Is this or isn’t this a “stock picker’s” market?
Correlations Suggest It’s Good For Stock Pickers
Generally speaking, the market becomes more favourable for stock pickers when the stock prices for various companies move independent of each other. Wall Street pros would describe a market with this condition as exhibiting low correlations.
Conversely, if stocks are moving hand-in-hand (or exhibiting high correlations), then you might as well just buy an index fund or some other big basket of stocks. When correlations are high, the successful stock-picker will have a very difficult time standing out from the indexers.
Currently, correlations are pretty low.
But just because the market is better for stock pickers doesn’t mean it’s easier for stock pickers.
Valuation Dispersions Suggest It’s Hard For Stock-Pickers
JPMorgan Funds’ David Kelly argues that it’s actually become a more challenging environment for stock-pickers. He notes that the valuation dispersion for stocks in the S&P 500 are actually historically low. In other words, each stock’s valuation isn’t too far from its long-term average valuation.
What is Kelly talking about? For example, let’s say Widget Co. on average trades at 10x earnings. If it’s trading at 8x earnings it’s arguably more attractive. If it’s trading at 4x earnings — all things being equal — it’s arguably really really attractive. To put it another way, at 4x earnings the valuation dispersion is high.
“Specifically, valuation dispersion as measured by the standard deviation in S&P 500 constituent price to earnings ratios, may suggest a wide or narrow opportunity set for investors, with low dispersion pointing to fewer opportunities for managers to find relatively attractively valued stocks,” said Kelly. “As the chart of the week depicts (see below), valuation dispersion has fallen after last year’s multiple-driven-cyclical recovery, implying identifying relatively “cheap” stocks is the most difficult it has been in 20-years.”
But Kelly also believes all hope is not lost for stock pickers. “[W]hile the cyclical sectors are largely responsible for driving valuation dispersion downwards, valuations have widened in the defensive sectors, which should continue to provide opportunities for active managers to outperform.”
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