My apologies to subscribers overinvested in the Internet, but this has been one of the most entertaining weeks in recent memory.
For the past x-plus months, the biggest question to be answered as an equity investor was when would the mighty -- Internet-related, the nifty-30, drugs, etc. -- finally run out of momentum and let nearly everything else rally, at least on a relative basis. Last week's massive shift out of the former and into the latter in near-record volume levels was truly a magnificent display of . . . mostly silliness. But it does raise the question of whether we are witnessing a great fundamental shift in the economy.
I think not. What we are seeing here is the beginning of a giant reversion to the mean between assets with very high expectations and assets with very low expectations.
Last week was a major inflection point in the market. There was a mad grab not just for anything deemed cyclical, but for anything that had done miserably over the past year. And the big recent favorites continue to be unceremoniously dumped. As someone who traffics in the unloved and out of favor for a living, this was something I hadn't seen in two years. For the first time in a great while, I have bids that have been left in the dust.
As is often the case at major inflection points, there were few tangible reasons behind the moves other than they happened. As is always the case, there were plenty of stock answers. Commodity prices firmed modestly: Oil prices breached and held at $17 a barrel. Several industrial companies reported that business was stronger in the first quarter than the fourth and that March was much stronger than January. OK, but not exactly the stuff of legends. I was disappointed to not see one of my favorite comments of yesteryear: "Middle East and Japanese buying."
So is this for real? Has the Internet craze crossed over the great hill of speculative fever and started heading down the other side? Is the profit recession in many industrial companies over? Are we ready for small-caps? I respectively vote a resounding "yes" on the end of the Internet craze; a "probably not" on whether the profit recession is over; and another resounding, and self-serving, "yes" on small-caps.
For the past few years, the same disciples sat in the Temple of What's Working, greatly outnumbered by the equally worthy but huddled, impoverished masses sitting outside. Everyone saw the greatest spreads in the postwar era between value and growth and between large- and small-cap, but very few made a move to swap camps. Those who did were generally punished. Value and small-cap managers in the institutional world are being dumped in favor of nearly anything, and there are billions of dollars in liquidations out of mutual funds. This is a self-perpetuating cycle that
to end as all self-perpetuating cycles do. It's that little element of "when" that usually manages to elude one's desperate grasp.
Yet there have been plenty of signs besides the growing absurdity of the numbers. How about Vanguard's
Windsor fund manager, one of the biggest value-oriented funds stuffed to the brim with
names, getting half-canned (they
added another management firm) just a few weeks before this move? Or the many lunches with friends who are whining about the performance of the value-oriented
mutual funds I told them to buy with their 25K. (They forced me to open ours!)
recently bringing on a bullish Internet analyst from
at a top-dollar number to replace its recently exited bearish one. It would be a lot of fun to see the bonuses of different Wall Street analysts and how that would surely inversely correlate with future stock performance.
, which is taking enormous pains to prove it is not a cyclical company by spinning off
at the bottom of oil prices. It's joint-venturing huge chunks of its commodity business (bought two years ago at higher prices) near the bottom of most commodity cycles and is on the verge of spending great sums in life sciences, yet its stock goes from 53 to 69 last week because, who are they kidding: Dupont is a chemical company and chemical companies are now in the first row of the Temple of What's Working.
And how about
Andrew Greta announcing "The Death of Value" as he is giving up his solid
column on the fundamentals of investing to focus on a new position at
The basic fact is that no one wanted to be first, and now everyone wants on the bus. You could have made the same persuasive, common-sense case a year ago and would have ended up being beaten like a gong, stuffed in a bottle and sent out with Japanese current (to paraphrase an old Hunter Thompson favorite).
But a few months ago, someone decided to be first, just as someone else decided to be the last to throw in the towel and get Internet-invested. Like the straw that broke the camel's back, last week the trickle turned into a deluge.
The professional problem for big money managers is that real performance is generated by being first, not trying to cram through the door with every other Tom, Dick and CFA. Now, you will have bids under a lot of stocks by people who missed the move, and a huge overhang of offers in the silly stocks just above the market. Things have changed. "As soon as I am even, I'm out" will replace some of the more bullish chat in taxicabs.
I am not making a case for cyclical stocks per se. I have a personal aversion to businesses that have little control over their destiny and infrequently generate returns above their cost of capital. I would also refer everyone to the latest issue of
where they have gone back and recreated a price history of commodities since the 1850s, and there is a clear and ugly secular trend toward down.
Yes, there is a price for everything. I would and have argued that at recent prices, you would certainly have a good chance of showing pretty decent relative performance by moving more industrial. While being up 30% in a week is silly and emotional, it's a long way to make up for four years or more in the wilderness. Cyclical stocks also tend to outperform early in the year as management is supremely confident about "the rebound in the second half," one of the deadliest phrases that can be uttered in an investment meeting. The economy also seems to have picked up a new seasonality over the past few years, with the early going much stronger.
But I am making the case that we are in the endgame of what has worked over the past few years: the Internet et al. If cyclical stocks continue to work, their success will come at the cost of higher interest rates, which will torpedo the higher P/Es and the far-into-the-future Internet-type stocks. But even if the cyclicals are just a headfake, I still think there will continue to be a strong relative shift toward smaller-caps and the Tent of Things That Haven't Worked Recently. Reversion to the mean is upon us.
Jeffrey Bronchick is chief investment officer of Reed Conner & Birdwell, a Los Angeles-based money management firm with about $1 billion of assets under management for institutions and taxable individuals. Bronchick also manages the RCB Small Cap Value fund. At time of publication, neither Bronchick nor RCB held any positions in the stocks discussed in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bronchick appreciates your feedback at