Times are really changing now, which we could describe as the disparity gap between the haves and have nots widening. Those who are stuck in the past will be more disadvantaged.
It is not that seeing the disparity between good and not so good stocks widen is a new thing, as this has actually been going on for a long while, but these things can only be noticed if you are paying attention.
While the tendency is to break down stocks into two main categories that we call growth and value, that can end up muddying the waters, and it’s better to categorize them explicitly as good and lesser performers, where we look upon their past performance to decide.
We could use the terms leading and lagging here as well, and even though those who are looking to talk you into something that has a lot of lagging stocks, or in a lot of cases, is entirely made up of them, may not care to use this term, but it is nonetheless an accurate description.
Just because a stock or a group of stocks is in one category or another doesn’t mean that they will remain in it, as lagging stocks can wake up and leading ones can wilt. We can speculate all we want on the potential for this performance to shift, but whenever we attempt this, we need to first make sure that there is a sound basis for this belief, and not assume that the leaders will lag and the laggards will lead.
We might think that no one, and especially people who earn their living making these decisions, would be foolish enough to assume that one will just magically turn into another, that stocks will shed their skins like a reptile and be transformed, but this actually is a big influence. Analysts may not bet the entire farm on just this, but it does very substantially influence their recommendations, playing a central role in the analysis of many stock analysts alongside whatever else they look at.
You can feel this in the air when they look at high performing stocks, where they just assume that if things are going this well, the investment gods will surely change their mind and frown on them. This worry is significant enough to drive a lot of them away from even the best stocks, like Apple for instance, where it can be too expensive at $200, $250, $300, $350, and so on.
They may end up admitting their mistakes, like Toni Sacconaghi of Bernstein, considered by many as the leading analyst who follows Apple. He has been doing this for years now, where he thinks it’s too expensive, it goes up a lot, and he realizes that he should not have seen it as too expensive then but it sure is now, and then the cycle repeats.
The problem with this is that if we assign a value based upon what we think a stock is worth, and the market continues to value it higher, it hasn’t been too expensive in reality, just in our own minds. The determinations of value that these analysts use is based upon making assumptions that aren’t even valid in the real world, and even when this becomes very obvious, they stick to their ideas undaunted.
Many are wondering how much higher the big 5 stocks that now represent 27% of the S&P 500 can go, and the only answer to this is that they will go as high as people want to bid them up to. They impose artificial ceilings on them, the market ignores these ceilings because they aren’t real, and they don’t even learn a lesson from it and just keep thinking the same broken thoughts.
They do the same thing with the laggards. While the leaders are seen as overvalued, laggards are viewed as undervalued, which actually cashes out to their thinking that leading stocks should be worth less in their mind and lagging stocks should be worth more. Sadly, for them, the market doesn’t care what they think and just does what it wants to anyway, and continues to favor stocks that it likes and continues to hold those it does not like in disfavor.
This does not mean that leaders will always be leaders and laggards will always be laggards, as things do change and these changes can be reflected in stock performance. These things do not change by themselves though, and certainly don’t change because someone believes it should, as this change is only produced when the market believes it as well, and not before.
We not only need a good reason to think that the market will change its mind about a stock one way or another, because of better or poorer business performance or changes in the macro environment, we also need to see these beliefs manifest. If we think a company will do better but it’s not being reflected in its stock price, with it remaining in the doldrums, we might have been right about the company but wrong about the stock, and since it’s the stock that we’re deciding on, this leaves us wrong period.
It is only when we understand that company performance is driven by objective data but stocks are driven purely by beliefs, about the company and a whole lot of other things, that we can finally understand enough to even be in a position to make good decisions about stocks.
We then form beliefs about not the company, but beliefs about the beliefs that the market may hold about not just the company but the stock itself, and do our best to align our beliefs with the market while understanding that when the beliefs conflict, our beliefs are the ones that are wrong because they have not predicted the market’s beliefs well enough.
We have beliefs about individual stocks as well as beliefs about certain sectors as well as ones about stock indexes. To do this even sensibly, our beliefs must be grounded in the present beliefs that the market has, and then look to analyze those beliefs together with whatever insight we can add to look to predict things in the future.
This is All About What the Market Wants to Do
We can use Apple as a good example, where we see the market’s beliefs about this stock continue to be very positive. We might see things in their business that we may believe may put their stock down, seeing the growth of the company’s profits slow down for instance, but that in itself does not mean that it this stock will go down.
We might see iPhone sales declining and conduct an elaborate quantitative analysis, even have a team work on this, and unless the market shares our negative view, these exercises simply are divorced from reality and have us pointed in the wrong direction instead of the right one.
We could bring in an analyst from another planet who doesn’t know an iPhone from an apple growing on a tree, even just give him a stock symbol and a chart and show him how to use this data, and he would beat the pants off these fundamental analysts because he’s at least looking at what matters rather than what is only assumed to matter but is afforded a much greater weight than in reality.
There are literally traders out here who trade in stocks that they in some cases don’t even know what the company name is or what business they are in, but this does not serve as an impediment at all as there is plenty to know right there on the chart. This approach is greatly superior to fundamental analysis because they mostly only look at the noise, and everything outside charts is noise, because price is itself a perfect filter of sound and has processed what it considers music and excluded the noise.
Ideally, we want to consider everything, but do so in perspective. The real answer to whether or not Apple can climb that much higher depends on how much the market ends up wanting to pay for it as we go along, not because someone thinks that the stock price is too high in their mind based upon Apple’s current earnings. They have not asked why we should even care about their present earnings, and the answer would be that however much the market cares about this is already priced into the stock, in real time, so wondering about this beyond that only serves to confuse.
People can also wait for a stock to move up because they think that their present earnings should be driving the price up, but it isn’t, and that should be the end of the discussion. Holding the thing while it languishes is simply not a smart thing to do as we have wondered why it isn’t higher and the reply is that the market does not want to price it any higher.
Stock prices aren’t just somewhat influenced by supply and demand, they are entirely influenced by this. Economists understand price by way of supply and demand, and these analyses can become pretty complex, but we don’t need to go into this in any depth beyond the very superficial, and just knowing that stock prices going up or down being a matter of changing supply and demand will in itself greatly empower our understanding of them and really have us standing out from the crowd.
This is worth saying again. Apple’s price has continued to rise simply because people have been willing to pay more and more for it. How will we know how much more? We need to watch and see. There’s not even any need to wonder this, and whatever guesses we make, we can just stay in while this continues and step away when it ends. It’s hard to outguess the market, but we don’t need to.
We don’t even have to know anything else, and do not have to do anything else but watch it alongside other stocks and make sure that its price is growing in a competitive way with other stocks that we could have our money in instead. Perhaps we wish to own several of these, and stick with them as long as they show that they are worthy, as long as the market thinks that they are that is.
One of the ways that people look at stocks, aside from individually or in the aggregate by looking at stock index movements, is to view them from various categories, including grouping them by sector.
Stock analysts love to root and invest in underdogs. As stocks in general have fallen earlier this year and have mostly risen since, not surprisingly, the leading sectors that previously have led the way have continued to lead and the laggards have continued to lag.
We panicked when COVID-19 really hit home and we started closing things down, and then came to realize that we overdid it and retraced a lot of our steps. Some retraced their steps differently than others, and this is where some people look to these sectors for opportunities.
Lagging Sectors Are Usually Worthless, But May Have Their Place at Times
Evercore ISI strategist Dennis Debusschere is starting to lick his chops over three lagging sectors, the financial, industrial, and materials sectors, and has his calculator out and is doing some math for us.
He has come to believe that, if not for the impact of COVID-19, industrials would be 19% higher, materials would be 25% higher, and financials would be at least 50% higher.
It doesn’t really matter why he believes this, although we expect this is taking a lot of noise into account, the fundamentals, as we can just do a reality check to see how reasonable this may be.
Industrials and materials have done poorly before or after this. We need a very good reason to believe that this will change, and there simply isn’t a good reason to believe it will. Pretending that the coronavirus didn’t exist only makes a difference if things are actually good otherwise. There is one big reason why these sectors lag as much as they do is the fact that companies in this sector just don’t grow much and growth is what the market cares about.
It is not even worth bothering looking at these mutt sectors, but we’ll take a quick peek anyway, using the Nasdaq 100 as a benchmark. We also don’t need to bother with how much these two sectors have been hurt during the crash, as this is a hypothetical example that pretends the coronavirus threat didn’t happen, but we can look at the period prior to this to see if they are all that without this.
In the two years prior to the coronavirus infecting the market, the materials sector is down by 11%. The industrial sector is “only” down 3% during this time, the Nasdaq is up 24% instead, and this has been a period of significant bullishness. Since then, both have performed miserably, while the Nasdaq has moved up 16% more, the part we’re not supposed to pay attention to.
Outperformance is a force that does not change course unless something causes it to, and it’s significantly more probable that a stock or index will outperform if it is outperforming already than underperform. The same is true with underperformance, stocks that haven’t been liked being more likely to be continued to be disliked than start being liked out of the blue.
While these two sectors, and especially the financial sector, have had an extra helping of unlove over the last while, this is the amount of love that the market considered to be appropriate with everything taken into account, where they have been, where they are now, and especially where they are headed from here, including when COVID-19 becomes just a memory.
This is a lot like a set of rubber balls, where balls of different construction will bounce higher and vice versa. The Nasdaq and even the considerably inferior S&P 500, where these sectors are derived from, are made of fairly hard rubber, where these lagging sectors are more like golf balls, which don’t really bounce much at all. The market determines their hardness.
These sectors didn’t do well before this, they aren’t bouncing much now, and it’s therefore likely that they won’t bounce much down the road either.
The financial sector is at least a more interesting case. While their 6% loss in the two years preceding the crash does not bode well either alongside things that move the right way a lot better, it is the degree of the fall combined with the likely overestimating the damage from this that has this at least worth a look.
With the other two sectors, they are both down for the year but in a way that should not even have us wondering, as they are behaving in the way that we have been accustomed to, not very good.
It’s not even how far that the SPDR Financial Sector ETF fell during the crash, it’s how far they still are from where they were in February, which notably includes a good-sized pullback over the last 2 weeks, over a time that a lot of people have believed we’re in some sort of second wave of COVID-19.
The media is still on their soapbox and have been happy to scare people with the increased number of cases lately, and don’t bother to tell you that the percentage of infections are still going down because that would just spoil the fun instead of using this to attract viewership.
The real story would be one that we’re still increasing testing and have amped this up a lot more lately, although we’re still finding that less and less people are testing positive over time. This would not glue eyeballs to screens though.
This crisis is very much still underway, and these are real people who have real COVID-19, and the truth is bad enough without looking to embellish, exaggerate, and deceive. The upshot of this for stocks and for the financial sector in particular is that this has caused them to sell off more than they should, just like with the first wave of panic, and this results in real overselling that we can play bounces with.
The financial sector isn’t normally a hard-enough ball but has been hardened at least temporarily from the excess pressure that the market is placing on them. Plenty of the pain that has been inflicted upon their stocks lately have been deserved, and with the economy in a recession or worse right now, these are the bag men that will end up collecting a lot less loot as some of the money they have out there doesn’t make it back home.
Holding this sector ETF beyond this potential rebound just plain smells, no matter what our friend may think, as this sector doesn’t pull its weight at the best of times, and this is not one of those times.
However, we can look to arbitrage the oversold part though, although we need to wait until the time is right and not jump on a horse while it is falling to the ground. It’s not all that hard to figure out when it is back up on its feet, when the mood of the market improves generally both toward this sector and stocks in general.
It has been of some value to not only look at the progress of this pandemic alongside the financial information that we consider, which doesn’t require any special knowledge other than a little common sense, at a time where its abundance in the world at large may be at an all-time low. Perhaps common sense is part of the cancel movement, and we sure have done a great job already of cancelling a lot of what we had by our allowing our minds to be so infected.
We want to not only look at the number of cases but at the number of tests as well, information readily available. We both want to look at the reality and the illusion, and looking at the illusion, such as the last 2 days being the two highest total cases ever, is the most important. We’re up to 650K tests a day now though, and while 43k is indeed a lot, we’re discovering more because we are exploring more.
That’s not what people are thinking though so we have to wait for both a decrease in this case total and the panic about this to die down more, and especially need to be on the lookout for more optimism out there generally. The illusion is the signal here, with the reality being the ground by which the illusion is measured and thus still important.
Then we can look to the chart of the financial ETF and wait for the train to start moving and then jump on. This may end up being a pretty decent trade overall, as long as we understand both the trade and its limitations, as we must.