By James Mackintosh
Stock picking is back.
After years of central banks lifting the entire market on a tide of freshly minted money, Donald Trump's U.S. election victory has already led to the biggest gap between winning and losing shares in seven years. After Mr. Trump takes office on Friday, fresh policies will "Make Active Great Again," says Goldman Sachs.
Investors who get their stock picks right should be able to beat the market by more in the new environment.
The bad news: If they get it wrong they will lose more.
Unfortunately for fund managers, facing a more diverse market "doesn't magically make people any more clever or lucky," said Tim Edwards, senior director of index investment strategy at S&PDow Jones Indices.
Measures of market diversity jumped to postcrisis highs after the election. November had the biggest gap between the best and worst performing S&P 500 sectors since April 2009, as bank shares soared and utilities plunged. A formal measure of dispersion, the asset-weighted standard deviation of stock returns, was at its highest for seven years in November, Mr. Edwards calculates.
The trend in recent years for share prices all to move together has broken down. The correlation between members of the S&P 500 is now the lowest since the Great Recession began, according to Bank of America Merrill Lynch calculations.
Mr. Trump inspired such big differences in share performance as investors bet on renewed inflation and faster economic growth.
While market dispersion fell back in December as investor excitement about Mr. Trump's election waned, the promise of new tax, spending, trade and diplomatic policies suggest plenty of scope for shares to swing in different directions in the year ahead. Add in the Federal Reserve's retreat from easy money policies and the dispersion between stocks which benefit or miss out from the new policies should rise.
Unfortunately for buyers of mutual funds, there is scant evidence that a more diverse market means the average fund manager does any better, as those outperforming by more are counterbalanced by those underperforming by more. But even given this, it is great news for active fund management companies and their marketing teams. So expect a lot more promotion of the fund managers who were smart or lucky and came in well ahead of their benchmarks.
How should investors take advantage? Those confident either in their own ability to pick stocks or their skill at selecting fund managers, should be putting effort into selection again. That is after years of focus on macroeconomic and political drivers. For everyone else--and history suggests very few of us are consistently good at choosing either good shares or good managers--the recent trend of choosing low-fee passive funds is still the way to go.
Rising dispersion doesn't make life easier for the supposed "smart money" managers of hedge funds, thanks to the same financial logic.
Investors taken as a whole will perform in line with the market, minus fees, since they are the market. For every fund manager making $1 more than the index, someone else has to make $1 less. Occasionally that someone is an insurance company, pension fund or individual investor, but with fund managers making up the bulk of equity trading, it is more likely to be another fund manager. Outperformers are almost completely canceled out by underperformers.
There are a couple of minor exceptions. First, higher dispersion of stocks means the clever or lucky investors who outperform are morelikely to beat the market by enough to justify their fees, which makes the funds run by the best managers rather more appealing (if only they could reliably be identified in advance!).
Second, because mutual-fund managers hold a permanent pool of cash against redemptions, they tend to outperform in falling markets. If the few remaining bears are proved right and the market falls, that means the average manager will have more chance of beating the market. Of course, those who expect a bear market will have sold their funds, and in a falling market investors are more likely to pull their money out anyway.
For investment businesses, rising dispersion could be good. Even if active managers underperform on average, the basic business model of flogging the funds which have done best works better when there are some really good performers to promote. Needless to say, there won't be any advertising featuring the funds that lost out.
Acynical investor might think rising dispersion makes the shares of active fund managers a better bet than their mutual funds. Even here, though, the long-running trend downward in fees as money switches to low-cost index trackers and exchange-trade funds is unlikely to reverse quickly, keeping the business of active fund management under pressure.
Write to James Mackintosh at James.Mackintosh@wsj.com
(END) Dow Jones Newswires
January 16, 2017 12:10 ET (17:10 GMT)
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