“Be patient, keep studying, and be 100% prepared. Later, at the least expected time, when all the news is terrible, winter will ultimately pass and a great new bull market will suddenly spring to life.” -Legendary investor, William J. O’Neil
We included this quote in our 9/17/2022 Market Update to NCM clients, about one month before the market--as defined by the S&P 500--bottomed. Back then, inflation was rising in the high single digit percentages, interest rates were rising fast, market gurus were lowering their forward projections for the market and lowering their price targets on technology stocks, the majority of economists were forecasting a recession was imminent, and many investors were dumping tech/growth stocks and seeking the safety of defensive sectors like utilities and consumer staples.
Fast forward to today: One by one, economists are pulling their recession forecasts; market gurus are now increasing their price targets on tech stocks, and investors are dumping utilities and consumer staples and piling into tech stocks……Never underestimate the power and risk of groupthink on Wall Street!
Internally at NCM, we would take the opposite view on all three aforementioned viewpoints. That is, we would say there is a higher chance of recession at this point; we would lower our current expectations for tech stocks; and we now feel other areas of the market look very interesting! One simple rule we follow is: When prices go lower, future expected returns are higher….and vice versa.
So what about the surge of those “Magnificent Seven” stocks (as they are now referred to)---AAPL, MSFT, GOOG, AMZN, NVDA, TSLA & META; they have all posted high returns backed by the market’s recent AI-enthusiasm. Given that a majority of the year-to-date return for the S&P 500 has come from these companies, could it be a winning factor to own just the largest companies of the S&P 500 as a strategy over the foreseeable long term future?
While it is true that for the period from 2013-2022, an annual rebalanced portfolio of the 5 largest stocks has outperformed both the S&P 500 and large value stocks (see chart below), it is also true that this was more of an outlier than a typical outcome.
In fact, if we look at this chart below--which captures a much longer period of time, we see that while a rebalanced portfolio of the 5 largest stocks was more in line with the S&P 500, it was large-cap value that outperformed.
In summary, while we certainly do NOT want to opine on how long these “Magnificent Seven”, AI-related tech/comm stocks will remain the largest (or best performing) in the S&P, we do respect the data which suggests that large-cap value outperforms over the longer term.
So, is the market too concentrated in these few mega-sized stocks today?” A valid question….(Although remember, short term traders/investors will ALWAYS find something to worry or panic about. Long term investors should be more adept at not getting caught up in the day to day hype, but this is sometimes easier said than done!)
What IS causing such huge interest in just a few big name stocks? Could it be that the dominance of ETF’s? After all, billions of dollars are flowing into the largest cap-weighted funds every day. And where do most of those dollars go? Like a virtuous cycle…into the biggest companies! So, yes, the rise of ETF’s does play a part in “helping the big get bigger.” But when you’re planning for something as serious as retirement, allowing your portfolio to be overweight in one asset class, by taking such a narrow bet on so few names is just not what any fiduciary advisor should support. And while we believe all long term investors should certainly have an allocation to tech and the S&P 500, long periods of history have proven that diversification BEYOND this asset class is prudent.
Which brings us to asking where are the opportunities and risks now? Well, as we mentioned, since FOMO (fear of missing out) is in full swing and investors do seem to be chasing expensive tech stocks, we look the other way to try to find other parts of the market which are more attractive. For example, last year, when investors shunned tech stocks at lower prices and chased utility stocks at higher prices, the utility sector traded at a premium of 22% to the S&P 500 index. Today, this sector sells at a 12% discount to the S&P.
We leave you with another great quote from Morgan Housel in a recent Barron’s: “You can almost guarantee that the biggest financial risk today is something that you and I and every newspaper and every twitter account aren’t talking about.”
So true. Just look at the last 18 months or so. The two biggest risks that came about were inflation and interest rates going up much faster and further than anyone expected or predicted. We certainly didn’t think rates could possibly go from 0 to over 5% in less than 18 months….and not cause a recession.
The key is to build portfolios for any market environment to make sure your retirement plan isn’t impacted by whatever comes our way. And coming out of one of the longest bear markets (again, we emphasize-not the worst bear market in percentage terms, but one of the longest) and arguably the worst year ever for a balanced investor, we are confident that the combination of our investment strategies coupled with the cash flow plans we have built for clients will continue to be successful in the long-term.
As always, feel free to reach out to us with your comments and any questions you may have about your own financial plan.
All the best,
NCM Capital Management
Disclosures: This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of NCM Capital Management, LLC and are subject to change at any time based on market and other conditions and NCM does not undertake to update or supplement its newsletter or any of the information contained therein. Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable. There is no guarantee that the investment strategies discussed above will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. References to indices or benchmarks herein are for informational and general comparative purposes only. Indexes are unmanaged and have no fees or expenses. An investment cannot be made directly in an index. Investment advisory services are offered through NCM Capital Management, LLC, an SEC-registered wealth advisory firm domiciled in New Jersey. This communication is not to be construed or interpreted as a solicitation or offer to sell investment advisory services. For additional information about NCM Capital Management, LLC, you may request a copy of our disclosure statement as set forth on Form ADV.