John Teahan

John Teahan

Portfolio manager

A winner’s curse

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You may remember in December we wrote in ‘Not so passive’  that  ETF flows were driving the market and that the correlation between passive and momentum/growth meant that such investing was far from passive.

Shortly after publishing I read that the Californian Public Employees’ Retirement System (CalPERS) were firing all but four of their twenty-two remaining active managers in favour of indexation.

With this constant flow of money away from active and into passive, the index constituents receive buy orders each day according to their index weight, pushing the biggest stocks higher and the index with it.

Over the last three months the S&P 500 Index rose on average 0.17% per day, grinding out +11% in three months, which would annualise at 50%. The Index RSI is in the 96th highest percentile, short interest in the 3rd lowest percentile and VIX shorts in the 98th percentile.

Note:  Purple is top quintile; blue is bottom quintile. Data as at 06 Dec ’19.
Source: Compustat, I/B/E/S, Goldman Sachs Global Investment Research.

Figure 1: A winner’s curse is developing, as great companies with competitive advantage have become much more expensive…

As investors witness this Index climb, along with Tesla’s 123% increase over the same period, they are getting more bullish as illustrated by the University of Michigan sentiment survey (consumer sentiment towards the stock market is back to January 2018 levels) and the TD Ameritrade Investor Movement Index (indicates that retail investors are positioning their portfolios more aggressively).

As a result, for the biggest stocks, valuation and fundamentals are of no relevance. KKR call it ‘a winner’s curse’ as valuations in the top quintile of stocks are pushed to levels last seen in 2000, “[T]he winners’ ability to compound at the same rate of return is now likely more challenging, given that these companies are now not only bigger but also they are starting from a much higher valuation point”.

As value investors we are looking at those cheaper, unloved stocks. Right now, many of those companies are doing the right thing at an operational level, running their companies well, creating efficiencies and investing while strengthening balance sheets and paying dividends. However, the market does not want to know, rather their valuation multiples are getting further depressed.

The performance spread between value and growth is at its widest since 1975 (as evidenced by MSCI World Value – MSCI World Growth). Such a dislocation is throwing up more companies for us to look at, particularly relative to 2017 and 2018. It also means that we must be hugely patient and disciplined, ignoring the market telling us that we are wrong via continued multiple contraction. Not because we think we can ignore the wisdom of the market, particularly on individual stocks, but an awareness that right across the board value is being systematically sold for the reasons outlined above.

Meanwhile, risks remain. Bobby Vedral at Macro Eagle pointed out the disconnect between the Global Policy Uncertainty Index and risk sentiment as represented by the VIX Index. As Bobby says, mind the gap!

Source: Macro Eagle, 7 January 2020

The statements and opinions expressed in this article are those of the author as of the date of publication, and do not necessarily represent the view of RWC Partners Limited. This article does not constitute investment advice and the information shown above is for illustrative purposes only and should not be construed as a recommendation or advice to buy or sell any security. No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment.

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