The 2-Minute Thought: A Stock Picker’s Market?

People say it’s starting to look like a stock picker’s market. 

That’s because the performance of individual stocks and the performance of different sectors are diverging.  Since President-elect Trump’s win in November, the disparity in returns among different sectors is the highest it’s been since 2009.  In addition, correlations among individual stocks have been falling. 

Source: Bloomberg

Source: Bloomberg

Source: Bloomberg

Source: Bloomberg

For those who believe there’s a time and a place for stock picking, this is cheery news.  While it is hard for stock pickers to distinguish themselves when shares are moving up or down together, it gets easier when they start moving in different directions. 

Since the election, U.S. stocks have surged to record highs, yet more than a third of the stocks in the S&P 500 are down.  That means there are losers among the winners.  At the same time, more small and mid-sized stocks have been performing well relative to the index.  That’s a sharp contrast to 2015, when much of the market struggled but a handful of mega-cap stocks with strong performance drove the index higher. 

It may seem surprising to see a stock picker’s market now.  Stock pickers historically have done well in low to moderate return environments when multiples are falling – yet we are in a sharp rally with expanding multiples.  In addition, some might have expected the surprise election results to act like a macro shock and drive assets in a single direction à la Brexit.  Instead, clear winners and losers started emerging soon after election day.

Jason Trennart of Strategas once wrote that stock pickers prosper when nominal GDP growth is low and inflation and interest rates are high.  Those are times when good companies start to distinguish themselves more clearly from less good ones -- and that is when stock picking skills come in handy.  While we have been living in an era of easy access to cheap capital that allows less effective companies to thrive, that could soon change.  If, as is widely anticipated, interest rates do rise and cheap capital becomes less available, it shouldn’t be a surprise if the fortunes of companies start to diverge more.