Bad Breadth

Market commentators have been basing predictions of doom for the US stock market lately based on the major averages being levitated by just a few megacap stocks.  While this has been the case for much of the recent past, it has not been in the past few days.  At this writing, the S&P fund VOO is trading down on the session, while the small cap extended market fund VFX – basically the US market less the S&P – is up.  It’s strongly outperformed over at least the past five days.

Investors may believe that smaller domestic companies offer less exposure than big international names to the potential impact of coronavirus.  That’s reasonable, but it doesn’t negate the negating of the narrowness argument.  There are plenty of arguments for worrying about US stock prices – valuations being front and center – as we have pointed out before, and continues to be an ill omen for the long term return prospects for US stocks, but bad breadth has at least for now been taken off the table.  

8 thoughts on “Bad Breadth

  1. jk says:

    my problem in assessing the huge apparent overvaluation of equities [leaving bonds aside for the moment] is my belief in the powell-put, and more broadly in the prospect of huge money printing in our not-too-distant future. this must devalue the dollar, but in so doing also support nominal stock prices. i keep thinking that nominal prices will continue to rise. what say you, bill?

    1. Bill Terrell says:

      I don’t know, JK. If you look at the projections for returns over the next seven to ten years put out by analysts like Research Affiliates and Grantham, Mayo, Van Otterloo, they’re expressed in real terms. Of course that begs the question of what criteria are used to determine what’s “real”. CPI adjusted? Ounces of gold? Hours of human time?

      As a practical matter, since we’re looking at an asset class that we can invest in, the most relevant comparison would be with something else we can invest in. The most obvious candidate would be gold, but it’s not at all a given that that’s what the the firms mentioned had in mind.

      But your question was about nominal returns anyway. This is where it gets hard. We have a pretty good handle on the current Fed’s attitude, but valuation based stock return projections are for seven, ten, or more years. What if another Martin or Volcker comes along?

      You could argue it’s actually easier to project stock returns than those of the dollar.

      The level of federal debt may be a better guide. Clearly there will be pressure to debase the dollar. Against this though we have to weigh dollar demand – something that increases with debt. Excess debt and demand after all drove up the value of the dollar in 2008, with the result that nominal stock prices crashed even as the Fed tried to inflate. One might speculate that we could see another deflationary surge in the value of the dollar – with attendant plunging stock prices – followed by a swing in the other direction.

      A substantial portion of federal obligations meanwhile are indexed to “inflation” via the CPI. This means the federal government can’t just devalue its way out, but rather resort to a second degree of inflation wherein its incentive is to increase the gap between official CPI “inflation” and actual inflation. This is virtually certain and helps explain my disdain for so-called “inflation protected” bonds. They will be impotent against this most certain of inflationary threats. Assets like stocks, real estate and physical commodities as a result are going to be necessary for genuine protection against inflation. For nominal portfolio risk, ordinary Treasuries remain the best hedge I’m aware of.

      In the long run, I expect nominal stock prices to rise. Short of that serious declines remain likely.

  2. jk says:

    how are you investing in commodities? i’ve been using producers, both individual and packaged in etf’s and cef’s, but i’m certainly open to other ideas.

    and if you are doing the same as i, any favorites? i’ve been using bgr, bcx, ixc, comt, moo, copx as well as a bunch of individual names.

    1. Bill Terrell says:

      Commodity related stocks are tenable, but they’re ultimately still stocks. For unadulterated commodity exposure, commodities themselves are more reliable. The menu is pretty broad. Physical commodities like copper, gold, silver and platinum can be owned in physical form or via funds than own them in physical form. Some such as oil and gas may be impractical to be held that way, in which case there are futures or funds that use futures. That’s complicated a bit by term structure issues such as contango and backwardation, but still better as pure plays than stocks.

      You can for example be right on gold prices, but nevertheless lose on mining stock due to unrelated issues like management malfeasance, strikes, nationalizations, natural disasters, or possibly even … plagues.

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