Expectation Control
I have a friend, a financial advisor, who keeps what he calls “The Yell-At-Tom Index.” (His name is Tom.) Interestingly, The Yell-At-Tom Index (TYAT) is low right now, he says. That's right. Despite the utter carnage in the equity markets, the frozen (or thawing) credit market and the housing slump, Tom's clients are mostly quiet. Perversely, “I was getting yelled at in 2007,” Tom says, when the Dow Jones Industrial Average was hovering closer to 14,000. During 2007, Tom began getting nervous about stock valuations, the economy and the continuation of an inverted yield curve. He began going to cash in 2007. In his model portfolio, he was 40 percent cash.
Not all of his clients were pleased; they felt like they were missing out on a rally. Of course, now, given the down draft, they are happy to have been spared. While some of the advisors in his branch in New York City “argued away” the importance of the inverted yield curve (which often portends a slowing economy) and stayed fully invested, Tom and a few other like-minded advisors “respect the yield curve,” and took action accordingly. As a result, “We've got guys in here who are relaxed,” he says. “Yes, their clients are down 10 percent to 15 percent, but they are not down 40 percent.”
That reminds me of the Great Buying Panic of the late 1990s. I remember asking the advisors I visited what their biggest challenge was. The advisors I most admired responded, “managing my clients' expectations. “They think 30, 40 percent returns are normal. That this is the way it's supposed to be.” They'd shake their heads in disbelief. Well, we all know how that turned out.
Just as you manage client expectations on the upside, you should also keep clients from freaking out during bear markets. While this bear market is painful — there seems to be a serious lack of confidence in the financial system — it isn't unprecedented, argues Steve Leuthold, the veteran contrarian value manager. Steve has been getting more and more bullish (although he was way too early) as this year wears on. (Please see page 75 more details on Steve's analysis of the current situation.) “Market history reminds us that previous financial crises, while frightening at the time, have produced some excellent investment opportunities. Take the period from January 2, 1986 through December 29, 1995 — the savings & loan crisis period. About half of the 3,234 S&Ls closed, Steve writes in a recent research report, “Yet, during this 10-year period spanning the majority of the S&L crisis, the Dow gained 233 percent, an annual compound rate of 12.8 percent.” Steve has examined panics going back to the “Sixes” Panic of 1792 (our nation's first bank bailout). “While the characteristics of each crisis are, in some respects, different, one element stays the same: They tend to produce exceptional buying opportunities.”
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