By the finance ghost Have you herd?
WBeacon in a storm
e need to talk about herd mentality, particularly when a stock such as Nvidia is up nearly 120% this year alone.
My favourite sentiment indicator is the ARK Innovation exchange traded fund ($ARKK) vs the Nasdaq 100 and S&P 500. Year to date, $ARKK and the Nasdaq 100 are both up 27%, with the S&P 500 up only 9.6%. Tech is frothy again, driven by excitement around artificial intelligence.
I’ve decided to take profit on my chip stocks this week. I think that a p:e of 439 at AMD is quite enough. In an even more controversial move, I plan to bring the dollars back to South Africa with the rand trading where it currently is. Before you worry about whether Toddler Ghost is going to starve one day, I’m not bringing all the dollars home.
Let me play the reverse, more “obvious” approach back to you. Right now, an investor somewhere is converting rand to dollars at our worst-ever exchange rate, all for the privilege of buying a stock like Nvidia at a record high. What could possibly go wrong?
I’m doing the exact opposite of that. Though there’s obviously no guarantee that it works (there never is), I would argue that following the herd and buying after a huge run is not the right near-term strategy.
The more time I spend in the market, the more I realise that fundamentals (like such as a p:e) are some kind of lighthouse at best.
In stormy macroeconomic seas, the ships are bashed around by numerous waves that can take them well off course. Though it helps to know where the lighthouse is relative to the ship’s position, it doesn’t explain short-term moves of 10%, 20% or even 30%. Those moves are driven by emotions in the market and the only way to predict them with any degree of consistency is with technical analysis.
If you are the type of investor who likes to buy quality companies and wait it out for a decade, then the lighthouse has traditionally been the only focus. In a less volatile macroeconomic environment, that works very well. Over 10 years, it hardly matters whether your entry price was 5% better off.
But what happens when the entry price is 30% away from the lighthouse? Or worse? In those scenarios, many moons and tides will pass before your ship gets back to where it “should” have been. In the meantime, those who were willing to be more aggressive in timing the market have taken advantage of ships that are so severely off course that the margin for safety for that trade is substantial.
Even for those who don’t want to actively manage their positions, simply avoiding stocks that are trading at levels way outside their average multiples is a sound strategy. Mean reversion can be very mean indeed. If a stock usually trades
on a p:e of 20 and is now at 35, there needs to be an extremely good reason for the step change, or that multiple will unwind back down again.
Mispricing certainly isn’t unique to the technology sector. With Dis-Chem having just released results that look great on a full-year basis and horrible if you isolate the second half of the financial year, I was reminded of the journey that Dis-Chem shareholders have been on since the IPO in 2016.
Obviously, hindsight is perfect. But even with that disclaimer, I was in the market in 2016 and I clearly remember everyone talking about how expensive the pricing was on that IPO. That was a buoyant time on the JSE, when a property company could simply whisper about an acquisition and Java Capital would raise hundreds of millions of rand before anyone had finished breakfast.
This is exactly why Dis-Chem came to market in that environment with its IPO and why it was a dangerous opportunity for investors. Of course, that didn’t prevent price exuberance and the “I told you so” crowd after the IPO, all the way from the low R20s up to the high R30s. That was terribly far from the lighthouse, with three tests of the high between December 2017 and April 2018. By June 2018, it was back at R26 and those who had bought at the peak needed to wait until 2022 to get their money back.
That volatility has played out again in the past year, with an almost identical slide from the high R30s to where we are today, in the low R20s.
Will investors ever learn?