When market narratives reverse

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Reversing Market Narratives

In the investing world, it is amazing if not scary how quickly a narrative or a fear about markets can reverse. Often times it feels like explanations are looking for outcomes opposed to events having an explanation in markets. This is ok because as humans, it is natural for us to yearn for order and reason. The world is scary if you do not believe there is some sort of grand organization to day to day events. This has never been truer when it comes to the stock market. Narratives are continually searching for a place to land and whichever one sticks; market participants will run with. Sometimes it may be right, other times it may just be convenient but one thing seems to hold true: The reason explaining a market move or thesis for the market one way never seems to hold true when markets move the other way. Let’s look at a few of these. 

FAANG stocks leading the market:

Over the last year or two, one of the main concerns for why investors should be scared of the markets was that FAANG stocks (Facebook, Amazon, Apple, Netflix, Google and whatever other tech companies you want to throw in here) were carrying the market and there was not enough breadth, or other companies pulling their own weight. So, the idea was that the market was being propped up by a few large and successful companies and for this reason, investors should be scared. Even if this were true that markets owe everything to FAANG stocks and we take it a step further and conclude this is an unusual scenario historically and a final step that this is a bad thing, we would ask, does it work both ways?

Over the last month, the S&P 500 has declined by 3.25% and is down by 8.32% over three months. Of those declines, the FAANG stocks (FB, AMZN, AAPL, NFLX, and GOOGL) accounted for 1.37% and 2.14% of those declines respectively (using current market values so the numbers will be inflated to some degree, but you get the idea). If markets were moving the other direction (up), you can bet that the narrative would be that too few stocks are driving the market higher. What happens when only a few stocks lead the market lower? Is it a good thing? Does it mean the selloff is not as bad as it appears? Is it a reason to buy, as the opposite situation was a reason to sell? Does it matter at all? This is a narrative you do not seem to hear in a downturn. 

Valuations: 

Over the last eight years or so, one of the common themes and reasons to not invest were that market valuations were too high. This proved to be a costly thesis in hindsight and while markets are seeing a pullback over the last quarter, it is a shadow of the gains an investor has made by doing something as simple as buying a passive ETF and doing nothing. Now, however, with US markets trading closer to the 15 to 16 times earnings multiple on a forward basis, those that were concerned about valuations are getting their wish but you do not hear anything about how valuations look far better than they did a year ago. If markets are not cheap, they are at least in a ‘fair’ range for a long-term investor. Except it is never that easy. You will not see those that were concerned about valuations all of a sudden being excited about those valuations compressing because there is always another worry to point to. Something causes the contraction in valuations and it is never a ‘good reason’. So, while it may have been easy to point to a bull market and say everything is too expensive, it is just as easy to point to an average market valuation and say markets are going lower because of * insert reason X *. 

Realistically, all of those that were too concerned about how expensive stocks were should be getting pretty excited about jumping into the markets right now but you do not hear this. The fear has only grown with the decline. This is a great example as to why it is so hard to invest in a down market and holding too much cash can be a risk in itself. When markets are not doing well, it is for a reason and buying ‘today’ means not only does the individual need to go against the grain by buying into markets but they also have to accept that markets very well may continue to decline.  Just like you do not hear investors complaining about too few stocks leading the market lower, you do not hear those (or many investors at all) that were concerned about valuations all of sudden deciding that markets look like they are showing a great long-term opportunity in the midst of a decline.

I am sure we could come up with a few more instances where a narrative fits nicely when markets move one way but are forgotten in the opposite direction but will leave it at these two for now. I think the lesson here is that for a narrative or excuse to hold weight in the real world, it probably should work both ways. So next time an investor says to not buy something because of reason ‘X’, a good question to ask would be if we flipped the scenario upside down, would this be an equally good reason to actually buy the investment? Alternatively, if the argument does hold weight on both sides of a market move, would you actually act on it? Sure, an investment could be historically expensive and that may justify not owning it, but if it declines by 20% in a month, are you going to change your view on it? If market valuations have been your biggest concern over the last eight years, you should probably be pretty interested in markets at this stage or you might need a new narrative to justify not owning stocks.

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