We find ourselves very frequently responding to the claim that a stock picker’s skill is essential in times of high market volatility. And with the Dow coming off its best weekly performance since March 2000, there has been ample opportunity to examine this assertion.

According to Barron’s during the most recent run up:

The 50 most shorted stocks have rallied 17.6%, outperforming the 50 least shorted stocks by 8.80 percentage points (over the same time frame).

The 50 stocks with the lowest analyst ratings have outperformed the 50 with the highest ratings by 3.80 percentage points.

One sample size does not lend itself to proof of anything but this pattern of underperformance (or simply put “Getting It Wrong”) is very consistent with past events.

Just a quick observation- Flipping through CNBC and Bloomberg this week and perusing through the Wall Street Journal, it seems the financial crisis is no longer “leading news” material. The health care debate has taken the mantle.

“Stocks will go back up when the housing market settles” or “The housing market will pick up once the stock market settles” are common refrains. Is there any truth to this? Perhaps.  Does this relationship have historical precedence? Let’s see.

CXOAdvisory provides a nice historical perspective of this using annual median home price data from RealEstateABC.com (1968-2004) and the National Association of Realtors (2005-2008) and contemporaneous annual S&P 500 Index data for 1968-2008 (41 years).

In the spirit of a blog, I will present two charts from their work that answers the questions- Might home appreciation systematically lead or lag stock returns, and how closely related is the housing and stock market?

(Of note a correlation of +1 indicates a positive linear relationship and a correlation of -1 indicates a perfectly inverse relationship. A correlation of 0 indicates no relationship between the variables).

The correlations remain in the range of .12 through -.30. Hence, data from the past 41 years indicate little or no relationship between the equity market and the residential real estate market.

The variation in home appreciation explains only about 1% of the variation in stock returns.

Jon Stewart last night hammered Lenny “Nails” Dykstra, a former Mets centerfielder turned financial-advisor-in-bankruptcy, and then tagged TV financial personality Jim Cramer with a jarring comedic blast.

Dykstra touted himself in recent years as a successful investment advisor and was profiled in 2008 as a “financial whiz kid” on the HBO program Real Sports. During the interview on HBO he states how he did not read books because it was bad for his eyes.

Stewart also revived his public humiliation of Cramer by playing an interview of Cramer on the HBO show in which he hails former Mets hero Dykstra’s as a brilliant financial advisor, “one of the great ones in this business.”

I’m not sure that phrase would carry the same punch it did when that commercial was popular but there still exists some very special folks worth listening to and Burton Malkiel is one of them. He is author of A Random Walk Down Wall Street, one of the must have books for any investment library.

He was recently a featured speaker at an investment conference and here are some of the highlights I thought to pass on:

Against institutional investors, who are responsible for 98% of all trading, individuals don’t stand a chance, Malkiel said. “Institutions can’t beat the market because they are the market and individuals can’t expect to do any better… Telling someone you can’t beat the market is like telling a six-year old that Santa Claus doesn’t exist.”

“Technical analysis,” he said, “is most akin to astrology.” It does not give investors a dependable way to beat the market.

He conceded that there is a “modicum of truth” that momentum helps explain stock prices. But he said the resistance to momentum can be enormous and “there is not enough momentum to make excess profits.” “Whatever irregularities exist in stock prices, such as momentum, are so small that after transaction costs investors cannot profit,” he said.

When faced with the mounting evidence supporting indexing as a superior investment approach relative to an active approach, an investor that follows an active approach may state something along the lines of: “I recognize it is tough to beat the market in highly liquid securities where all information is known BUT (always a BUT) … there are certain areas of the market that are more inefficient and therefore allows a more seasoned investor to spot bargains.” The inefficient areas being referred to usually include small cap and emerging market asset classes. While on the surface this makes sense and sounds like the investor is being open-minded in willing to concede his active approach in certain “more efficient areas” to indexing, the subsequent returns do not bear this out. The results for active managers are just as bad if not worst for the perceived less efficient areas of the market than the more efficient areas.

Barron’s recently featured an article, Passive Portfolios’ Emergence, that details the continual inability of active managers outperforming an emerging market index portfolio over the short and long term. To quote:

“The move into index funds has also proved smart. Over the one, three and five years through May, emerging-markets funds on average lagged behind the benchmark MSCI Emerging Markets Index-over the long haul, by a meaningful two to three percentage points a year.”

Underperforming the markets are the equivalent of leaving money on the table, and when Emerging Markets return over 36% as they did for this past quarter, we need to make sure we capture those returns.

“Hedge funds exhibit no ability to time sectors or pick better stock styles. Surprisingly, we find no evidence of consistent differential ability between hedge funds. Overall, our study raises serious questions about the perceived superior skill of hedge fund managers.”

This is a direct quote from the abstract of How Smart are the Smart Guys? A Unique View from Hedge Fund Stock Holdings, by John M. Griffin and Jin Xu and published in the Review of Financial Studies.  A recent a fairly detailed academic study investigating the performance of hedge funds.

This is not surprising as journalist David Reilly points out in a recent article,

“Markets sank last year. So too did hedge-fund performance. Markets soared in the just-finished quarter. Hedge funds notched up big wins.

Now remind me why they are called hedge funds.

Bull-market geniuses may be a better moniker. For all the talk of being able to make money whether stocks rise or fall, hedge funds too often look more like index-hugging mutual funds.”