stocks in lockstep: what’s going on

US stocks have been travelling more or less in a herd–with, statistically speaking,  little to distinguish he performance of one individual issue from the next.  This sort of thing often happens at the start of a bull market, not almost five years in.

In other posts I’ve described 2013 as a year of “normalization” of the stock market.  During bear markets, fearful investors shift their focus from buying stocks based on anticipated earnings a year or so in the future to concentrating on reacting to actual earnings as they’re released.  Normally, six months or so into a recovery investors begin to reverse this stance and begin to value stocks based on (higher) future earnings rather than historicals.  During this period the market’s price earnings multiple expands.

After the Great Recession, that didn’t happen until 2013.  It took almost four years, plus two years of Treasury security losses–and the expectation that the returns from fixed income would remain negligible for a considerable time to come–for many investors to be willing to take the risk of investing in stocks again.

I think three points are important:

1.  It seems to me that any cyclical asset allocation shift away from bonds has already run its course.  Individual Baby Boomers, who hold much of the wealth in the US, have a distinct age-appropriate preference for income-generating investments. So they’re going to continue to hold some bonds, no matter how poorly they perform.   Also, in what I expect will be a flattish year for stocks, there will be little pain-induced motivation from equity gains to make further asset allocation shifts.

In addition, institutional investors appear to have reached their maximum allowable allocation to equities after a year in which the performance differential between stocks and bonds has been massive.  They may actually be forced to sell equities–although my sense is the reason institutions continue to hire hedge funds (despite a decade of continuous horrific underperformance of traditional managers) is to get around their investment guidelines by reclassifying equity exposure as “alternative” investments.

–I’ve believed for some time that the Great Recession shattered individuals’ belief in the merits of actively managed equity mutual funds.  A shift to index products, ETFs or mutual funds, would explain why stocks have risen across the board.  True, many hedge funds are run by former traders who lack the skill to analyze individual stocks, so they’re index-only players, too.  But that’s been true for years.  Their behavior doesn’t explain why there was less differentiation among stocks in 2013 than in 2010 or 2011.

–Last year’s homogeneity sets up a potential bonanza for stock pickers this year.  There may be some segments of the stock market–the 100 largest names by market cap?  the top 200?– where the asset allocation mindset will continue to dominate, however.  My guess is it will be better to look among smaller names and among stocks that have short histories being publicly traded.  But the important thing for now is to pay attention to the market’s behavior as we get through the quirks of January and into a more normal market next month.


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