Investors have become quite complacent as evidenced by the recent 15 year low in the VIX “fear index” and the growing number of crowded trades.
In the February issue, I had mentioned that the P/E ratio of the top quintile of stocks was over twice as high as the next quintile. This is a gap larger than at any other time. This momentum towards a concentrated group of investments has continued.
According to a recent Bank of America Merrill Lynch report, $1 billion of investors money flowed into tech stocks in a single week, the highest annualized pace in 15 years. The QQQ has returned almost 30% over the 52 weeks and 15% year to date, doubling the returns of the S&P 500.
The top 3 holdings, Apple, Microsoft and Amazon, now account for over 25% of the total assets of the QQQ index fund. The top 5 holdings adding in Facebook and Alphabet (Google) total over 40% of the current assets.
Stock Year to Date 52 Week
Alphabet 20% 32%
Amazon 28% 37%
Apple 33% 58%
Facebook 28% 27%
Microsoft 10% 35%
Here is the performance of some other household names
Stock Year to Date 52 Week
Netflix 26% 64%
Priceline 23% 45%
Tesla 45% 44%
Shopify 107% 242%
As an investor, if you’ve missed the big names above, it’s most likely that you’re currently lagging the markets. Be careful about chasing hot names however, unless you’re especially adept at timing those moves. As we’ve learned over history, while it may work in the short-term, stocks have always come back to normalized valuations.
While high profit margins coupled with low interest rates justify higher than normal business valuations in the short-term, there are still a multitude of risk factors that could cause a mild shock to the markets. These include:
– Allegations of Russia interfering with U.S. elections and their relationship to President Trump.
– The Federal Reserve ending its QE program and the desire to raise interest rates.
– Tensions related to North Korea and their recent missile launches.
– Unexplained variables in economic indicators including productivity, wages and inflation.
– Recent weakness in the retail market and car sales.
– Questions into the high debt levels and continued economic growth in China.
– Inflation rising in Europe putting pressure on the European Central Bank to become less accommodative in its policies.
– Bond markets hinting at slower growth expectations.
Although we’re in rare territory when it comes to historically high valuations, you can never predict how long momentum will last or how high they can go. Unless the valuation of businesses has fundamentally shifted or are no longer a concern (passive investing) we can only conclude, that at some point high valuations will end. This typically results in an over correction to the downside, leading to great buying opportunities as investors scurry to unwind their positions. It’s a great time to have cash on hand.
As I’ve spoken about numerous times, different investing styles (growth and momentum, passive, value) will underperform and outperform each other depending upon what the market is drawn to. Near the end of bull markets, value investing lags.