It’s no longer a stock market
It’s no longer a stock market
It’s a market of stocks again.
A stockpicker's market I’ve been waiting years for—at least a decade plus.
A stockpicker’s market is one that shows differentiation between stocks. It can be found (in hindsight) by studying intra-stock correlations—meaning the relationship of returns between stocks. If they are low, then it’s more a stock picker’s market than one that rewards just purely buying a broad index because stocks are moving based more on their specific situation (AKA “idiosyncratic”). Correlations have dropped in the last year—to an average of 0.25—similar to the pre-Great Financial Crisis (GFC) period.
Why is it happening now? Interest rates.
From around 1982, the foundation for interest rates used in stock valuations-– the yield on 10-year US Treasuries – started to decline from peak levels (along with inflation). Although there were bumps in the road, rates kept falling until they effectively dropped to zero during the Covid-19 pandemic. Since this time, inflation increased and central banks materially increased interest rates, sending yields above 5% by mid-2023.
Why would this matter? The answer lies in the cumulative impacts of falling rates for more than a generation. Because of it, borrowing capital was continuously less expensive and volatility fell, increasing risk tolerance, and increasing tolerance of higher stock valuations.
In fact, according to an April 2023 paper by the Federal Reserve, 42% of overall profit growth in the US market between 1989 and 2019 was “due to the decline in relative interest expenses and effective corporate tax rates”.
But it’s not just interest rates.
Thanks to globalization, global businesses were able to operate with very low costs for labor and taxes, maximizing their earnings per share. You can see in the chart below how around the year 2000, the number of manufacturing employees started to fall as globalization took hold.
Today, the multi-decade long trend of globalization is fracturing what many companies’ counted on in their strategies. As a result, I believe there will be greater variance in business outcomes, and a premium for demonstrated good business decision-making.
This is not to say that the broad market won’t or can’t go up over time. It’s more that returns between stocks could vary more, allowing for opportunity—for those that want to do the research and pick individual investments.