Insight Line—August 3, 2007

Recently Barron’s suggested, “The public simply is not enthusiastic about stocks, judging by what individuals are both saying and doing.”¹

Considering that the U.S. economy is generating more total commerce than at any point in our history, such investor apathy is really quite perplexing.

Why haven’t investors gained enough confidence to return to the equity market? Perhaps the consumer’s financial advisor may be the key. As I see it, investor confidence is influenced more by the mood on Wall Street than on Main Street.

Wall Street firms, unlike Main Street firms, naturally tend to look inward at their own firm’s performance to gauge the condition of the broader financial markets. The general attitude on Wall Street or, better yet, Wall Street’s perception of itself and of the market arguably rises and falls with the market value of the companies’ stocks.

To measure Wall Street’s “feelings” and, in turn, their effect on investor confidence, no convenient survey exists. The next best indicator may be the Amex Broker Dealer Index (XBD). The XBD tracks the performance of the industry’s most well-known names including Bear Stearns, Jefferies Group, Legg Mason, Raymond James, TD Ameritrade Holding Corp., Lehman Brothers, A. G. Edwards, Morgan Stanley, Goldman Sachs, Charles Schwab, Merrill Lynch and E*Trade Group. As such, for our purposes, the XBD represents an appropriate cross-section of Wall Street and its collective psyche.

Representing Main Street is the Standard and Poor’s 500® Index (S&P), which contains a diversified group of many well-known household name companies.²

A comparison of performance returns year over year reveals an interesting pattern of Wall Street’s influence over Main Street. Keep in mind, of course, that past performance is no guarantee of future results. Though the XBD dates back to 1993, official trading began in April 1994. By the end of the index’s first year, Wall Street, or the XBD, eked out a barely positive return of 0.30 percent. Main Street, as represented by the S&P, fared much better during the same period, up more than 5 percent.³

By 1995, however, Wall Street’s attitude saw a marked improvement. The XBD rose 49 percent and, coincidently, the S&P turned in its best year since 1958—up 37 percent. Wall Street would continue to outperform Main Street until midway through 1998. As 1998 unfolded, the XBD rose more than 20 percent while the S&P was up nearly 18 percent in the first half of the year. However, the second half of the year was a different story. The international currency crisis and the collapse of Long Term Capital Management descended on Wall Street with a vengeance. By year’s end, as concerns on Wall Street heightened, the XBD’s total return fell far short of the overall market and the mood from Wall Street turned dour.

In early 1999, however, the XBD was again in full ascent, as Wall Street regained its confidence as well as the attention of Main Street. However, by mid-2000 Main Street’s enthusiasm began to fade, despite Wall Street’s upbeat attitude.

In 2001, unable to overcome the slowdown in economic activity, the XBD and the S&P retreated. Simply put, with little in the way of encouragement from Wall Street, investors went home—for almost two years!

However, by late fall 2002 the XBD turned upwards. Wall Street became more optimistic, but faced a skeptical Main Street.

Over the next five years the XBD would climb relentlessly, giving Wall Street the conviction needed to engage Main Street.

That is until recently.

You see, year-to-date returns on the XBD, which were soundly in Wall Street’s favor, recently stumbled.

So, rather than asking when individual investors might re-enter the markets, perhaps the better question is: When will Wall Street feel comfortable enough to ask them to?

The index performance shown is not meant to depict the performance of any specific investment The indices do not include any expenses, fees or sales charges, which would lower performance. They are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

¹ Santoli, Michael, “The Missing Man,” Barron’s, July 23, 2007.

² I recognize that the members of the XBD are also members of the S&P 500 and as such represent an imperfect comparison. The Standard and Poor’s 500® Index (S&P 500) is a broad-based index, the performance of which is based on the performance of 500 widely-held common stocks chosen for market size, liquidity and industry group representation. The indexes do not include any expenses, fees or sales charges, which would lower performance. The indexes are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

³ Source for all data presented in this commentary: Bloomberg LP.