Big 5 stocks dominate markets
Over the past year, the 5 largest S&P 500 companies (AAPL, MSFT, AMZN, GOOGL, FB) returned 58% vs. 1% for the rest of the market.
At $6.2 trillion, the combined market cap of Apple, Amazon, Microsoft and Google is now greater than the GDP of every country in the world with the exception of the US and China.
In his latest memo, Howard Marks dissects the impact of the COVID-19, Fed policy, and the long-term implications of low-interest rates in equity markets.
Marks concludes with some thoughts on today's extreme valuations and the current market darlings:
On one hand, we have the surprisingly rapid recovery of the stock and credit markets to roughly their all-time highs, despite the fact that the spread of Covid-19 hasn't been halted, and that it will take a good number of months for the economy to merely return to its 2019 level (and even longer for it to give rise to the earnings that were anticipated at the time those market highs were first reached). Thus p/e ratios are unusually high today and debt yields are at unprecedented lows. Extreme valuations like these are usually justified with protests that "this time it's different," four words that tend to get investors into trouble.
On the other hand, John Templeton allowed that when people say things are different, 20% of the time they're right. And in a memo on this subject in June of last year, I wrote, "in areas like technology and digital business models, I'd bet things will be different more than the 20% of the time Templeton cited." It certainly can be argued that the tech champions of today are smarter and stronger and enjoy bigger leads than the big companies of the past, and that they have created virtuous circles for themselves that will bring rapid growth for decades, justifying valuations well above past norms. Today's ultra-low interest rates further justify unusually high valuations, and they're unlikely to rise anytime soon.
But on the third hand, even the best companies' stocks can become overpriced, and in fact they're often the stocks most likely to do so. When I first entered the business in 1968, the companies of the Nifty Fifty - deploying modern wonders like computing (IBM) and dry copying (Xerox) - were likewise expected to outgrow the rest and prove impervious to competition and economic cycles, and thus were awarded unprecedented multiples. In the next five years, their stockholders lost almost all their money.
We reach our conclusions, limited by the inadequacy of our foresight and influenced by our optimistic or pessimistic biases. And we learn from experience how hard it is to get the answer right. That leads me to end with a great bit of wisdom from Charlie Munger concerning the process of unlocking the mysteries of the markets: "It's not supposed to be easy. Anyone who finds it easy is stupid."
Seth Klarman on the Fed
Seth Klarman said the Federal Reserve is treating investors like children and is helping create bizarre market conditions that are unsupported by economic data. "Surreal doesn't even begin to describe this moment," Investor "psychology is surprisingly ebullient even though business fundamentals are often dreadful". "Investors are being infantilized by the relentless Federal Reserve activity. "It's as if the Fed considers them foolish children, unable to rationally set the prices of securities so it must intervene. When the market has a tantrum, the benevolent Fed has a soothing yet enabling response."
Taking the the best managers over the past 10 years in Canadian equities. These are the ones that have crushed it over a decade of measurement and are in the top position among their peers. But, during that same 10-year period, almost all of them spent a three-year period or longer with below average results. (chart 2) Half spend at least a three-year period in the bottom quartile. If you are prone to chasing performance, you would likely have bailed on these managers when they were underperforming
Alternatively, we looked at Canadian equity funds that were in the top quartile in June 2014 based on their three-year trailing performance (June 2011-June 2014). Some 69% of these funds were not positioned in the top quartile in the next three year period (June 2014-June 2017) - 44 % were actually below average. Similarly, 65% of the top-quartile funds in June 2017 were not top quartile during the next three-year period (2017-2020). See Chart 3.
A narrow group of companies or business models is perceived to be so valuable that any company that is seen as belonging to this group is valued at extraordinary levels.
In the 1920s it was the radio stocks. In the 1960s it was the conglomerates and the Nifty Fifty. In the 1990s it was the Internet stocks. Now it's "platform companies".
Company "stories" become more impactful than financial results.
Many of the current market darlings don't have amazing financials to lean on. What they do have is stories, and perhaps some period of revenue growth which is yet to translate into substantial profits. So which do you think will help them promote their stock: the stories or the numbers?
Securities are purchased based on belief rather than thorough analysis.
This sign refers to which part of the brain investors are using to make decisions: the part they use to figure out which refrigerator offers the best value for the money, or the one that makes some of their heads turn when a really attractive sports car drives by.
Doubters have been wrong for a long time and are largely disregarded as people who "just don't get it".
When a group of people have been warning about danger for a prolonged period of time, a certain fatigue sets it. Kind of like the story about the boy who cried wolf.
Ironically, in stock market as prices rise higher and higher without the fundamentals to support that increase, the longer the warnings have been sounded and ignored, the more relevant they become. Only they do not appear so. These naysayers become largely discredited and ignored. Usually just as what they have been warning about is on the cusp of wiping out a large chunk of investors' portfolios…
The specifics change, but the general pattern reoccurs throughout investing history. The most expensive words in investing are "this time is different." Yet investors think and say these words every few decades. In large part, they do this because every time is different. The details change. What doesn't change is that in the long-term, stock prices are determined by weighing the cash flow streams of the underlying companies, not by stories or by popularity of these companies for a period of time with investors.