Are stocks marching to the beats of their own individual drummers or are they moving up and down in lockstep with each other? Mark Hulbert explains.
The 2021 investment newsletter scoreboard illustrates the extent to which Wall Street has become a market of individual stocks rather than a monolithic stock market.
The distinction has to do with whether stocks are marching to the beats of their own individual drummers or are, instead, tending to move up and down in lockstep with each other. When it’s the former, our focus should be on stock picking. When it’s the latter, market timing is more the order of the day.
Consider how little correlation there is between the broad stock market indices last year and the returns of the top-performing investment newsletters. The message of those indices was that the largest stocks are dominating the market, since the largest 50 stocks gained 30.1%, according to the Russell Top 50 Mega Cap Index, more than doubling the 14.8% return of the Russell 2000 Index of mid- and small-cap issues. Yet the top-performing investment newsletter, among those tracked by my performance auditing firm, is far closer to the small end of the market-cap spectrum.
I’m referring to Investor Advisory Service, edited by Douglas Gerlach. My firm calculates that the newsletter’s model portfolio produced a 53.8% return in 2021. Though Gerlach doesn’t exclusively focus on small-cap stocks, his portfolio currently is heavily skewed in that direction. Of the 33 stocks he currently rates “Buy,” for example, 18 have market caps of less than $10 billion. To put that in context, the largest stock in the Russell 2000 index has a market cap greater than $20 billion.
(Full disclosure note: Investor Advisory Service, along with all newsletters that my performance-tracking firm monitors, pays a flat fee to have its investment returns audited. Because each newsletter pays the same fee, there is no incentive for my firm to report that one firm has done better than another.)
The same goes for the newsletter in second place for 2021 performance: The Cabot Turnaround Letter, edited by Bruce Kaser, whose three model portfolios produced an average gain of 52.8%, according to my firm’s auditing. Nearly half of the stocks Kaser currently rates “Buy” (15 of 33) have market caps below $10 billion.
Lest you think that only small-cap newsletters did well last year, however, consider the newsletters in fourth and fifth place for performance last year: The Investment Reporter (published by Canada’s MPL Communications) and Blue Chip Investor (edited by Steven Check), with audited returns of 32.8% and 32.5%. The average market cap of stocks currently recommended by the former is $135 billion; for the latter it is $176 billion.
A similar contrast is evident when focusing on the role played last year by the growth and value styles. Many (though not all) of the top performing newsletters favored the value end of the value-versus-growth spectrum. Yet at the level of the overall market, growth beat value: The S&P 500 Growth Index last year produced a gain of 32.7%, versus 24.9% for the S&P 500 Value Index.
To illustrate the value focus of some of the top performers: Consider that more than half the stocks on the buy list of the top performing newsletter (Investor Advisory Service) have price-to-book-value ratios below that of the S&P 500. This ratio is the standard academic criterion for determining where a stock stands on the growth-versus-value spectrum.
How To Invest When It’s a Market of Stocks
The message of the performance scoreboards is clear: We’re in a “market of stocks.” As mentioned above, that means we should be focusing less on the trend of the overall market or of various sector or style benchmarks. Instead, we should focus our analytical energies on finding particular companies whose investment rationales appear to be most compelling—regardless of whether they are in the large-, mid- or small-cap camps, or whether they are categorized as “growth” or “value.”
By definition, that means it’s hard to generalize. “Buy high quality stocks at reasonable prices” sounds good in theory. But the devil is in the details.
To give you some ideas, below are the stocks currently recommended by the greatest number of newsletters my firm tracks. I include in the table the market-cap and price/book ratio data only to illustrate the wide range that exists for the top-performing newsletters. But, as I’ve argued in this column, you shouldn’t base your assessment of any of these stocks based on this data.
