Quietly, beneath the surface of the daily news cycle, something extraordinary is happening in the stock market. A group of ‘hype’ stocks, which are usually growing businesses but trading at unprecedentedly high valuations have, for several years, continued to see their share prices rise (and rise), with little connection to the valuation of their underlying businesses, rewarding those fund managers who continued to buy in anticipation of yet further share price rises. This ‘momentum’ strategy, which has made superstars of some of its’ most public supporters, has stopped working.
Zoom, a must-have for any momentum strategy fund manager, has seen its share price decline by 57% since February.
Zillow, the US-listed online real estate platform and favourite of the momentum crowd, is down 70% from its 2021 highs. Even Tesla is down 25% from its recent highs. Don’t forget Bitcoin, that’s down 20%.
The ARK Innovation Fund, mothership to the momentum boom, is down 36% from its highs.
Looking at the S&P 500 stock index, however, you’d be forgiven for being unaware that this carnage in momentum stocks is happening at-all. Year-to-date in 2021, the S&P 500 is up +26%.
And it’s not simply a case of the sell-off being a ‘growth stocks’ problem, or a ‘technology stock’ problem. Alphabet (parent of Google) is up +71% this year and Microsoft +53%. Charles River, a leading growth stock in the healthcare R&D space, is up +43% this year. LVMH (luxury consumer heavyweight champion) is up +39%.
Investors often make the mistake of thinking that successful investing is all about buying ‘great companies.’ Clue: it’s not that easy.
The price you pay (valuation) is fundamental to your investment returns. Think about buying a high-quality property as an investment. Only focussing on buying properties which are high-quality, without considering valuation, is a recipe for disaster. Imagine paying 10 times the price of similar quality properties on the same street… your investment returns are going to be poor (likely negative).
The same thing has been happening in the stock market. While some high-quality companies, like Alphabet, have continued to trade on reasonable valuations, others have seen their valuations lose touch with reality and go stratospheric (Zoom, et al.). Not only did many fund managers fail to warn their investors of the risks inherent to these stocks, many actually bought them in anticipation of even higher share prices. The momentum of the share price was reason in and of itself to buy. It’s a cliché, but ‘what goes up must come down’ pretty much explains what’s happening to the valuations of those momentum stocks now.
As we go into 2022, the solution for investors is clear, in our view. Avoid momentum stocks and hype valuations as though your life depends on it. Their time has come and gone.
Valuation matters, it always did. It’s possible to buy fantastic businesses on the stock market today trading at very reasonable valuations. You don’t have to overpay. You just need patience and effort to find them. Even easier, you can invest in funds that follow this investment strategy for you!
We’ll be taking a break from publishing the Weekly Brief over the Christmas and New Year period. We will return in early January.
Merry Christmas and a Happy New Year to all!
Disclaimer: The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Capital Strategies Limited or its related companies. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.
