Author and investment analyst Humphrey B. Neill once warned, “Don’t confuse brains with a bull market.” He said this well before indexing came into vogue. We wonder how he would characterize that same concept today, in a market where brains are an unnecessary burden for passive investors, who are required to check them at the door when entering the room of investing.
As we enter this ninth year of a bull market, it certainly has become easy to become agnostic or atheistic with regards to investing. The rear-view mirror shows that doing so has paid handsomely. Despite this, any experienced investor also understands there are no atheists in foxholes. At some point, those who want to remain in the game will need to spend time in the trenches. As Peter Lynch’s quote above indicates, if you don’t know what you own and why you own it today, you will simply not possess the strong hands necessary to sit through a war, or perhaps even a small challenge.
In today’s market, the battlefield is being set, in part, by the dumb-money that has flowed into the indices. Index investing works well in markets favoring growth vs. value, mainly because of the nature of how these indices are created and capitalization-weighted structure they employ. There have been four major periods since 1929 where “growth” has beaten “value.” We currently sit at the tail end of the longest stretch where that has been the case, creating the biggest differential between the two we have ever seen.
Given all of this, there are a few things that need to be understood:
1. The leadership in this market is very narrow, and that is not normal. Today’s market has many similarities to the tech boom of the late 1990s. Consider what drove the S&P 500 in 1998:1
Or 1999, when the largest 25 contributors to the S&P 500’s performance provided more than 100 percent of the S&P’s return. In that year, the average of the other 475 companies contributed negatively to index returns, and over half the index (257 of them to be exact) actually saw their stocks decline. All of this turned on its head on March 10, 2000, when that bubble popped.
With a quick look at last year, you can see the parallels:
2. The leadership of a market during one era is not the same leadership in the next. Do you recall the idea that the internet was going to change our lives in 1999 and how the world capitalized the stock market accordingly? The thesis proved true, but when the truth gets massively overpriced in the stock market, it leads to severe heartache. In the aftermath, it was the areas of the market that were drastically undercapitalized that did the best over the subsequent eight years.