There are many strategies for investing in financial markets but at the core most revolve around two basic principles. The first group we can generally describe as “do what everyone else is doing”, which is called momentum investing. The second, which we believe to be a more thoughtful approach, is to constantly seek out businesses where value is not being recognized by the stock market. This is broadly referred to as stock picking.
The problem with momentum investing is that a trend eventually exhausts itself, at which point you really do have to get completely off the train and wait on the sidelines. But nobody is there to tell you how long the trend will last and then when to get off.
Stock picking strategies vary from targeting distressed businesses that might turn around, to focusing on acquisition targets, to discovering businesses that have lots of cash that is unrecognized by the market. Avenue prefers the stock picking strategy of looking for a diversified group of quality businesses that share the common theme of generating free cash flow and where their stocks trade at a reasonable valuation. We should be able to stay invested to capture the long-term compounding of our stocks and not have to jump in and out in the same way as momentum investing.
The reason we are addressing this now is to highlight the momentum strategy and its effects on a handful of stocks that have taken over investor psychology once again. The chart below shows the S&P500 index which represents the largest stocks in the US compared against the index of all the biggest stocks in the world but without the US stocks. The chart shows 12 years of returns in percentage returns.
What is so striking about the relative performance is the understanding that over the past decade only the US has gone up. You can understand that the resulting investor behaviour is now to get your money into the US large technology stocks at the expense of everything else.
We know an asset bubble when we see one, we just don’t know when it is going to end. We believe we are closer to the end point where the technology trend is exhausted because everyone who can buy it now owns it.
The following chart illustrates the exhaustion of this trend. The chart shows that new money flowing into the stock market over the last six months has gone almost exclusively to technology stocks. Yes, we have a potential renaissance in artificial intelligence but profits from AI are a long way off and it is not entirely clear which AI companies will be the winners and which will be the losers.