These days, your fellow investors have adopted a distinct preference for working with fiduciary advisors as opposed to the broker-dealers and wirehouses of the past. The Registered Investment Advisor (RIA) channel has absolutely exploded in size since the prior peak in household investing back in 2007. Large Wall Street brokerages have seen their market share of the investment business shrink below 50% for the first time in, well, ever. Increasingly, clients and assets are finding a home with advisors who are bound to a higher standard of care. RIA firms are paid solely by individual clients like you, and, as such, they do not have the myriad of conflicts inherent in the old brokerage model.”