MW The market is getting less efficient. Copy this strategy from the 'apes,' says a veteran fund manager
By Steve Goldstein
Critical information for the U.S. trading day
The market can stay irrational longer than you can stay solvent is the old adage attributed, probably incorrectly, to the famed economist John Maynard Keynes. Frothy rather than irrational is a better description for the stock market this year, but it's hard to argue that there haven't been some recent periods of jaw-dropping valuations.
Clifford Asness, the managing principal of the quantitative investment firm AQR Capital Management and 35-year veteran of value investing, concludes that the market is now less efficient than it used to be.
It's a remark he's made before, but he expounded on it for an essay in the 50th anniversary issue of the Journal of Portfolio Management that he's released in draft form. While he doesn't say the market is in a bubble - a noun he seldom uses - Asness says pretty much any measure finds the valuation ratio of expensive stocks to cheap stocks is historically high.
Asness says that's true regardless of common critiques of value investing. "We looked at whether the famous critique of 'value doesn't account for intangibles' was driving things. It only (barely) mattered at the margins. We looked at whether a handful of super-expensive, supermega-cap stocks were the problem (first the 'FANGs,' today likely the 'Magnificent Seven.') Nope. We looked at whether value was 'more short' attractive factors like gross profitability and return-on-assets, possibly indicating that while value spreads were wider, they were somehow more rationally wide this time. They weren't," he said.
He gives three reasons why markets are less rational. Two factors, he says, probably have a small influence - the rise of index investing and the long duration of low interest rates. "Prices are a dollar-weighted average of opinions, and if a larger fraction of this is misguided, so will be prices," he says of indexing. As for interest rates, he says not particularly scientifically, "perhaps super-low interest rates for a long time make investors go cray-cray."
But the biggest reason for a less efficient stock market, he says, is social media and related advances in technology. "I'm far more certain that social media, the overconfidence that come when people think all the world's data is at their fingertips, and gamified, fake-free, instant, 24/7 trading has done so in a significant way," he says.
So how should investors react? Ironically, they should take a lesson from meme-stock investors, he says.
"The meme stock world -- a fever swamp if there ever was one, and if a small subset of the market could prove market inefficiency, which it can't, it would be 'Exhibit A' -- gets one thing sort of right. They use an acronym HODL for 'hold on for dear life.' Now, they apply it to super-low-quality, near-bankrupt-yet still-overvalued companies often run by scammers playing to and preying on them, and do so using [not-safe-for-work] language with any who disagree and various 'ape' images as logical argument. So, you know, that's bad. But if applied to good, intuitive, reasonable strategies you rationally believe in for the long term, HODL is a hell of a motto," says Asness.
That's not easy. Take, for example, the advice (to Americans) of diversifying by investing outside the U.S., which hasn't worked for the last 30 years or so. In practice, Asness says, investors should push themselves to have the longest time horizon possible.
And he also says investors shouldn't get hung up when the 'line items' of a portfolio perform poorly and instead view their holdings in their entirety. "Line items can be asset classes (after a bad period for them, saying why do I bother owning bonds?), geographies (why do I ever invest outside the USA when it's done so well?), styles (why do I try to be a rational investor when the world clearly doesn't care anymore?), and even individual managers," says Asness.
He concludes by saying good investing has always been a challenge of discerning what is right and then sticking with what is right. "But if markets are indeed 'less efficient' the first task has actually gotten easier and the second harder - and the skills needed to pursue good investing have shifted. That tells us what we should work on going forward. Good luck," he says.
The market
U.S. stock index futures (ES00) (NQ00) were slumping after the three-day weekend, with the S&P 500 SPX just 0.3% short of a record high.
Key asset performance Last 5d 1m YTD 1y S&P 500 5648.4 0.24% 5.65% 18.42% 25.08% Nasdaq Composite 17,713.62 -0.92% 5.59% 18.00% 26.24% 10-year Treasury 3.913 8.20 1.60 3.21 -34.58 Gold 2533.4 -0.79% 3.32% 22.28% 28.85% Oil 72.81 -5.64% -1.50% 2.07% -15.39% Data: MarketWatch. Treasury yields change expressed in basis points
The buzz
The Institute for Supply Management manufacturing report is due at 10 a.m. Eastern, as is the latest read on construction spending.
Intel $(INTC)$ CEO Pat Gelsinger is due to present a strategic overhaul that will include divesting its programmable chip division Altera, Reuters reported.
U.S. Steel shares $(X)$ fell in premarket trade as Vice President Kamala Harris says she opposes its takeover by Nippon Steel.
While earnings season has wound down, there are a number of conferences with major companies including Exxon Mobil $(XOM)$ and Coca-Cola $(KO)$ due to make presentations.
A Brazil Supreme Court panel unanimously backed a judge's decision to block the social-media service X in the country.
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The chart
As noted above, the stock market is not too far away from its July 16 peak. Analysts at Goldman Sachs crunched the numbers on how different groupings performed since then, and value, low volatility and defensive stocks have led the way. And extending that analysis to bonds, currencies and commodities, there's a historically large gap between risky and safe assets. "While divergences between risky and safe assets are not unusual, the current gap sits at the 86th percentile since 2000. Historically, this gap typically closed with safe assets selling off," say strategists led by Andrea Ferrairo.
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-Steve Goldstein
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September 03, 2024 06:28 ET (10:28 GMT)
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