The Myth of the Stock-Picker’s Market

Although it may be hard to remember right now–what with the Dow once again over 10,000, Internet stocks reaching even higher new highs, and the Nasdaq bellwethers booming–until just a few weeks ago most observers thought the stock market was going to be locked for a while in what’s usually called “a trading range.” The Dow was going to meander back and forth between 9,200 and 9,600, with the occasional foray up or down. The Nasdaq was going to be held back from significant gains by concerns over weakening demand for PCs and anxieties over a supposed slowdown in corporate technology spending. And Internet stocks … well, not even the gutsiest forecasters were saying much about what Internet stocks were going to do (as opposed, of course, to what they should do).

Thanks primarily to the rapid evaporation of all those concerns about the technology sector, the “trading range” days appear to be behind us, although perhaps we’ve just entered a different trading range now. (If such things as trading ranges actually existed, after all, think of the money you could make, buying the market at the bottom and shorting it at the top.) And what also may be blessedly behind us, at least for now, is the most absurd phrase among the host of absurd phrases the financial media uses to talk about investing: “It’s a stock-picker’s market now.”

We heard this phrase a lot in the past couple of months because the assumption was that unlike in a raging bull market, when all you have to do is buy an index fund to do well, in a sideways market only smart fund managers would be able to put up the numbers. At first glance, this may sound somewhat plausible. But at second glance, and at every glance thereafter, it’s absurd, and its constant incantation shows just how desperately Wall Street continues to cling to the idea that the market can be beat.

The premise behind index funds, of course, is that over an extended period of time the market can’t be beat, a premise borne out by the fact that 84 percent of mutual fund managers have underperformed the S&P 500 over the past 10 years. There are exceptions, and a few of those–most notably Bill Miller, who runs the Legg Mason Value Fund–I’d be hesitant to dismiss as simply statistical anomalies. But for the most part, you’re better off putting your money in an index fund than trusting it to some fund manager, especially one who’s charging you to invest. (Whether the economy will be better off if we all start indexing is a different question, of course.)

Now, most people on Wall Street now pay lip service to this reality, but secretly–and not so secretly–most people don’t believe in it. (And they don’t want to believe in it, since it would mean the destruction of their whole business.) And that’s why this idea of a “stock-picker’s market” keeps recurring. “Indexing works in a bull market,” they say, “but what happens when the market stops going up?”

The answer, of course, is that you don’t make money, but that you don’t lose as much money as you would if you were invested in most mutual funds. Fund managers who can’t pick winning stocks better than the market does when times are good are not suddenly endowed with great stock-picking ability when times are mediocre or bad. All a sideways market means is that most managers will find their portfolios’ returns flat or even negative. If there are such things as stock-pickers’ markets, then they’re all stock-pickers’ markets. And if there aren’t–and it really doesn’t look like there are–then none of them are.

And here’s some evidence, if not to prove, then at least to suggest the point: In the first three months of this year, the S&P 500 rose 4.99 percent, which isn’t exactly sideways but these days is close to it. The average U.S. mutual fund, according to Lipper Inc., rose exactly 0.93 percent. The stock-pickers just keep on shining.