WASHINGTON, April 30, 2012 – It’s hard to fathom last week’s market action. The news was never really very good. But in spite of our caution, the investing mood seemed persistently upbeat. Aided by a couple of key positive earnings reports, the market worked off its short-term oversold condition and has already snapped back to the point where it risks being overbought.
March had been a strong month for the market, aided, almost beyond any doubt, by the illegal, immoral, deceptive practice of “window dressing.” This term means one thing in accounting—a flavor of “cooking the books”—but another on Wall Street. Or, more particularly, in the world of portfolio managers. As holders of mutual funds know, funds are required to provide customers with annual and quarterly updates of portfolio performance. In the Internet age, as opposed to the Jurassic Age when this writer was in the trading business, info can be accessed online in addition to the older mailed pamphlets and brochures.
Most retail investors take at least a passing interest in these quarterly and annual reports, as they want to know that their funds are making money for them and, perhaps more importantly, are in all the hot stocks of the moment. For example, if, say, you’re in a technology fund and the latest report and list of holdings discloses that your fund holds little if any Apple, you’re likely going to get irritated and consider dropping the fund in favor of another.
Fund managers don’t particularly like this tendency, nor do they like to be seen as running behind the advisor pack. So they indulge in “window dressing.” Investopedia defines this practice as:
“A strategy used by mutual fund and portfolio managers near the year or quarter end to improve the appearance of the portfolio/fund performance before presenting it to clients or shareholders. To window dress, the fund manager will sell stocks with large losses and purchase high-flying stocks near the end of the quarter. These securities are then reported as part of the fund’s holdings.” In other words, fund and portfolio managers intentionally deceive their investors, making it appear that they’ve always been in highflying stocks during the current quarter.
Hence the term, alluding to the time-honored retail store custom of freshening up or changing entirely the latest hot monthly or seasonal goods they’re inducing you to buy. That’s perfectly fine in retail. But it’s actually illegal in the investment business, as it is, as we’ve said, clearly deceptive.
Which is why one industry wag (who probably learned to write in Washington) has refined the definition of “window dressing” a bit more delicately, describing it as the activity whereby a fund or portfolio manager strategically manages “his funds’ holdings to better serve capital acquisition efforts.” But what’s really going on, the writer explains candidly, is “a superficial manipulation of the appearance of a fund’s past activity in order to garner new capital….” Bait and switch, anyone?
Which brings us back to March Madness. Since the market, for whatever reason, went straight up in January and February, portfolio managers who’d been late to the parade concluded in March that they’d better get lots of 2012’s hottest stocks into their portfolios so they could brag about them in their quarterly reports and/or portfolio holding listings.
Problem is, the guy who came late to the parade on Apple, for example, might list two million shares held in the first quarter. But you, the investor, have no idea whether he acquired those shares in early January, 2012 (as he’d like you to think) or on the last trading day of March. He’s not required to tell you how long the stock has been held.
Ergo, you get huge rushes of buying near the ends of calendar quarters, goosing both stocks and the market. Unfortunately, in March, during this predictable goosing, corporate insiders and hedge funds were massive sellers of stocks, meaning that your late-to-the-game fund managers were buying hot stocks at the top—precisely when “the boys” were dumping them at a profit.
This phenomenon isn’t universally true, of course, but the patter happens often enough that you wonder where the SEC is in all this. (Maybe they need to import a few regulation fanatics from the EPA.)
In any event, this activity explains, at least in part, why we had a letdown in April, save for last week’s weirdly optimistic tone. The only thing your friendly writer can think of here is that the market tanked after the March window dressing buying ceased, only to be revived, if perhaps briefly, by the usual brief juicing the market tends to experience after tax day, after which prudent investors customarily send at least part of their tax refunds to their brokers to invest, resulting in a temporary cash flood.
This week begins somewhat more ominously. Spain is now officially in the second leg of a double-dip recession. The French elections are coming on Sunday with a possible change in presidential horses midstream. And the Greeks will be electing yet another batch of thieves in May, all of which weighs on thoughtful traders.
The supposed good news is that U.S. household income was reported to be up slightly in March. But that, itself, is tempered by the fact that the effective U.S. jobless rate, as calculated by new unemployment applications, actually worsened slightly in the first quarter.
Understandably, the futures this morning are also confused. As of this writing, the Dow futures are gyrating between negative 10 to negative 26. S&Ps are down about two and a half. And the tech-heavy NASDAQ is down over 8.
With window dressing over for now, and with the early initial blast of tax refund money nearing an ebb, the not-so-merry investing month of May is almost upon us as is the nagging old adage, “Sell in May and go away.” Things don’t look so good.
And yet the respected McClellan Oscillator (more on this in another column) gives us a good chance of a nice rally in June. If so, do we sell in early May and then come back in time for June? Or is the oscillator’s predictive power simply a head-fake.
We’ll find out soon. Meanwhile, a prudent investor should be sitting on a nice cash hoard on the side, considering for now only investments in utilities, income-producing ETFs, and selected REITs and MLPs.
Stay tuned. We should probably get a better read on things after the Workers of the World dance enthusiastically around their collectives’ May Poles.
(Again the usual disclaimers apply. In this uncertain market, the best we can do is provide a few guideposts and remain hiding in our refurbished fallout shelters.)
Read more of Terry’s news and reviews at Curtain Up! in the Entertain Us neighborhood of the Washington. For Terry’s investing and political insights, visit his Communities column, The Prudent Man, in Business.
Follow Terry on Twitter @terryp17
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