A new scary chart is circulating around showing that the top-10 stocks this year are up more than 60%, while the rest of the index is down on average. The only time the spread has been larger since 1991 was back in 1998 and 1999.
When I read this the part of me that loves racetracks and poker tables is screaming out for put spreads on the top 10 and long calls on the Russell broad market indices. This kind of chart is just enormously attractive to my inner gambler.
Of course, the MOB Spread chart was even prettier when it showed the spread between munis and Treasuries had never traded above a certain level when I saw it back in 1989. It passed that level and then some about 15 minutes after I put on the trade. I have seen a lot of pretty charts and data points in my life since that vomit-invoking trade and the results have rarely been in sync with the story with any sort of immediacy.
The problem is, when I look at the admittedly small data set of the current story chart, it is not highly predictive. The spread of one year is not highly predictive of anything in particular. If anything, the data appear to show that the spread is "trendy," with the relationship between the top 10 and the rest of the market remaining static for long stretches of time. If that is the case, then the current scare is wildly bullish as this is the first year of positive spread since 2011.
Looking over the data since 1991, this is the only time the top 10 were wildly positive while the rest of the market is down. I don't think we can take one data point and declare it predictive.
It is no secret that I have been cautious about the market all year. There are currently not many safe and cheap stocks around right now. The economy may be doing OK but it is not great and Wall Street has done a lot better than Main Street. Some very smart folks, such as Seth Klarman, Sam Zell, Carl Icahn and James Montier, have made very cautionary remarks on the market valuation levels, too.
The Value Line Median Appreciation Potential Index and market cap-to-GDP ratio are historically high right now. There are plenty of factors to be concerned about but much like the top 10 vs. the rest of the market chart, they are more yellow lights than precise timing indicators to trade on.
It is important to use common sense with all this data. If it is cheap and passes the safety filters, we should buy it. If it is overvalued, we should sell it. If we cannot find enough ideas to get fully invested, we should hold cash. If there is nothing to do, then we should do nothing.
We will make our money by reacting to what the market does rather than relying on a timing mechanism to move in and out of the market. The bull market is indeed long in the tooth but I do not want to short stocks or move entirely into cash only to see the market scream higher or a geopolitically inspired oil spike cause my energy related holding to double in a short period of time.
We will know the market has cracked and dropped after it happens, not before. With cash balances running about 50% outside the community bank portfolio, I am ready to react and put capital to work at attractive valuations. The cash, by the way, speaks more to my inability to find bargain issues than any broad market factors.
While I am concerned about overall market levels, I have learned this is fun to talk about, but not worth acting on. I am not about to run out and sell stocks like Volt Information Sciences (VISI) and Unisys (UIS) that I think can double or more over the next year or two. I am not going to sell a world class portfolio of property like the one Brookfield Property (BPY) owns in hopes I can buy it back lower because of a scary chart. I am not touching my community bank stocks because of something that may or may not happen in the near term.
The market moves on fear and greed. The trick to making money over time is not to respond to either impulse. Think like a businessman, not a speculator. The chart showing the relationship between the top-10 stocks and the rest of the market actually confirms my thoughts on market levels but I am not going to do anything based on the information.
Business, like investing, is driven by valuation, not by emotional responses to anecdotal data.
