A Fatal Blow to the Financial Services Industry Has Been Dealt

An interview on CNBC’s Fast Money on Thursday November 13, 2008, is the reason why I am recommending that investors aggressively purchase shares of certain companies in the online financial sector.  I am also recommending investors sell the shares of the asset managers who manage mutual funds and the shares of any brokers who are in the business of selling mutual funds to approximately 90 million individuals in the USA.

During Fast Money’s show on Thursday November 13, 2008, Dylan Ratigan and the Fast Money cast including Pete Najarian interviewed Daniel Ariely, who is the James B. Duke Professor of Behavioral Economics at Duke University. He also holds an appointment at the MIT Media Lab where he is the head of the eRationality research group. He was formerly the Alfred P. Sloan Professor of Behavioral Economics at MIT Sloan School of Management.  Ariely is the author of the book, Predictably Irrational: The Hidden Forces That Shape Our Decisions, which was published on February 19, 2008 by HarperCollins.

One of the topics that the cast of Fast Money discussed with Professor Ariely during the popular CNBC show was the potential behavior of the millions of individual investors who are being whipsawed by the stock market’s extreme volatility.  Below is a transcript of an excerpt in the dialogue between Pete Najarian and Professor Ariely: 

Question from Pete Najarian:        

“Will they [individual investors] actually start saying to themselves, I am going to take my own personal responsibility?  In other words, not just completely eliminating themselves from being in the market, but actually being in the market with their own money and trying to manage it.  We’ve got all of these new tools, the ETFs and all the rest of it, so that they can diversify with out having to go into mutual funds, without having to put their money in other places.  Psychologically, don’t they want to take their own responsibility going forward?”

Answer by Professor Ariely:   

“I think they would as people understand how less and less the people, who are managing their money, understand what is going on; there will be more reaction and self-management.  We have seen actually in an experiment that people even in random patterns are trying to take ownership and are trying to create their own control.  When you feel that a sense of control is lost, people try to take things in their own hands and manage themselves.”

To view complete interview go to: http://www.cnbc.com/id/15840232?video=927691652&play=1

Based on the answer by Professor Ariely, who is one of the world’s foremost experts on behavioral economics, the mutual fund industry is in deep trouble.  The confidence that 90 million mutual fund holders, in the USA alone, have had in the financial advisors who sold them the mutual funds and the managers who managed their funds has been shattered.  The likely result is that there will be millions of mutual fund holders who will now begin to manage their own money.  That could be the death knell for the outdated, archaic and inefficient mutual fund industry.  The bottom line is that the investment management industry and the public companies in it are likely to suffer staggering losses of shareholders, revenue and profits for 2009 and beyond.  I predict that before it is all over the companies in Investment Management Industry will become mere shadows of their former selves or what they were at the peak of the secular bull market during 2007.  I am also predicting that the number of mutual funds will decline from over 10,000 at their peak in the recent secular bull market, which ended in October of 2007 and will fall to less than 2,000 within 10 years.

Professor Ariely’s answer to Najarian’s question and the research that he has been conducting gives further validation to my most recent October 1, 2008, Equities Magazine article, which was titled “The Carnage for Financials Isn’t Over”.  In the article (http://www.onlinefinancialsector.com/v/winnersandsinners.pdf) I warned readers that the shares of Goldman Sachs and Morgan Stanley would go a lot lower.  Both were trading at $135.50 and $32.19 respectively and have since gone down by an additional 50%.  I also warned readers that the investment management industry or those companies that manage mutual funds would be the next to fall precipitously and I specifically named Franklin Resources (NYSE:BEN) and Eaton Vance (NYSE:EV) as two to avoid.  Franklin shares have since dropped from $91.71 on October 1, 2008, to $51.16, a 40% decline and Eaton Vance shares have fallen from $34.34 on October 1, 2008 to $15.17, a decline of more than 50%.

The beneficiary of the mayhem that I am predicting for the asset management industry will be the online financial sector and those public companies, who reside within it. Millions of former mutual fund holders will trust no one with their money but themselves.  They will avoid making investments in mutual funds.  They will be skeptical of any advice that is given to them from financial planners and the advisors.  Instead they will opt to do business with those online investor services providers who provide online investor education, online financial information and online brokerage services. 

Due to the escalating Global Financial Crisis and the predicted meltdown of mutual funds the online investor education industry and more specifically Think or Swim Group Inc., and Global Investor Services, Inc., are both in the position to exponentially grow their revenue, profits and customer bases in 2009 and beyond.  This is an industry that has educated or has trained less than 1,000,000 individuals on how to invest in the stock market.  Now that millions are likely to flee mutual funds, I believe that the investor education industry will be the number one industry for return on investment, out of all 216 Industries in the U.S., for all the reasons I outlined and additionally since its marketing, sales and fulfillment activities can all be done online. 

There is another major reason why I believe that the investor education industry will soon enter into a hyper growth phase in the near future.  It is what I discussed in my “Cyber Gains” article (http://www.onlinefinancialsector.com/v/cybergains.pdf) that I wrote in Equities Magazine’s March 2008 issue.  In that article I compared the origins of the Online Investor Industry with the origins of the Airplane Pilot Education Industry back in the 1950s and 1960s, when there were a lot of airline crashes.  The result was a lot of fear and insecurity about flying.  In order to deal with the fear and insecurities a record number of individuals paid a thousand dollars (in 1950 dollars) or more to learn how to fly.  I know this because my father was a flight instructor.  They (1) wanted to be able to land the plane in the event that the pilots were incapacitated and (2) they wanted to learn about airplanes and how they operated so that they could better understand the risks that they were taking when they boarded a plane. 

Now that the markets are going through the most vicious correction since 1929, individual investors and mutual fund holders are watching their portfolios crash and burn.  The result will be an acceleration in the number of investors who will no longer trust those who are piloting their portfolios.  An even greater amount than I originally anticipated earlier this year will want to be educated on how to pilot their own portfolios.  Once educated many of these individuals will become clients of online brokers.  They will also become subscribers to financial information. 

I believe the events of 2008, and most especially the serious losses suffered by those investors who own mutual funds, have dealt a fatal blow to the Financial Services Industry and the Asset Management Industry.  The reason why, is that the foundation for both of these industries has been based on the premise that a mutual fund was much safer than a stock because of the diversification.  Now millions of investors are learning that this is not the case.  They have learned the hard way that mutual funds are not immune to stock market volatility as they watch their years of retirement contributions go up in smoke.  I believe that the fallout will be that the mutual fund industry will lose an entire generation of investors who have lost their trust in mutual funds.  They will no longer rely on mutual funds because they now know that mutual funds do not protect them from the risk of the stock market. 

Disclosure: Michael Markowski, the founder of OnlineFinancialSector.com currently holds shares in the public companies recommended on the OnlineFinancialSector.com website and may buy or sell shares without notice.