A lot of people think that picking the right investment or investment strategy is hard. I don’t think that is true. It’s the implementation of the strategy that is hard. The hard, cold fact is that the investment markets beg you to do the wrong thing at the wrong time and it is very hard to ignore the markets.
The stock markets have been very good over the last few years. Most of the overperformance has come from large-cap growth stocks. In other words, stocks that are usually very well-known and trading at prices that most analysts would consider to be overpriced. Specifically, investors are investing in overpriced companies in the hope that their earnings will catch up with their price or the company will simply become more overpriced than when they bought it. The laggards in the past few years have been smaller stocks, value stocks (stocks that are considered to be underpriced) and international stocks.
So, I am having a lot of conversations with investors who want to buy large-cap growth stocks. They have seen the returns and they figure, “If I can get those returns over the next 10 years, I will be doing great!” The problem is that you can’t get past returns in the future. You can only get them in the past. We are a reversion-to-the-mean business, which means that if something has been overperforming it is likely to underperform in the future and vice versa.
The last time we saw these kind of outlier returns in large-cap growth stocks was right at the turn of the century. I remember vividly having the Chief Financial Officer of one of my corporate clients tell me, “The S&P 500 is 38% tech stocks and you only have 5% tech stocks in your portfolio. Tech is where all the money is being made. If you don’t get closer to 38% you’re fired.” We didn’t make that move because there was no real data to support that it was a good idea. So ... we were fired. All of this happened in the first quarter of 2000. In August of 2000, the tech market began to crash and it was not pretty. As near as I can figure, chasing the hot tech stocks cost his company over a million dollars in market value.
I have many more stories about chasing the market, but they all end the same. Not very well. The point is that when the markets are begging you to do something, they are usually wrong. The markets, day to day, reflect the emotional response we all have to greed and fear. They do not reflect the reasonable response to empirical evidence and real data; and that is where the money is really made.
The data says that small-cap stocks and value stocks outperform large-cap and growth stocks over long periods of time. The data says that international stocks add value to a portfolio over long periods of time. Over the past few years we have been in a bit of an “Alice in Wonderland” market where those things have not been true. Am I surprised to see small-cap value stocks rallying so far this year? Am I surprised to see international stocks rallying year to date? I am not. I have been expecting it. Do you need to sell all of your large-cap growth stocks and buy small-cap value? I wouldn’t. But then again, I still have them in my portfolio because I don’t chase the hot stocks.
Chasing the hot stocks is fun, so do that with the money you don’t have to count on. For the rest of your investments, pick a strategy and stick with it, even when the markets are begging you to do something different. A good strategy will beat your gut every time.
Be careful out there.
March 21, 2021 at 12:00PM
https://www.djournal.com/news/business/scott-reed-why-does-it-have-to-be-so-hard/article_4f3187ab-b3cf-5c7a-871a-bf49992c7507.html
Scott Reed: Why does it have to be so hard? - Northeast Mississippi Daily Journal
https://news.google.com/search?q=hard&hl=en-US&gl=US&ceid=US:en
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