As we round the corner toward the end of the first quarter in 2018, I’ve noticed a trend in performance recently that looks very familiar. The stock market’s performance seems to be driven by a smaller subset of stocks. Just consider YTD, the divergence between the have and have nots is striking. Large cap growth stocks are up 4.3% YTD while small cap value stocks are down 3.83%. Digging deeper into the large cap world reveals an even narrower subset of winners. The FANG stocks (Facebook, Amazon, Netflix and Google) are up almost 18% YTD as of the end of February. Expand the view out a year and you see Large Cap Growth up 26.1% and Small Cap Value up barely 3%.
While I’m not here to argue for or against any of the names in the FANG index (I’ll save my thoughts on Netflix and Tesla for another time), I do see trends in the market today that remind me a lot of other points in time, namely, the end of past market cycles. Take the markets in 1999 for example. The major indexes were up substantially that year. The Dow Jones Industrial index was up 25.2% and the NASDAQ was up over 85%. You might not remember that over 64% of the stocks on the NYSE declined an average of 28%. On the NASDAQ, 50% of the stocks dropped on average by 32%. While the technology sector was a major winner, sectors like Financials, Utilities and Consumer Staples were flat to down on the year. Small cap value stocks were actually down 1.5% in 1999. Fast forward the next two years and those losers were the winners. My point being: reversion to the mean is real and no matter what the talking heads on TV or social media say, this theory is still very much a valid one.
Today, as the indexes hit new highs, there are stocks which are being ignored in the market and their prices are lagging. A quick screen of the Russell 2000 shows that around 21.5% of the index is down 20% or more over the last 12 months. Just like in 1999, there are names being ignored as a small group of companies rocket higher. I’m not arguing that today’s winners are anywhere as close to overvalued as their 1999 brethren were. Timing of these things is very difficult and the Investment Team at Ironwood doesn’t profess to be market timers. We do, however, believe in reversion to the mean and while everybody appears to be focused on the top end of the market, we are doing our best to be forward looking and find opportunities that have lagged recently but will benefit when the winds change.