One of the phrases I have always hated on Wall Street is a “stock picker’s market.” It just seemed like a cop-out for talking heads who didn’t want to venture a guess on the market’s next big move. It was a safe answer that couldn’t possibly be proven wrong because certain stocks would always go up and down more than the broader averages. But recently, the term has made a comeback and the ramifications are interesting.
What Is It?
I would define a stock picker’s market as an environment where many different stocks and groups of stocks are making big moves that are independent on the broader market. In other words, correlations between certain stocks are low with the averages. This environment is a dream for gifted stock pickers and investors that do their due diligence because the chances for relative outperformance is high. Unfortunately for them, this hasn’t been the case of late.
Starting with the 2008 financial crisis, macroeconomic trends have been whipsawing stocks back and forth as a group, rather than individual stocks moving to the beat of their own tune. According to the Wall Street Journal, correlation hit 80% in 2008-2009, which is an unheard of number. To put that in perspective, correlation was 27% in the early part of the decade.
This kind of environment is murder on mutual fund and hedge fund managers. If everything is moving together, where is the value-add from good stock picking strategies? These managers make millions and sometimes packages approaching billions in order to provide alpha to their shareholders. If investors can simply put their money in index funds and get the same or better results, where is the need for these managers? The rise of exchange-traded funds, or ETF’s, are another reason for this phenomenon. These are baskets of stocks that trade on the exchanges and their growth has been rabid. There is a built-in diversification benefit in ETF’s which seems to take some of the risk away from buying an individual stock.
Nothing Last Forever
If history has taught us anything, it is that no environment lasts forever. We are slowly (very slowly) coming out of the worst recession since the Great Depression, so there is still a lot of fear in the market, which tends to raise correlations. One of these days, market conditions will return to “normal,” whatever that means. I think we can all agree that the last three years have not been normal, even by Wall Street’s crazy standards. Fundamentals such as earnings growth, cash flows, and market position will matter again one day. Until then, think twice about becoming a hedge fund manager.
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