Last Friday, the newsletter from the Wall Street Journal hit my inbox. It immediately raised my attention as the core topic read Why This Isn’t a ‘Stock Picker’s Market’. Being a passionate stock picker myself, having little left for both, mainstream stocks and passive investing, I cannot let this statement left untouched for obvious reasons.
Summary and key takeaways from today’s Weekly
– Be careful with headlines, expressing that stock picking is not worth it.
– I explain what this recent WSJ newsletter email was about and what I think of it.
– My Premium and Premium PLUS memberships prove what’s possible — to beat the market.
Although I delete most such newsletters without wasting too much time on them as I don’t care about most points, it occasionally happens that an interesting topic arises. This can be a certain stock hitting the news, but also a big-picture view.
Like this time.
The question about active vs. passive investing, picking individual stocks vs. letting someone else doing it, is not a new discussion. It is unlikely to change anytime soon.
Such generalizations are a road to nowhere, anyhow.
Everyone is convinced of their own approach. But that’s far from all. Even inside of stock picking as a discipline you have vastly different ideas, investment styles, valuation assumptions, requirements, circles of competence, time horizons, income vs. capital gains orientation, etc.
In this Weekly, I am going to discuss what the newsletter was about and — more interesting for readers of Financial Engineering — why we simply can afford not to care about such headlines.
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These two camps, stock pickers and supporters of so-called passive investing in indices, likely will never agree, except that they disagree.
For each, their approach is the better one.
“Better” can be less volatile, achieve higher alpha (outperformance), more / less beta (bigger / lower swings vs. bechmark), require less maintenance after an initial setup, offer better risk-adjusted returns, etc. Die-hard stock pickers can only laugh about these points, as we don’t care about volatility or any of these nonsense statistics.
We care about business fundamentals and bottom line results.
Not “risk-adjusted returns”.
If you have a fat rocket in your portfolio, in most cases it will be more volatile — and it will have a dramatically higher beta, as an outperformance must exceed the underlying’s return by definition.
This is the difference to both, active fund managers and passive vehicles, which are constantly monitored and benchmarked against each other. Important deadlines like quarter or year end periods for them can decide about make or break, whether client’s money flows or is being pulled, whether a job is safe or terminated.
We couldn’t care less.
Before I point out why we have the upper hand, let’s discuss the email from the WSJ.
I saw the following in my inbox.
Compressed into two sentences, the email says active funds are struggling despite a volatile market (which should offer plenty of opportunities to buy on the cheap), with only 13% of large-cap stock funds beating the market over the past five years. While some believe skilled managers can outperform the market, data shows that most active managers are not consistently successful.
Luck vs. skill.
While I can live that, I absolutely do not see myself and my colleagues being thrown into the same bag as active fund managers. This is how this newsletter reads, respectively what the headline suggests. While both are stock pickers, not all stock pickers are fund managers not being able to keep pace with the market.
Quoting directly from the newsletter (bold by me):
Part of the reason active managers still attract trillions in assets is the widespread belief that some are better. Just because most don’t deliver doesn’t mean that yours won’t—especially if he or she has done well recently. And there will always be some that beat the market handily because any random distribution has outliers.
I fully agree that not everybody or even the majority can beat the market.
This is the same thought like socialism makes everyone rich. It is simply not possible in reality, no matter what people who have never left a university or Politburo claim.
Stock pickers aren’t automatically fund managers, and clearly less so some “statistical outliers”.
This reads like passive investing propaganda an ad for ETFs.
On the topic of skill, the WSJ writes (again, bold by me):
It’s wrong to say there’s no such thing as investing skill. And certain niches—value, small cap, fixed income or emerging markets, for example—benefit more often from human managers with good judgment. But when it comes to those managing the largest stocks, three godfathers of finance theory have explained why investors should set a high bar before believing someone is good and not just lucky.
Two things here with which I agree, before I start to disagree.
It is correct that what is called “certain niches”, together with good human judgement can offer an edge when it comes to returns.
Absolutely.
Financial-Engineering members know that firsthand.
In contrast, when it comes to the largest stocks, these advantages become smaller, in most cases leading to lackluster performances. Often trailing the market.
Even though not discussed in this email, this makes sense, as large caps are much more wildly followed and less likely to be mis-priced. Also, when everyone sits in the same boat, it should not be surprising that they arrive at the same target.
Then, we also have the topic of weighting — many fund managers have micro positions to “diversify”, not seldom strictly regulated. The more you diversify, the lower your returns, if you take this business seriously. I am not writing this for the first time here. Try to find an active fund that has been extremely overweight the Mag 7 for many years.
At the end, they show the following chart.
The chart says in plain that the longer an investment journey, the less likely it is for active investors, i.e. stock pickers, to outperform the market. Short term is luck, long term the wheat is separated from the chaff, uncovering the truth.
But on the other hand, this period is unlucky, as we have not had a recession for more than 15 years. Today’s highfliers will get their wings cut during the next cyclical downturn — whenever it may happen.
All in all, a bit cherry-picked and one-sided.
Regarding active fund managers, this makes sense insofar, as they sooner or later are driven to the big names. This can be for reasons like “because everyone is there, we cannot afford to miss this trend”, or simply due to size restrictions — the same issue Warren Buffett’s conglomerate is experiencing (see here).
As logical as it sounds, this does not say anything about private, individual stock pickers like you and me. I find this email’s headline insofar misleading, as it suggests active investing is not worth it, especially the longer you practice is.
It is exactly the other way around.
In the beginning, you will do unlucky picks, position-size wrongly, get overwhelmed by emotions at exactly the wrong time, throwing away a potential year’s outperformance in the blink of an eye — proverbially. We simply don’t have any monthly, quarterly or yearly reporting periods, we do not need to invent any excuses for why something did not work out or why we haven’t bought the same stocks like everyone else.
The funny thing is, when you don’t own Nvidia (ISIN: US67066G1040, ticker: NVDA), you’re practically an idiot. But when you lose together with everyone else, you are not guilty — because everyone caught the dirt.
Speaking of “what everyone else” owns, this fits now perfectly into what I’ve been preaching ad nauseam — following the herd to the slaughterhouse does not make it better, only because you were one of many sheep.
The following post from Twitter illustrates that nicely.
Many popular names that had many fans. Some still have.
But these fans ignored fundamental shifts and valuations. It is nice to have paper gains of 100%, 200%, or maybe 500%. What’s not nice is to give them back entirely, or even fall into the red — only because it was supposed to be a small correction. Stupid Mr. Market simply overreacted.
Or maybe not.
I’ve had a few of these names in the crosshairs myself, here on Financial Engineering or on twitter, frequently. My longer-time readers will instantly remember my warnings not to touch most consumer stapes, being it food or alcohol.
Of course, I am not perfect either — I do not have that ambition.
But where I am relatively good at is passing on grossly overvalued “opportunities” — value traps — where the crowd is licking their fingers.
Focussing on fundamental business analyses together with doing valuation exercises for me has been the go-to tool. Over time, I managed to gain the upper hand about my emotions, assessing and valuing numbers and figures, not sentiment or click-baity headlines.
Throw in some experience and gut feeling (highly underrated!), and you have a good recipe to shrug your shoulders about such headlines.
The cases that I have closed so far — 4x from my elite Premium PLUS membership and 20x from entry-level Premium — prove that. Closed, not paper gains that fall off the cliff next week.
If you want to be ahead of the market, ignoring such mainstream bullshit bingo, take the next step — join Financial Engineering Premium or Premium PLUS for member-exclusive reports with stock ideas that provenly beat the markets.
Conclusion
Be careful with headlines, expressing that stock picking is not worth it.
I explain what this recent WSJ newsletter email was about and what I think of it.
My Premium and Premium PLUS memberships prove what’s possible — to beat the market.
By becoming a Premium or Premium PLUS Member, you get instant access to all my already published research reports as well as several updates.
Likewise, you qualify for eight, respectively four more exclusive reports with my best investment ideas plus updates on the featured businesses over the next twelve months.