The Bull Market Has Increasingly Depended On A Few Stocks, Maybe Just Two

Posted: Oct 19, 2018 8:45 AM
The Bull Market Has Increasingly Depended On A Few Stocks, Maybe Just Two

The bull market is now a decade old. Some people have suggested that because this is one of the longest running bull markets, this means that the bull is too old and ready to die. It doesn't work like that. Bull markets, despite the name, are not biological entities -- they don't die of old age. Quite often, they die when bubbles pop, and they often pop when the easy money which filled the bubbles in the first place is withdrawn.

Monetary policy became very easy in 2008 and has only begun in the past couple of years to get even close to normal. When bubbles occur in the stock market, they are not uniform; growth stocks tend to perform better, and very large cap, high-visibility companies which are household names tend to be the drivers, especially towards the top. During bubble periods, the market tends to be less skeptical about financial reports that might be a little too good to be true. There's an old saying about hyped companies and the boom/bust cycle: "Only when the tide goes out can you see who has been swimming naked." I would change that saying a little. It's when the tide goes out that everyone is finally forced to see who has been swimming naked.

Let's look at the bull-market since 2015. The chart below clearly shows that growth stocks drove the high returns more than value stocks.

Clearly value has been 'out of favor' for an unusually prolonged span of time.

But has growth uniformly outpaced value? No. As the chart below shows, when we show growth on the same chart with the subset of growth called FAANG (the collection of Facebook, Amazon, Apple, Netflix, and Google), we see that FAANG has significantly outpaced the entire growth group of which it is a member.

Clearly FAANG has been driving the growth group. Its return over the past five years is so strong that it makes the high-performing growth sector look flat by comparison.

But is FAANG uniformly overperforming? No, it has actually been quite uneven. Look at the chart below and you can see that over the past five years, the FNG part of FAANG outperformed the AA portion.

However, in the quarter which just ended, AA moved ahead and became the driver of FAANG, which was the driver of Growth, which was the drive of the market… Meaning markets had become disproportionately dependent on two gigantic companies.

This set the stage for what we've seen so far in the 4th quarter, especially the recent sell-off of October 10-11.

Remember the point that I made earlier about naked swimmers and low tides, as we look below at the FAANGs and FLAG (the forensic accounting and valuation-based fund that I helped to design) as a proxy for value, and for conservative (as opposed to aggressive) accounting practices.

The recent sell-off, triggered by a shift in expectations towards more interest rate hiking, shows FLAG outperforming high valuation companies which signals of overhyped earnings. After this sell-off, market participants became less convinced about rapid tightening and so the FAANG stocks bounced back to some degree, but we got a glimpse of the underlying vulnerability of this bull market. If fear of higher rates broke the bull market, with FAANG leading the way down, and a shift away from an aggressive pace of tightening brought that market back, then another shift towards expectations of aggressive tightening (or even actual tightening) would likely break the bull again, with the leading members of the herd likely being the ones fastest over the cliff.

In other words, retail investors who jump into household name companies with celebrity CEOs, and investors in cap weighted indices which automatically drag their customers into concentration in these big name companies, are highly vulnerable to possible severe underperformance if the tide really does go out.