It was the fall of 2000.  Ed Noonan (founder of Contravisory) and I had gone to Vermont to attend the Contrarian Opinion Forum.   Ed had published a SELL recommendation on technology three months earlier.  By the fall, the ensuing pullback was seen by many at the conference as a “buying opportunity.” Of course, with perfect hindsight, we know it wasn’t.  It turned out to be a three year nightmare.    

The top of a bubble is very hard to identify.  The reason is that a “crowd “will always reaffirm, and strengthen, everyone’s belief on pullbacks.  As we headed into the lecture hall, a made over barn but then it was Vermont, to hear another speaker, Ed and I were still talking about this crowd phenomenon.   Ed stopped, turned toward me and said, “Frank, it’s not that the crowd is always wrong.  The crowd can be very right for a period of time.  The crowd was absolutely right during 1995 to 2000 that technology was the place to be.  But what a crowd will always miss is the inflection point of change.”  

The crowd now believes it must own passive index and ETF funds.  It has become accepted “wisdom” that active managers cannot beat the S&P 500.  Such total belief is an inflection point of change.  In truth, most haven’t for the past three to six years.  In fact, many famous managers have been down sharply during this bull market period.   Some were off as much as 20% last year.  Did they suddenly become inept, or was something else involved?  In my opinion there was.  It was stock correlation.  Stocks have moved up and down in lock-step for the past six years.  This happened because a major macro event had taken place … the global debt crisis.  Its fallout represented an unknown threat to all international companies.   The debt collapse caused what is now known as “The Great Recession.”

The 2008-2009 experience was similar in many ways to 1973-1974.  At that time, we had the worst recession since the depression.  Then three macro events occurred.  OPEC, rampant inflation and rising interest rates disrupted the economy.  In both periods, the stock market went down 50%.  Public sentiment in the 70s was much like that of the past eight years.  There was a social malaise and stock market indifference that had been created by the two-year bear market.  The Dow went sideways for the next eight years.  In 1979 BUSINESS WEEK ran the famous cover story, “The Death of Equities.”

It has always been the success of individual stocks that determines a portfolio’s ultimate performance.  Success rarely comes to those trying to outguess the market’s next turn or the next macro event to hit the economy.  Last year’s BREXIT vote and the election of Donald Trump are two dramatic examples.  Yet, that is what the investment world tries to predict every day.   

We believe the investment world will soon be moving away from large S&P index names and have positioned our portfolio accordingly.  The crowd, with its unanimous belief in passive funds, will largely miss the change.  Individual stock selection and active management will benefit.  Cost is the major benefit of ETFs.  When was the last time the less you paid for something the greater was its value?

-Francis Patrick Boland