Love and attachment should be reserved for entities with legs, either two or four, and perhaps fins. We caution against becoming emotionally attached to stocks. In conversations with clients, we often find, despite the warnings, that a stock or story behind a stock is still “great.” It is common to extrapolate the past to the future and foresee continued outperformance. Despite many of the Magnificent 7 names being crowded, it is tough to be the first one to the exit – even if only to trim outsized gains. It is counter to prevailing popular opinion. It is antithetical to common sense to consider reducing a stock that has driven portfolio gains. Investors bought into the story and were handsomely rewarded. But this kind of group think and “commitment” to a theme has its pitfalls.
One only has to revisit the last time in the market when investors embraced what was most assuredly a transformative technology – the internet. The parallels are worth revisiting. At the expense of seemingly most stocks other than those blessed with the internet moniker, several stocks reached atmospheric heights in 1999. The Nasdaq 100 index was up +102.0% that year after a whopping 85.5% the year prior and returns greater than 20% annually since 1995. Investors seemed unwilling to part with the names that would drive the future. But there is rarely a straight line to the promised land.
As swiftly as money flowed into these names, the exit occurred at warp speed. Investors trained to buy the dip, as that strategy was historically handsomely rewarded, continued to pile in even as technical levels eclipsed fundamentals on the downside.
But we often say that stocks’ performance is not entirely driven by fundamentals – it incorporates the time involved in reaching the forecasted theme and the many pitfalls along the way. In fact, in reviewing the list of stocks posting hyperbolic gains in 1999 (left), many failed to reach these heights again for many years, some never regained them, and many companies you will not recognize because they no longer exist. In 1999, some of the top internet service providers included America Online (AOL), Netbanx, Zycom, UUNET, and Internet ONE. There is no guarantee that technology innovators participate in the implementation and eventual monetization of that technology.
Historically, the 30 largest stocks have made up about 40% of the S&P 500’s market cap at comparable points over 5, 10, 15, 20, and 25 years. For instance, during the 1990s tech boom, companies like Microsoft, Intel, and Cisco Systems held significant weight within the index, reflecting their immense growth and influence. Currently, this percentage is more than 10 points higher than in June 1999 when it was 42.18%.
Such concentration in a smaller number of dominant companies, such as Apple, Broadcom, and Alphabet can lead to increased volatility, as the performance of these key stocks exerts a larger impact on the overall market. Meanwhile market breadth, which measures the number of stocks increasing versus those decreasing, indicating overall market health beyond major indices, has been weak. Diversification and nimbleness are key. Most importantly, forming emotional attachments to specific stocks or bonds can sometimes blind investors to measures of rational valuation or moderating fundamentals.
“Bulls make money, bears make money, pigs get slaughtered”
— Anthony M. Gallea
Source: FactSet
By Kimberly Woody, Senior Portfolio Manager
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