Kim Shannon: Why Stock Pickers Will Shine

Kim Shannon, President & CIO, Sionna Investment Managers discusses why she believes stock pickers will shine.

Dan Richards talks to Kim Shannon, CEO, Sionna Asset Management, former Morningstar Fund Manager of the Year, and fund sub-advisor to Brandes Investment Partners in Canada, on the subject of why stock pickers will shine, enjoying a reversion to mean in record high correlations of the past few years.

Dan Richards: Kim, we're gonna talk today about some recent research from JP Morgan, talking about whether stock picking matters in today's market environment. Let's start by briefly talking about that research.

Kim Shannon: Yes, the Global Equities Derivatives Group wrote a piece about correlations that they're seeing in the market and what they have found is that stocks are trading together much more frequently than they are on their own individual merits, and, to a level that they've never done before, historically.

Dan: And the reason they've suggested that we're seeing this very high, record high correlation levels ...?

Kim Shannon: What's underlying that is there has been tremendous growth in the last few years, most especially in Index futures options, but also in ETF indexes and as well a tremendous increase in program trading. All three of them together have added up well over half of all trading on exchanges today, is primarily driven by what we would call passive management, and in a sense, its what I would call 'dumb' money, in that its just a passively buying index as it is currently composed.

Dan Richards: And, so just not paying attention to the individual merits of stocks?

Kim Shannon: Exactly, and not paying attention to the relative risks or quality of the stocks within that basket.

Dan Richards: Kim, theres another factor that some suggest has driven this high level of correlation; all stocks moving up or down together has been the focus on macro-development, sovereign debt, the US federal reserve moves to try and stimulate the economy... has that contributed to that in your view?

Kim Shannon: Absolutely, there's a fair amount of evidence that players are using ETFs to make macro calls on the market and that's interesting because we learned in the 80's that tactical asset allocation although in theory makes a lot of sense, in practice, no one can consistently do it well, and we have people attempting to do it with a new product category, ETFs, to try and make it more successful in this market environment. I'm a little skeptical about that.

Dan Richards: Kim, as someone who's had a long and successful career, fundamentally picking stocks, how do you respond the suggestion, "It really doesn't matter, high quality stocks, low quality stocks, high valuation, low valuation; they're all gonna move up and down together..." How do you respond to that?

Kim Shannon: Well I think it creates an opportunity for long term orientated bottom up stock pickers. Truth will always out, and in the long term the economic equilibrium drive is that stocks should be priced on the underlying fundamentals. And, We have evidence that that is not happening today, that the risk-on/risk-off days are so driving the market, and stocks are moving together that, I welcome that future day, when stocks start trading on their fundamentals.

Dan Richards: So Kim, we've talked about the recent past. Let's shift forward; Did JP Morgan provide an opinion as to whether they expect this record high level of correlation among all stocks to continue going forward.

Kim Shannon: Yes, interestingly enough, in their piece they, and they understand the whole derivatives market far better than most of us do, that they believe that the correlation will revert to the mean, which I found amusing as a value manager that they moved into that world, and that was that it should [revert] correlate within the next year or two.

Dan Richards: And what do you expect, if and when that happens, what do you expect that result to be of what the opportunities are going to be?

Kim Shannon: What we've seen in the aftermath of the lows in '09, is that we've seen a junk rally, and depending on the credit rating and the quality of an operation, you've seen a performance differential. So, the lowest credit rated, the junkiest, most exploration orientated stocks have performed the best, and the traditional quality, low risk, low volatility, value oriented stocks have tended to lag.

And so, we anticipate that when correlations start to revert back to a more normal level as people step away from their strategies, that a quality active stock picking managers and the underlying stocks will start to outperform again, as they generally do most of the time in financial market history.

Dan Richards: Kim, thank you very much.

Source: ClientInsights.ca