Why Individual Stock-Picking Is Harder Than Ever
The pitch: getting the outlooks for specific companies right can provide investors' cover from bigger lurches.
And while there's no shortage of analysts claiming to know what the future of a company looks like as second-quarter earnings season continues, investors should take their recommendations with a big grain of salt.
Harder to Discern Specific Company Merits
Whether investors can outwit the broader market over the long run is a perennial, hotly debated, topic. But as computerized trading and virtual baskets of stocks make up an ever-increasing portion of the market, getting the fortunes of specific companies right may matter less than it ever did.
The increasingly haphazard nature of the stock market is vexing big-name professional investors, too. "The fact that index [exchange traded funds] have become such a significant portion of total trading activity suggests to us that most [high-frequency trading] strategies are either short-term directional bets on the overall market or inter-sector arbitrage bets, as opposed to efforts to discern the relative merits of one individual security versus another," David E. Nelson, a senior vice president and portfolio manager at high-profile investment firm Legg Mason Capital Management, wrote in a note to clients earlier this month.
Indeed, high-frequency trading jolted into the spotlight in May when trades gone wrong caused the Dow Jones to drop a stomach-churning 1,000 points in a matter of minutes. But behind the scenes, the growth in computerized trading is making stocks trade in lockstep more than ever, thereby minimizing whatever ability fund managers had to pick the right ones to begin with.
"This trend is consistent with our view that stocks are becoming increasingly commoditized and helps explain why the movements of individual stocks are near all-time high correlation levels of 80%," Nelson wrote in an unusually candid letter to investors. "We find this environment a challenging one as we try to make fundamental judgments about the relative attractiveness of individual securities."
Analysts paid to follow specific companies continue push things like their stock-price targets with near-scientific precision, of course. But investors should note that the market these analysts are depending on to come to fruition resembles a roulette wheel that never really stops on a winning number.