Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, February 26th, at 2:00 p.m. in London.
A running joke in investing, probably as old as time itself, is that the key to the market is simply buying low and selling high. But as self-evident as this advice might seem, which is kind of the point of the joke, over the last five years it's often been wrong. The best performing strategies were often those that focused on momentum, buying assets that were already going up and selling assets that were already going down.
Consider the following: until about two weeks ago, a strategy of buying stocks that had gone up the most, outperformed the S&P 500 by over 44% over the last five years. Buying high worked.
Trying to buy low, meanwhile, was also pretty challenging. There are many, many ways to define value in the stock market. But if we use the definitions in the Russell Indices, the more expensive half of the US market has outperformed the cheaper half of the market by about 110% over the same five-year period.
Now, there are some fundamental reasons for this dynamic. The more expensive half of the market contained many companies that have been major winners from greater technological investment and disruption. These stocks rose, and then kept rising as that disruption continued, rewarding investors for staying invested.
As they rose, the valuation gap between these two halves of the market stretched further and further. When yields were very low, or falling, this valuation gap mattered little. The more abnormal the economic environment, the easier it is for the market to pay a higher valuation for better, more exciting businesses.
But recently, the story of the market has been bond yields rising, and this stretched band of valuation bouncing back. In the last two weeks, the more expensive half of the US market is down about 5%, while that cheaper half is up about 1%. This extends globally. European stocks, an inexpensive market that has also lagged its global peers badly over the last five years, is higher over that same two week period.
Bond yields are rising as economic optimism improves. This is a normal pattern and one that we think is ultimately going to be manageable. As these yields have risen, cheaper, less popular parts of the market have started to outperform. That may seem obvious, yet by the standards of the last five years, it's anything but.
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