12. There is a flip side to this story, one that also holds little validity. Suppose we look at the periods associated with market tops, and ask whether sentiment tends to be especially bullish at these times. The answer is no more bullish or bearish than at other times.
13. Ip, “Final Bears.”
14. See the discussion about Werner De Bondt’s (1993) “betting on trends” concept in Chapter 5.
15. The reaction to the Dow is a little different. Before the crash, a 10 percent increase in the Dow led to a 6.7 percent increase in the Bullish Sentiment Index, whereas the same increase afterward only led to a 3.6 percent increase.
16. Less than they would have been in a less volatile market, that is.
17. The correlations between the different sentiment indicators are quite low, somewhere around 25 to 35 percent for most pairs of indexes. The strongest correlation is 40 percent, and it is between the discount on an equally weighted portfolio of closed-end equity funds and the AAII sentiment index. I thank Bhaskaran Swaminathan for providing me with historical data on closed-end fund discounts, and Meir Statman for historical data on the advisory sentiment index and AAII sentiment index.
Chapter 7
1. I thank Rich Dubroff, executive producer of Wall $treet Week with Louis Rukeyser, and writer Georgette Jasen of the Wall Street Journal for furnishing me with the data underlying these claims.
2. See Andrei Shleifer and Robert Vishny (1997) for a discussion of the limits to arbitrage.
3. There is varying terminology used to describe analysts’ recommendations. Most use a 5-point scale: strong buy, buy, neutral, sell, strong sell. First Call uses buy, buy/hold, hold, hold/sell, sell.
4. Examples of the three types are Raymond James Financial in St. Petersburg, Florida (local), A.G. Edwards in St. Louis (regional), and Travellers/Salomon/Smith Barney in New York (national).
5. John Dorfman, “How Stock-Pick Prowess of the Brokers Is Judged,” Wall Street Journal, 2 February 1990.
6. John Dorfman, “Edwards Wins ′88 Stock-Picking Crown With Shearson Tops for 30-Month Period,” Wall Street Journal, 3 February 1989.
7. John Dorfman, “Brokerage Firms Beat the Market with Stock Picks,” Wall Street Journal, 25 February 1993.
8. I am grateful to Rick Chrabaszewski at Zacks for preparing and providing me with this data.
9. There is always a question of survivorship bias: whether we are focusing only on the winners and ignoring the losers because they drop out. However, the results reported over the period 1993–1997 are based on a stable group of brokerage firms.
10. Brad Barber, Reuven Lehavy, Maureen McNichols, and Brett Trueman (1998) confirm Womack’s findings. Their study covers the wider period 1986–1996.
11. “Intel Stk up; Merrill Sees Declining 80386 Inventories,” February 1, 1989, Dow Jones News Service Ticker. I thank Kent Womack for kindly sharing his data with me.
12. Kurlak cited evidence that the excess inventory of 80386 microprocessors had been worked down by Intel customers, that IBM was increasing its orders to Intel, and that Intel’s own inventory was also declining to more normal levels.
13. John Dorfman, “Your Money Matters: Few Brokerage Firms Beat the Market Last Year,” Wall Street Journal, 8 February 1996.
14. John Dorfman, “Your Money Matters: Latest Stock Picks of Brokers Fare Poorly,” Wall Street Journal, 22 May 1997.
15. Geert Rouwenhorst (1997) documents that the momentum effect occurs on global markets.
16. I discuss this issue in more detail in Chapter 5.
17. John Dorfman, “Your Money Matters: Weekend Report: Following a Broker’s Advice Can Reap Nice Gains—Until You Get the Tax Bill,” Wall Street Journal, 15 August 1997.
18. In an article by Daniel P. Wiener that appeared in the June 19, 1989 issue of U.S. News & World Report, the author indicated that all participating brokerage firms recommended only five stocks. The article was titled “News You Can Use; Investing. What to Do When Your Broker Says ‘Buy.’ A Stock Awarded a Thumbs Up by Wall Street May Be the Last Investment You Should Be Considering.”
19. John Dorfman, “Your Money Matters: Stock Pickers Do Well, Even If Their Employers Don’t,” Wall Street Journal, 9 May 1989.
20. John Dorfman, “Wall Street Beat the Market in Third Quarter,” Wall Street Journal, 8 November 1995. My reading of the data shows that the PaineWebber recommended stocks were about as volatile as the average recommended stock. Compared to the S&P 500, PaineWebber stocks were 25.7 percent more volatile. The most volatile recommendations were those of Alex. Brown, which were 64 percent more volatile than the S&P 500.
21. John Dorfman, “Your Money Matters: Successful Stock Pickers in Quarter Avoided High Tech,” Wall Street Journal, 7 November 1988.
22. John Dorfman, “Edwards Wins ′88 Stock-Picking Crown, with Shearson Tops for 30-Month Period,” Wall Street Journal, 3 February 1989.
23. De Bondt and Thaler (1994) credit Humphrey Neill (1954) for having popularized the term contrarian, Neill in turn credits economist William Stanley Jevons.
24. When I ran my investor expectations survey, I also included the Fortune magazine questionnaire. I obtained results very similar to the results reported by Fortune magazine.
25. Subject to the qualification that P/E is not negative. Negative earnings present some complications.
26. The winner-loser effect has other puzzles associated with it. First, although past losers tend to outperform the market for five consecutive years, all the action takes place in January. This is surprising—and troubling. If price movements are truly driven by overreaction, then it is difficult to understand why the correction only occurs one month in the year, and always the same month. The small-firm effect, which has not reappeared with the strength it exhibited prior to 1980, also appears to be a January phenomenon.
27. By growth stocks, I mean stocks with a low book-to-market ratio.
28. Like Lakonishok, Shleifer, and Vishny, we control for size and market-to-book equity.
29. Fama’s argument reminds me of a story about a retired attorney who is writing his memoris. The attorney recalls the time when he was young and inexperienced, and because of this was losing cases he should have won. But as time goes on, he learns from his mistakes, so much so that in later years he wins cases he feels he should rightly have lost. Thus, he concludes his memoirs by stating that on average, justice was done. By the same token, markets are efficient.
30. Barbara Donnelly, “Your Money Matters: Investors’ Overreactions May Yield Opportunities in the Stock Market,” Wall Street Journal, 7 January 1988.
31. A study by Paul Griffen, Jennifer Jones, and Mark Zmijewski (1995) finds that the stocks recommended on Wall Street Week with Louis Rukeyser do indeed outperform the market by 4 percent, and that the recommendations on the program have been large, low beta, high price-to-book stocks.
Chapter 8
1. “Stephens Inc. Starts Plexus Corp. with Buy Rating,” Dow Jones, 2 February 1997.
2. Jay Palmer, “Growth Versus Value: Computer Searches Turn Up Promising Stock Picks for Both Persuasions,” Barron’s, 2 June 1997.
3. A December 18 report on the Dow Jones News Service offered similar remarks: “According to A.G. Edwards & Sons analyst Mark Jordan, the company’s projection is ‘about $10 million’ below his estimate. He attributed the shortfall to weak orders and volumes from ‘one large customer,’ as well as a general ‘tightening of order flow’ in the electronics industry. Jordan, who rates the company maintain, said he thinks it is ’solidly profitable, with margins under control,” but he also expects slower sales growth for the second quarter.”
4. Kathleen Gallagher, “Plexus Shares Take 44 Percent Nose-Dive,” Milwaukee Journal Sentinel, 19 December 1997. The next three excerpts are also from this article.
5. I am grateful to Fred Stanske and Russ Fuller of Fuller and Thaler Asset Management for their help in preparing this chapter.
6. Leslie P. Norton, “Mutu
al Funds: Fund of Information. Bad Behavior: If It Looks Like a Duck, Don’t Buy It; The Cold Hand of Sheldon Jacob,” Barron’s, 5 January 1998.
7. See the discussion in Chapter 2 on the illusion of validity.
8. This is consistent with work by Kent Womack (1996).
9. The size effect is consistent with evidence provided by Bernard and Thomas (1989) that post-earnings-announcement drift is stronger for smaller firms. And larger firms do have more analyst coverage. The Plexus case illustrates something about the process by which analyst coverage grows with firm size.
Chapter 9
1. Robert McGough and Michael Siconolfi, “Buy and Hold: Their Money’s Fleeing, But Some Investors Just Keep Holding On,” Wall Street Journal, 18 June 1997. Their article also describes the case of Melvin Klahr discussed here. The quotes by Klahr are from this article.
2. Ibid. McGough and Siconolfi attribute this statement to Wall Street historians.
3. Robert McGough, “At Dead-Last Steadman, Past Is Prologue,” Wall Street Journal, 15 April 1997.
Chapter 10
1. Dread is extreme anxiety.
2. O’Neill has changed the names to preserve anonymity.
3. The time period for O’Neill’s study was the late 1980s, so the income figure would have to be adjusted up significantly to place it into current dollars.
4. Jonathan Clements, “Getting Going: If Santa Had This List, He’d Be Wiser, Wealthier and Ready for the New Year,” Wall Street Journal, 23 December 1997.
5. Jonathan Clements, “Getting Going: How Much Should You Invest in Stocks? It All Depends on Goals and Time Frame,” Wall Street Journal, 11 February 1997.
6. Ibid.
7. Jonathan Clements, “Getting Going: Need Cash in Five Years? Dumping Stocks Isn’t Always the Best Investment Strategy,” Wall Street Journal, 7 January 1997.
8. The investors varied in location, age (mid-twenties to their mid-fifties), income ($30,000 to upwards of $500,000 per year), and wealth. The responses across all three groups were similar.
9. In my survey, I also examined how the choice of securities depended on the time horizon attached to a given goal. I found that when the time horizon is short, such as for a vacation or a home remodel, and investors feel close to being able to fund the goal at the end of their horizon, then the tendency is to invest in low-risk securities such as money market funds. Those investors who indicated that they do not currently have the resources to fund a goal said that they relied on stock options and commodities to provide the necessary funds. This was particularly true for luxury items such as boats and jewelry.
10. In the interest of disclosure, I should mention that I served as a consultant in the design of the Financial Engines software.
11. There are numerous other examples of securities designed to appeal to cautiously hopeful investors. Merrill Lynch offers S&P 500 Market Index Target-Term Securities (MITTS), which mature in five years and pay the principal but no interest. Instead of interest, they pay 115 percent of the S&P 500 gain, if there is any. Another example involves so-called Click Funds, which offer index-linked investments with specific downside protection. These funds have recently become very popular in the Netherlands. See Smid and Tempelaar (1997). Investors have also been known to simulate securities such as these. John McConnell and Eduardo Schwartz (1992) report that some Merrill Lynch investors held large balances in their money market accounts, and used the interest to buy call options.
12. I discussed the issue of skewed confidence intervals in Chapter 5.
13. At least, these are the types of stocks they hold.
14. The broad issues involve the role of financial market regulation as a means of dealing with potential conflicts between fairness and efficiency.
15. Rebecca Buckman, “These Days, Online Trading Can Become an Addiction,” Wall Street Journal, 1 February 1999.
Chapter 11
1. Not their real names. Ira and Jeannie engaged the services of a financial planner, and their case became part of a financial-planning database.
2. These statistics come from the financial-planning database containing Ira and Jeannie’s case.
3. Greg Ip, “It’s Official: Stock Market’s Pups Are Likely to Be Bulls,” Wall Street Journal, 8 July 1998.
4. This question is based on an actual situation. In 1974, the utility Consolidated Edison did omit a quarterly dividend, and many of its shareholders complained, indicating that they would be forced to cut consumption expenditures.
5. There are other puzzles about dividends. Roni Michaely, Richard Thaler, and Kent Womack (1995) study the price reaction to dividend initiations and omissions. Investors react positively to initiations, and negatively to omissions. But the reaction to omissions is larger. In both cases, investors appear to underreact, in that the full price impact takes many months. Interestingly, they find little evidence of a clientele effect, meaning that investors do not move in and out of stocks sharply in response to dividend initiations and omissions. Shlomo Benartzi, Roni Michaely, and Richard Thaler (1997) show that firms raise their dividends when their earnings have been rising, and reduce them when their earnings have been falling. However, these changes carry little predictive power about future earnings growth, with one exception. Firms that increase their dividends are less likely to experience a drop in future earnings.
Chapter 12
1. The folks at Fidelity Investments certainly hope so. In 1998, they used Peter Lynch in a series of television and newspaper advertisements, teaming him up with well-known comedians such as Lily Tomlin.
2. Gerard Achstatter, “Fidelity’s Peter Lynch: How He Conducted the Research That Made His Fund Best,” Investor’s Business Daily, 2 February 1998.
3. I am grateful to Tisha Findeison at Vanguard Fiduciary Trust for providing me with this statistic.
4. Achstatter, “Peter Lynch.”
5. By my rough estimate. There are over 6,500 funds that the Wall Street Journal screens in consort with Lipper Analytical Services, Inc.
6. The evidence on this point is reviewed in Goetzmann and Peles (1994).
7. Jonathan Clements, “Looking to Find the Next Peter Lynch—Try Luck and Ask the Right Questions,” Wall Street Journal, 27 January 1998.
8. Personal interview; 3 March 1998.
9. Adam Shell, “Making Money in Mutuals: Should You Sell a Fund That’s Past Its Prime?” Investor’s Business Daily, 3 March 1998.
10. Jeffrey M. Laderman with Geoffrey Smith, “The Best Mutual Funds: BW’s Ratings Tell You Who Gave the Best Returns—with the Least Amount of Risk,” Business Week, 2 February 1998.
11. See Tom Petruno, “Your Money: Who is the Typical Fund Owner?” Los Angeles Times, 1 August 1996. This article summarized the findings of both the ICI study and the Vanguard study.
12. Jonathan Clements, “Abracadabra, and a Putnam Fund Disappears,” Wall Street Journal, 5 May 1993.
13. There are survivorship issues that arise in this connection and paint an overly positive picture of the mutual fund industry. See Brown and Goetzmann (1992).
14. Charles Gasparino, “SEC Chairman Levitt to Criticize Fund Industry over Fee Disclosure,” Wall Street Journal, 15 May 1998.
15. Andrew Bary, “The Trader: Fund Managers Get Rich, But Not Their Customers,” Barron’s, 29 December 1997.
16. Kathryn Haines, “Fund Attracts Attention: Gets High Ratings,” Wall Street Journal, 13 June 1997.
17. Eric J. Savitz, “Silicon Values: An Interview with Kevin Landis and Ken Kam,” Barron’s, 23 June 1997.
Chapter 13
1. I am grateful to William Kehr, Andrew Schell, and Brad Shaw of John R. Nuveen and Company for their helpful comments on this material.
2. Andrew Bary, “After Rout, Many Muni Funds Sell at Steep Discounts,” Barron’s, 29 November 1993.
3. In fact, 1993 was an extremely active year for the introduction of new closed-end funds. During 1993, 126 new funds were brought to market at a value of $19.1 billion. Amon
g those was Nuveen Premium Income Fund 4 (NPT), which began trading on February 17, 1993, at an initial price of—can you guess?—$15.
Beyond Greed and Fear Page 39