Value’s Lifeblood is Performance Chasers
While listening to Rob Arnott on a recent Morningstar podcast, I became enamored with something that Arnott was emphatic about. He pointed out that the structural advantage of being a contrarian isn’t being smarter. Every winning purchase in the stock market comes as an opportunity cost to the seller. In aggregate, the non-passive portion of the market will look like the respective index. Arnott asked the question, “Who are you trading against?” In other words, who is on the other side of your transactions in the stock market?
It’s a very interesting question to ask all investors. With 60% of U.S. large cap markets indexed, as of a year ago, who is the seller to the buyer of the S&P 500 Index? For the value buyer, who sells them the names that are cheap? Arnott points out that 150 basis points to 200 basis points a year is the structural advantage to the contrarian investor. Once again, not because of intelligence. It is because the person on the other side of the transaction is doing something catastrophic: performance chasing.
Looking back at 2020 thus far, this is very easy to see. Names that have rallied the most this year are the biggest momentum winners. The performance chasers are loading up on these trades on a regular basis. The flip side of this today is economically sensitive names in the economy that were sold by the performance chasers in March. They rallied for a while and have been led in the last 90 days by names we own like the homebuilders NVR (NVR), Lennar (LEN) and D.R. Horton (DHI).
When you find any one agreeing with you, change your mind. When I can persuade the Board of my Insurance Company to buy a share, that, I am learning from experience, is the right moment for selling it. – John Maynard Keynes
John Maynard Keynes was one of the chief progenitors of the idea of independent thinking. Why? He knew from experience that performance chasing didn’t work. In 1929 Keynes was speculating on commodities in the belief that the economic future of America was just getting started. His theory was right. America became the global superpower that he had assumed. The blessing of being right caused Keynes’ personal finances to be destroyed as commodities were crushed by the crash of 1929. He learned that performance chasing didn’t work.
Thus, Keynes began his contrarian investing approach. The structural advantage he gained in his new approach was the person selling to him was running off to buy the next hot issue. Keynes’ quote above was in reference to his experience at National Mutual Assurance Society. For the board of that insurer, he knew he had to bet against what the consensus of the directors chose to do. It is only human to chase. It’s exciting. It makes us feel good initially, like joining a great social club. Once the honeymoon is over, the feeling can change.
Chasing Liquidity and Performance
Money manager Murray Stahl pointed out a wonderful fact pertaining to the current construct of the U.S. stock market in large capitalization securities. With 60% passive ownership in large cap one year ago, Stahl assumes this has grown to 65%. He also assumes this passive owner is a natural buyer of stock at this point in the cycle, so there are not sellers aggregated among 65% of big cap stocks. He assumes this because dogs chase cars and humans chase stocks.
Amazon highlights this better than most securities. Insiders own 15% of the stock. This means to find a seller you must look among the other 20% of stockholders. As Stahl points out, this other 20% represents a market cap the size of United Health Group. Remember, insiders are owners. They do occasionally sell, though not regularly.....MORE
This cap structure would point to a greater than 3-to-1 potential buyer (passive) versus potential seller (active managers) among the other 20% of owners of Amazon. This works in bull markets....
From Advisor Perspectives mini-descriptor:
Smead Capital Management is a Seattle-based investment firm that manages a high quality, large-cap value portfolio with boringly dry turnover via separate accounts, subadvisory, and mutual funds in the United States and abroad. We are contrarians and welcome like-minded investors on this journey.
