Eddy Elfenbein at the Crossing Wall Street blog had a great quote on Twitter yesterday:
Most investors want to do today what they should have done yesterday. – Larry Summers
Whatever your quibbles with Larry Summers (I have many), that’s sound market wisdom. You’ll see traders quote Wayne Gretzy frequently too, “I skate to where the puck is going to be, not where it has been.” But it is much easier said than done.
We’ve pounded home our dislike for the traditional “defensive” sectors on these pages before. Microfundy has been all over this theme as well, with his most recent update earlier this month. To me, it’s another classic example of chasing past performance. Investors in consumer staples and utilities in particular (I actually like health care, where valuations are much more reasonable) are setting up for serious long-term disappointment.
The Buttonwood column in the Economist issue 2 weeks ago (it was a very good issue) quantified just how expensive “defensives” had become on a historical basis:
Orrin Sharp Pierson, a strategist at BNP Paribas, points to a huge preference among investors in recent years for “quality” stocks. He defines such stocks as those with the least volatile profits. As the chart shows, when the market was bottoming in late 2008 and early 2009 there was little difference in valuation between high-quality and low-quality companies. But the gap has widened steadily ever since. Quality stocks now trade at around 3.5 times their book (or asset) value.…Mr Lapthorne’s research shows that in the past, periods when higher-quality, higher-yielding stocks have been scarce have led to disappointing returns from equities. The really bullish conditions for equities will be satisfied when (or rather, if) growth returns to pre-2007 levels and a lot more stocks pass the quality test.
