August 2023 Newsletter
In a few short months the portfolio has gone from a small beat to lagging by 2.4% – see performance stats further down. Don’t get me wrong, it’s still a nice return, but its concerning as the situation worsened at one point during the month, lagging by 3.5%. I usually start looking at why performance is lagging once there is a 2% difference between my portfolio and the market. Sometimes something gets screwy with the portfolio, other times it can be bad luck (or a combination), and sometimes the market changes. In this case, it’s my opinion that the market is changing and it’s likely normal.
The market is always evolving based on millions of buyers and sellers creating the “efficient market hypothesis” which basically means that it reflects all known information and provides the right market value at any point in time. I do not entirely agree with the hypothesis because to me, it’s much more complex than that. The market is emotional because buyers and sellers are emotional, so when you add that layer to the hypothesis, the market becomes much harder to value and predict, and can even behave irrationally at times.
That being said, the market lately has been oddly bidding up just a few stocks like Apple, Microsoft and five others – see the list below. The effect is that market index returns have become a reflection of just those few, mainly because of their oversized influence on the market. This situation is not unusual and has often occurred in the past as part of new bull markets. The reason for this is difficult to pinpoint, but after a bad period like 2022, investors likely want to stick with what worked, in other words big American tech.
This creates bad market breadth, not halitosis as your brain likely read first. In simpler terms, breadth is how much of the market is participating in any up or downturn. The issue is made worse because the market index is weighted. The bigger the company (measured in capitalization) the more it influences the average and skews results in their favour. 7 big winners and 493 losers can still be a positive market. If the market is up 10% then it would be nice that no matter what you hold in your portfolio, you could still participate in the rise. But bad market breadth can leave you behind. This is especially true when market moves are up big or down big.
The Big 7
Please find below the weights of the big 7 as a percentage of the total sp500. Example: Apple represents 7.6% of the total value of the SP500.
- Apple 7.6%
- Microsoft 6.5%
- Google 3.8%
- Amazon 3.1%
- Nividia 3.1%
- Tesla 1.88%
- Meta 1.8%
As you can see, the 7 biggest stocks in the SP500 control almost 30% of the index’s return. If all 500 stocks were equal, then each would contribute exactly 1/500 of weight, or 1/5th of a percent. So the top 7 are disproportionately influencing the index’s return.
This also means that no matter what you pick for stocks, from a probability perspective, you will likely underperform the market without some of the top 7. As per last month’s newsletter, you can see the results of bad market breadth by looking back at the RSP ETF, which tracks the SP500 without the traditional weights. This effectively shows us how the average market is doing, which in this case is heavily underperforming at 4.27% (vs the SP 500 return of 13.8%).
So does that mean stock picking does not work? Maybe we should simply buy market index ETFs? There is an argument for that. It’s certainly harder in this situation if you are looking at today’s probability of selecting winners for your portfolio. On the other hand, macro investors, those who try and choose stocks based on interest rates, sector weights, economic cycles etc., historically tend not to over perform either. In recent years, momentum strategies (following the heard) seem to be one of the few strategies that have been over performing. Until the heard eventually runs off a cliff… no strategy works forever.
Traditionally higher over performance (also higher under performance) is achieved in concentrated portfolios (smaller number of stocks), like 6-8 as an example. With a bad breadth situation, the odds are much worse. Your stock picks might be awesome, but if they do not include some of the top 7, your likely underperforming big time.
In my case, with 40 stocks in my portfolio, I have more chance of holding a winner. In fact, I hold 4 out of the 7. I am much more like the market but at the same time, I have lots of under performers diluting those big returns. If I only held a portfolio of 8 stocks and 4 of 8 were big winners, I could become famous, or rich, or both! Again, concentration creates compromise – you can become a bigger winner or a bigger loser. With a higher number of stocks, your returns will likely be closer to the market return, so it will be more difficult to win big but also harder to lose big.
Should I Change Strategy?
That is a really good question. No one knows for sure what the market will do next. We only have history to provide some insight. If we are in a new bull market that will last 5-6 years, then we can expect the market to rotate in a fuller breadth situation and the big players will slow down and the rest of the market will catch up. But how long will this bad breadth keep going? Months? A year? 2 years? No one knows for sure.
What if the new bull market stumbles and we go into a recession? Returns will go negative, led by the big 7. Money for Marc is about getting rich slowly and not about taking huge risks. I like to play the odds and these determine my strategies. I really prefer to have a bit of everything in my portfolio so as to never lose big, which also means never win big either. Market like returns are good enough for me. It’s a relative game after all.
Am I Really Going To Do Nothing?
Contrary to most financial vloggers, advisors, etc., I would advocate the “do nothing approach” at this time, which more often than not is the right answer. Even if it means under performing for a while. I play the long game after all. The knee jerk reaction is to start selling off losers and buying more of the big 7. This unfortunately caries higher risk as you are potentially buying high and selling low. You could argue that these new positions may be expensive relative to the market. The benefit however is that if the trend continues, you will be pulled up along with the market. This situation is difficult because no one likes falling behind, and as humans, we tend to want to react and do something about it. Any changes need to be made carefully when the market starts getting away from you. Loading up on the big winners will increase risk for sure. Will it be worth it? Maybe, maybe not.
Looking Forward
I am still bullish on a strong year return. I will likely make some small changes in the portfolio to rebalance some sectors and adjust my country mix. I will likely invest in one new position, maybe Japanese.
I expect that the market will have a much fuller breadth and that market leaders will eventually stall.
I expect an eventual rotation into more unloved areas like small to mid-caps, value stocks, foreign stocks, and actually most sectors (that are not technology, communications, or consumer discretion). There are a lot of loser areas that will one day become winners.
Marc’s Monthly Moves
- Sell ATVI (Activision Blizzard), for 91$ for a return of +66%. I bought this before Warren Buffett did and sold it at a better price than he did… nice to out invest the best (obviously some luck was involved)! This company is being bought out by Microsoft for 95$. There is only 4$ of uncertainty left of whether the sale will go through or not, so its a good time to sell and super return.
Marc’s Portfolio YTD Performance
- Portfolio return:11.4 % (including currency losses)
- Portfolio return: 11.4% (without currency losses)
- S&P 500 return: 13.8%
- RSP ETF S&P equal weight 4.27%
- TSX: 2.24%
The portfolio has under performed the S&P 500 by 2.4 percentage points.
Money with Marc 