One of the interesting aspects of the brief selloff in stocks in late November was that breadth deteriorated markedly. The broad indexes were only down a few percentage points, but there were more than a thousand stocks making 52-week lows on a daily basis. And, of course, the stocks that went up were the same ones that seem to always go up: Apple Inc., Microsoft Corp., Nvidia Corp. and a few others.
This presents challenges and difficulties to a range of players on Wall Street. In the analyst community (of which I am a part), how can someone honestly and objectively recommend Apple? It is poised to gain at least 30% for a third straight year and its market value is on the edge of $3 trillion. Analysts, no matter where they sit on Wall Street, are incentivized to find rare opportunities and unloved stocks that are typically ignored. I have a newsletter, and if I wrote to my subscribers that after hours of thought, research and deliberation that my best idea was Apple, I would be a laughingstock. After all, everyone already owns it, either directly or indirectly through something like an exchange-traded fund or similar investment vehicles.
The problem for money managers is that when the returns of the market are being driven by a handful of stocks, they must own those stocks or risk underperforming the market, which creates continuous demand for those stocks that are leading the market higher no matter what their prices. And it was clear during the small correction late last month that so-called market neutral players had been using Apple, Microsoft and Nvidia as a hedge, because as the market declined, those stocks actually rose, as hedges were unwound.
There have been episodes of declining breadth in the past, and those usually presage large corrections or bear markets. The Nifty 50 episode in the 1960s is one example. But even in the dot-com bubble, breadth declined steadily until March of 2000, at which point there was only one stock standing: Cisco Systems Inc. When Cisco broke on an earnings report, that was it for the dot-com bubble.
Another reason that the big stocks are so impervious to pain is because of cost basis. The vast majority of investors in these names have a cost basis in the stocks that is far below current prices. Psychology dictates that people don’t experience as much pain with the loss of big unrealized gains as they do with outright losses, and are willing to withstand corrections of some magnitude. If you have a 500% gain on a stock instead 1,000%, it’s still a 500% gain.
Also, equity investors are at least partially imitating the cryptocurrency world, where players “HODL” their investments and never sell. Crypto, as we know, only goes in one direction: up. I’m only being half-sarcastic. I have heard comments from investors over the past few years that they will never sell a certain and plan to hold it forever. What’s remarkable about the last month is that so many investors held to their convictions and bought the dip, because it has worked every time in recent history.
I tend to look at things more skeptically. There is always a time to sell. Everyone has their point of maximum pain, and they may think they can withstand a large drawdown—until it happens. An old Lehman Brothers Holdings Inc. colleague, perhaps imitating Yogi Berra, told me that “you can’t go broke making money.” There seems to be a pervasive fear of selling too early and leaving money on the table. In my personal investing, I take profits lustily, and if the stock continues higher, it is no big deal—there is always another trade.
I have also come across more and more investors who characterize themselves as optimists. Sure, optimism works most of the time. But there are long stretches when it doesn’t. Most people forget how painful the dot-com bust was at the time. It was a full three years before stocks finally returned higher. And don’t forget the sad period of 1929-1945. If the time you have to wait for new highs is years or decades, it’s not easy to be an optimist. Remember, as recently as 13 years ago, pessimism worked as a strategy. They made a movie about it, if you recall: The Big Short.
Investors and analysts have spent the last five years tying themselves in knots looking for the “smart” or “cool” investment, when the answer was right in front of them the whole time. Sure, there have been some opportunities outside of the biggest stocks, especially in energy. But I am fond of saying that it’s better to be contrarian for the sake of being contrarian than being part of the consensus for the sake of being consensus, but that doesn’t fit with recent experience.
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