Published 2/15/2011

The Wall Street Business Model is Broken

Is there a logical, profitable and safe alternative to the current business model?

Irvine Blackman, Brian I. Whitlock

Wall Street’s current business model works like this: An investor buys a stock, bond or mutual fund; pays a commission; and possibly pays an investment advisor a management fee. If the advisor helps the portfolio increase in value, this is a good thing. However, if the value of the portfolio goes down, the same commissions and fees continue, compounding losses.

How has this insane business model survived decade after decade? Jim Shepherd, author of the Shepherd Investment Strategist, says it best:

“The media now calls the last ten years the ‘lost decade.’ But it did not seem ‘lost’ as they reported. Instead, viewers were hit with an unceasing litany of omission and positive spin, effectively coloring a gloomy economy consistently brighter. But why the spin? Because the media relies on advertisers … they must report the news in a manner that pleases the advertiser, or the advertiser takes its business elsewhere. … Large brokerage houses … want investors to keep buying, or at least not selling stocks. The media are pressured to report financial releases as ‘news’ in as positive a manner as possible.”

This positive spin met its purpose: It kept most investors in equities, even though equities lost almost 35 percent over 10 years.

My research further revealed another financial investment that should be a national scandal. In Eleanor Laise’s January 2009 article, “Big Slide in 401(k)s Spurs Calls for Change,” she writes:

“About 50 million Americans have 401(k) plans, which have $2.5 trillion in total assets, estimates the Employee Benefit Research Institute. In the 12 months following the stock market peak in October 2007, more than $1 trillion worth of stock value held in 401(k)s and other ‘defined contribution’ plans was wiped out. The most obvious pitfall … 401(k) plans. ”

The losses outlined above are the result of an invest-in-equities, buy-and-hold mentality.

I also researched traditional conservative investments, such as municipal bonds, and found that it could be the next bubble to break. Interest rates are at an historic low. If rates go up as predicted, along with anticipated inflation, the value of bonds will plummet.

So, is there any hope for other conservative investments? Here’s what Kiplenger said in its November 2010 newsletter:

“Short-term interest rates are headed even lower … to zero on CDs with terms under 12 months, as well as money market accounts. The average for CDs is now 0.85 percent, which is likely to slip an additional 5 basis points a month. … Money market accounts are typically paying even less, roughly half a percent.”

Now, think back to the ‘80s and ‘90s. It was easy to hire an investment advisor and make a profit as the equity markets roared higher. What changed? As we entered the 21st century, the market switched from a bull market to a secular bear market, which is a period of great volatility of investment returns with little or no upward
price movement, even though the trading range is large. Based on market history, such secular bear market periods last between 17 and 25 years.

Following are the unhappy numbers of what actually happened during the last four secular bear markets with the S&P 500 stock index.

Market Period	Annualized Rate Of Return
2000 to present (11/30/10)*	Loss of .43%
1966 to 1982	Gain of .83%
1929 to 1953	Gain of 1.69%
1906 to 1924	Loss of 4.29%
* Current secular bear market should end between 2017 and 2025.

Buying and holding securities does not work during secular bear markets. You can make money during a secular bear market, but only if you have a proven plan that identifies an approaching change in market direction.

This is where the investment strategy known as “Trend Following” shines. This strategy does not attempt to predict market or stock movements. Instead, the strategy capitalizes on the natural market’s movements. Trend following managers take advantage of what is actually happening in the market, rather than trying to guess what might happen in the future.

Trend following turns volatility from a foe into a friend. A trend is a strong, sustained move that can last from several days to years. A trend may be rising or falling and is applicable to any specific security, index or commodity. So, how does a portfolio manager who is a trend follower make money? He or she waits for the market to develop a new trend and then invests with that trend, holding that position until there is a reversal. The manager does not invest at the exact bottom because there must be confirmation that a turn has occurred. Likewise, the manager generally does not sell at the exact top. Rather, the manager sells after a clearly identified change in trend in order to capture a majority of the trend.