Manic markets switch from fear to greed

Where has all the fear gone? Last month, the S&P 500 was in correction mode, and the Vix, or fear index, was soaring as traders bought protection to guard against steeper declines.

That was then. Last week, the S&P 500 hit fresh all- time highs on five consecutive days. The Vix has fallen from 30 to 13, near multi-year lows. The bears, too, have disappeared. The Investors’ Intelligence poll of newsletter writers has seen the biggest fortnightly jump from bears to bulls in more than 40 years. American Association of Individual Investors polls show just 15 per cent of ordinary investors are bearish – just half of last month’s figure, and the lowest recording in nine years.

In 1987, Warren Buffett cautioned investors to insulate themselves "from the super- contagious emotions that swirl about the marketplace". Clearly, that remains equally true today.

Japan looks good for gains

Bipolar trading has been even more evident in Japan, stocks shrugging off last month’s double-digit correction and hitting a seven-year high last week.

Japanese stocks have doubled over the last two years but remain cheap. Almost half of the Topix’s constituent stocks trade below the value of their net assets. The overall index trades on just 1.3 times its book value, well below European levels and less than half that of the S&P 500.

Indices can be cheap for years, but BlackRock's Russ Koesterich points to some obvious catalysts. Japan's Government Pension Investment Fund is to up its holding of domestic stocks from 12 to 25 per cent; other institutions should follow suit.

The Bank of Japan is in full- blown quantitative easing mode, last month’s announcement of further stimulus lighting a fire under stocks.

Earnings, too, are soaring, up 53 per cent over the last year. The Nikkei has had many false dawns over the last 20 years but the latest rally may well be a longer affair.

Fund managers hit new lows

Fewer than one in five active managers is beating the market this year – the lowest percentage in at least a decade.

Just 17.7 per cent of US funds have beaten the large- cap Russell 1,000 index, compared to 40.5 per cent in 2013. Although 2014 has been especially bad, underperformance is the norm. Over the last decade only once (2007) did a majority of active managers outperform.

Investors are finally catching on. In the US, 28 per cent of assets are in index funds and exchange-traded funds, up from 9 per cent in 2000. Vanguard’s main index fund tracking the US market is now the world’s biggest mutual fund.

In the UK, passive funds account for around a quarter of stock investments, up from 15 per cent a decade ago. Vanguard’s European Stock Index Fund now manages twice as much money as Europe’s largest actively managed fund. The trend makes sense and will continue. Active managers will increasingly be forced out of money management and into financial planning, where they can help ordinary investors understand just how difficult it is to beat the market.

The limits of expertise

There are many reasons for this underperformance. Perhaps experts, unconstrained by job pressures, make better decisions in their own private investments?

Well, no. A recent paper, Do Financial Experts Make Better Investment Decisions?, studied the personal portfolios of fund managers in Sweden and compared to them to non- expert investors of a similar age, income and education background.

“They do not outperform”, the paper found, “do not diversify their risks better, and do not exhibit lower behavioural biases”. The study politely concludes there are “limits to the value added by financial expertise”, but follow-up comments by co-author Prof Andrei Simonov are blunter: “You have these very educated people who are supposed to know what they are doing, but they are just not that good, on average.”

Gold bugs look to Swiss

Gold bugs have had a tough few months and will be hoping Switzerland’s forthcoming gold referendum on November 30th will arrest the downtrend.

The Save Our Swiss Gold initiative calls on the Swiss National Bank to hold 20 per cent of its assets in gold, up from around 8 per cent today. If passed, it could lead to $60 billion in gold purchases over the next five years – the equivalent of giving a large put to the market, says Société Générale. Bank of America estimates the purchases would catalyse an 18 per cent rally, while UBS says a Yes vote would have a "quite spectacular" impact.

Although the polls indicate a close race, the initiative must be passed by a majority of voters and a majority of Switzerland’s 26 cantons. That remains unlikely, indicating gold investors’ woes are not over yet.