Rogue Missives
Rogue Missives
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A Guru and Her Critics Last week saw the public return of longtime stock market bull Elaine Garzarelli, the former Lehman Brothers strategist who became famous for predicting the 1987 crash. This time, Garzarelli was making headlines for a special alert she issued on Tuesday, July 23rd, advising her clients to sell all their stocks. Her unexpected bulletin sent a shiver through already skittish investors.
Indeed, this sudden bearish turn marked a decisive shift for Garzarelli. Just two days earlier, she was quoted in THE NEW YORK TIMES saying that the market correction was over, and that the Dow Jones Industrial Average would shortly continue its rise to a new record level of 6400. Moreover, Garzarelli has been one of the few market analysts who has remained consistently optimistic on the long-term outlook for stocks since September of 1990, when the leading stock indexes were trading at less than half their current levels.
When Garzarelli's comments were reported on CNBC, they contributed to a dramatic 84-point turnaround of the Dow that took this widely followed index from a gain of 40 points to a loss of 44 points. The index closed the day at 5346, down from a twelve-month high of 5778 set only two months ago.
Garzarelli now says she expects a bear market that will send the S&P 500 index down 15%-25% from its high of 678. She predicts the Nasdaq will fair far worse, falling up to 30% to 40% from its high of 1249. At the beginning of trading last Tuesday, the S&P stood at around 634 with the Nasdaq at 1081, down 6.5% and 14.5%, respectively, from their recent highs.
After the latest wave of economic statistics, however, all of the indexes are now substantially above the levels they were at last Tuesday morning. The Dow, for example, closed today at 5679, up 5.3% in the last ten days. No matter how you figure it, Garzarelli's recent advice looks decidedly bad at this point. Some individual investors are already complaining that listening to her has cost them thousands of dollars.
Nevertheless, one of the most interesting aspects of Garzarelli's announcement was the skepticism with which it was greeted, both by the mainstream financial press and by Wall Street itself. After all, Garzarelli was once a star in both worlds. For 11 consecutive years, U.S. money managers rated her the top quantitative analyst in the annual poll conducted by INSTITUTIONAL INVESTOR magazine. And reporters had for years fawned over her as a dynamic, opinionated woman always ready with a clever quote.
Last week, though, the story was different. According to the THE WALL STREET JOURNAL, some "market strategists cringe at the idea that Ms. Garzarelli is still a big enough name to have an impact on markets." The article quoted others who said her latest call was a little late considering the Dow had already dropped 400 points.
Indeed, for a newspaper that had played a key role in making Garzarelli famous, the JOURNAL now seemed intent on dismissing her out-of-hand as someone whose reputation eclipsed her actual performance as a strategist and money manager. The writers, Robert McGough and Patrick McGeehan, suggested that Garzarelli had long played to the media and that it was her "hunger for publicity" that had driven her to do a No Nonsense pantyhose TV commercial in 1993.
This past Sunday, July 28th, the TIMES highlighted Garzarelli in a piece that addressed the penchant of some analysts to make bold market predictions in the hopes of attaining the fame and financial rewards reserved for market "gurus."
"The most shrill voices often belong to people not backed by a major institution. Some attract attention by staking out extreme positions and by then being the quickest and the loudest to say they were right. And the prospect of a bear market is particularly enticing to them, because it offers a once-in-a-market-cycle opportunity to seal their fortune as market gurus.
"A well-timed market call could mean huge rewards as a highly paid investment strategist, a sought-after portfolio manager or a popular newsletter writer."
Neither the TIMES nor the JOURNAL came right out and said so, but both implied that Garzarelli's call had more than a little to do with her recent direct-mail campaign to attract subscribers to her newsletter. In the words of the JOURNAL article and its headline, she had "returned from obscurity" with a prediction that "proves she can still roil the market."
In short, both newspapers suggested that Garzarelli was simply working the system that she knew so well to milk it for some attention and, in the process, perhaps to acquire thousands of new subscribers at $225 a pop annually.
What are we to make of all this? Well, both more and less than initially meets the eye.
It's important to recognize that Garzarelli has essentially been banished from Wall Street. We should be cheered by any article holding would-be market mavens accountable for their performance. But the JOURNAL's piece is nearly disingenuous compared to the TIMES article (which still failed to be genuinely self-critical about the media's role in the creation of so-called gurus). The JOURNAL didn't bother to even suggest that the media and the financial institutions themselves play a role in creating and marketing such stars because stars sell product: both newspapers and mutual funds.
The JOURNAL article is also less a dispassionate critique of Garzarelli's investment performance than it is a reminder that she has fallen out of favor with those parties that once supported her.
Garzarelli lost her job at Lehman Brothers in October of 1994, a victim in part of cost-cutting by a revamped firm. In May of 1994, Lehman was spun off to American Express shareholders as a new entity largely devoid of its former retail business, which remained with Shearson. Though Garzarelli was the director of sector analysis, her main support at that point came from retail investors. This made her an anomaly at the new Lehman.
Equally as important, Garzarelli remained steadfastly bullish even as Lehman's chief market strategist Katherine Hensel was predicting a flat-to-down market into 1995. Essentially, the firm's most visible analyst was directly contradicting its principal strategist.
Other factors almost certainly played a role, too. In August of 1994, Smith Barney Shearson had closed the Sector Analysis Fund that had been run by Garzarelli. The fund had turned in truly depressing results since its inception in August of 1987, producing a cumulative return of 37.7%, only half as good as the 73.6% return of the S&P 500 over the same period.
While Garzarelli's fame had initially drawn hundreds of millions into the fund, she had simply flopped as a money manager. In the meantime, her fame had proved annoying to colleagues and competitors. Though she says that her bosses encouraged her to become a media darling in order to promote the firm (part of the reason behind the pantyhose ad), her stardom led to a typical backlash.
Considering all these factors in light of her reported $1.7 million annual salary, Lehman decided to cut her loose. And the rest of Wall Street was either tired of her or simply unwilling to pay such a high salary. So Garzarelli indeed found herself in unexpected isolation, temporarily holed up in her million-dollar digs in Boca Raton.
In the last year and a half, however, Garzarelli has opted to start her own empire. In March of 1995, she launched the research firm Garzarelli Capital Corporation. It reportedly serves 1,000 institutional investors, who pay thousands of dollars annually for her monthly market reports (the TAMPA TRIBUNE puts the price at $3,500 to $8,500 annually; USA TODAY says between $12,000 and $30,000).
Last September, she launched Garzarelli Investment Management, which manages money for investors with at least $1 million. She's also interested in starting her own mutual fund. In February, to address the needs of retail investors, she started THE GARZARELLI OUTLOOK, a monthly newsletter in which she provides research highlights and guidance to the market's direction. Her special "Sell" alert last week went out to 70,000 subscribers in a special fax release of this newsletter.
In these materials, Garzarelli indeed presents herself as a market guru who "has called every major turn in the Dow since 1982." The publicity mailings offer the typical newsletter pap about the "edge" her forecasts give the investor and the astonishing, though less-than-substantiated, "average yearly gain of 20.2% since 1982" produced by her "scientific" system.
Her "Confidential Flash Alert #3" from last Friday offers the kind of strong advice that some investors love. "If you haven't sold all your domestic common stocks, please act now. And if you waited, wait no longer. Sell now."
Nevertheless, such flash alerts from market "gooroos" justifiably turn the stomachs of investors who see eye-to-eye with the brothers Gardner, co-founders of THE MOTLEY FOOL investment forum on America Online. The cultish quality of such pronouncements tends to infantilize investors rather than empower them. And trying to time the market ("Elaine is 100% OUT of The Stock Market") will more than likely cause an investor to miss exactly those dramatic and unexpected advances that Garzarelli hopes to catch.
Moreover, the Fools frown on the Nostradamus-like market predictions that such advice is grounded in, since these guesses can turn out to be true enough and yet still be virtually useless in making good investments.
All of this seems true. After correctly calling the October of 1987 decline, and cutting back on her fund's holdings in August of that year as her readings turned negative, Garzarelli actually missed much of the post-crash recovery, despite the fact that her system had soon thereafter registered a "buy" reading. It's impossible to say whether her failure to follow her system religiously was really the cause of her fund's poor performance during that period.
But her demise as a fund manager, despite her incredible bullishness through a period when markets soared beyond most Wall Street expectations, at least raises doubts about her abilities as a trader if not her general system. That system calls for shifting assets to the leading stocks in sectors that promise to be hot based on her reading of the economic tea leaves. Such trading often leads to a rolling correction in the markets as money goes from one sector to another.
On the other hand, it's worth doubting whether her mutual fund's performance offers sufficient grounds for measuring Garzarelli's expertise. After all, her fame follows from her proprietary methodology for conducting quantitative analysis. Unlike some market timers who rely on the mere charting of technical analysis, Garzarelli relies principally on economic fundamentals.
When forecasting movements in the stock market, she relies on 14 factors, including earnings, cash flow, the money supply, interest rate momentum, earnings yields as compared to interest rates, and the market's overall price-to-earnings ratio. Readings of investor sentiment are the only non-fundamental factor that figures into her outlook.
Garzarelli's market predictions typically include a target price for the Dow or S&P 500 along with some caveat about how possible changes in interest rates might affect her forecast. These predictions also include specific stock recommendations based on her sector analysis, which in turn depends on some sense of where we are in a particular economic cycle.
Given the nature of her research, one can imagine four very different ways of judging her results. And considering her expertise, the performance of the mutual fund may be the least valuable for all but those thinking of having her manage their money. We might also look at the accuracy of her sector bets or how well her individual stock bets within those suggested sectors have fared. But the data to judge her performance by either of these alternative standards is simply not readily available.
What does remain accessible, however, is her overall market calls. These are both of most and least importance to investors. A check of her public pronouncements go a long way toward substantiating the general accuracy of her calls. All she really claims is that her black box system of indicators can catch market moves within 4-8% of the top or bottom. And while there may be considerable hoodoo to this guru's system, it remains an interesting and seasoned system.
A quick Lexis-Nexis search revealed, for instance, the relative accuracy of some of Garzarelli's recent predictions. In August of 1994, with the Dow at 3800, she predicted a near-term trading range with a top of 4200. At the same time Lehman's chief strategist Hensel was expecting a down to flat market into 1995. By February 1995, a furious rally to begin the year had sent the index above 4000.
Even as Hensel was continuing to recommend that investors cut back on their stock holdings, Garzarelli said markets had begun a new phase of the bull market. Though she saw a 7% sell-off as a near term possibility, Garzarelli also predicted 4400 by the end of the year, or 4900 with a bond-market rally. Indeed, as bonds rallied, the Dow continued to soar, blowing through 5000 by December.
In September, with the Dow at 4770, she upped her target to a Dow of 5500 to 6000 by the end of 1996 or early 1997. Five months later, the Dow had again hit her range.
Obviously, closer scrutiny of Garzarelli's market predictions might reveal a less stellar record. Nevertheless, it's generally true that she has called key shifts with a fair degree of accuracy. Her correct calls before and after the market crash of 1987 and the recession/Gulf War shock of mid-1990 stand out.
If Garzarelli's current Sell recommendation came abruptly, it nonetheless reflected a significant change in her black-box economic reading. One key component of her system involves comparing the cash flow yield to bond yields. Her latest corporate cash flow numbers are pointing to trouble ahead for corporate earnings. The cash flow number counts for 20 points in her 100 point system, where anything above 65 is bullish, anything below 30 bearish.
Her numbers have dropped this year from 80 to 48.5 in April due to rising rates and slowing earnings growth, according to an article this week in INVESTOR'S BUSINESS DAILY. The recent weakness in corporate cash flow sent her numbers plummeting to 28.5, the first clear sell signal in nearly six years.
Many analysts use cash flow to predict the strength of future earnings. As an excellent article in BUSINESS WEEK recently pointed out, other analysts who have developed their own particular systems for analyzing cash flow are also finding cause for concern. Like Garzarelli, Jeff Fotta at Ernst Institutional Research in Boston also sees a red flag in the latest corporate stats. He says many companies may not be growing as fast as their earnings suggest.
Even so, one must realize the stated limits to Garzarelli's system. Consider a bear market that takes the Dow down 20%, from a high of 5778 to 4622. By her own account, she may do no better than call the top and bottom within 8%. That means, she might recommend investors sell at 5315 and buy back in 8% above the low (at 4991). Given the volatility in the markets, the 4.5% (324 points) she might save an investor here seems modest to say the least. The savings may simply go to pay the cost of her newsletter.
For all the perhaps justifiable skepticism regarding Garzarelli, however, her record of long-term bullishness in recent years would likely hold up quite well against the predictions of Oppenheimer's Michael Metz or other permabears who continue to be quoted regularly in the mainstream financial media despite disturbingly poor track records. For that reason, the JOURNAL's dismissal of Garzarelli seems worth closer scrutiny.
Though the writers act as if she's been on the moon, Garzarelli has only been toiling in obscurity because she's no longer working on Wall Street. And more than a little of the criticism of her comes not from her track record (which is certainly no worse than that compiled by most Street professionals) or even the obvious resentment of her personal and intellectual flair in an industry dominated by men, but from her following by individual investors. After all, the JOURNAL points out that her comments affected the markets only after CNBC broadcast them.
The JOURNAL writers quote Jeffrey Applegate, Lehman's current chief market strategist, as one analyst said to cringe at Garzarelli's continued ability to have an impact on the market. "I think she's still got a retail following," he said.
Later, the writers reinforce the point: "While her name remains known to individual investors, she is now far from her onetime Wall Street pedestal." Still later, the writers again repeat that "while widely known among individual investors, Ms. Garzarelli didn't have as ardent a following among institutions" while at Lehman.
The direct trading advice given by an Elaine Garzarelli is likely not as useful to individual investors as a proper financial education might be. But one suspects that the TIMES article hardly means the media plans to abstain from anointing new gurus in the future. More important, we're unlikely to see the JOURNAL launch a new series of articles holding analysts accountable for their predictions.
In fact, one suspects that analysts without a strong following among individual investors get away with murder. Garzarelli's biggest crime may be that individual investors actually listen to her. It's not clear that Wall Street and the financial media such as the JOURNAL have any particularly altruistic reason for finding that troubling.
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