The Bullishness of Bad Breadth
Bill Noonan
June 08, 2020

In October of 2000 we were invited to speak at the Contrary Opinion Forum in Vergennes Vermont.  The Forum had a long history, beginning in the 1960’s, of gathering an eclectic group of speakers which included climatologists, geologists, money managers, family office managers, individual investors, writers etc.  The setting was gorgeous.  The multi-day event took place at the picturesque Basin Harbor Club sitting on the edge of Lake Champlain.  Not easy to get to, it was a five-hour drive from Boston, some took private planes landing on the grass airstrip at the club. 

At its core, the forum was inspired to appeal to those interested in discussing concepts of contrary thinking, crowd psychology and its practical application in understanding investing, current day politics and reading which way the cultural winds were blowing.  As I write this, I cannot help to think about group think (crowd psychology) in our current discourse.  If you have a differing opinion, a contrary opinion, be very careful.  The crowd may not be receptive even if you have the facts, sometimes especially if you have the facts, on your side.  In 1852 Charles Mackay wrote in his book, Extraordinary Popular Delusions and the Madness of Crowds, “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

So why does this matter?  In the investment world, stock market breadth (how many stocks are going up versus down) has narrowed dramatically.  During the past ten years the herd has increasingly crowded into one single trade, buy large cap growth.  Today, there are many similarities to that time in October of 2000 when the herd was crowded into a single trade, buy technology at any cost.  Then, like now, the death of value investing was no longer even debatable.  And its at that point that the contrarian steps forward and says, not so fast.

So, we are dusting off the chart we presented to the Contrary Opinion Forum in 2000 which demonstrates the deterioration in the broad market and build up of potential positive change for the market.  The attached chart shows the percentage of “F” ratings in our universe.  An F rating is applied to stocks that have been underperforming for a minimum of twelve months.  Think of Fs as kinetic energy waiting to be released.  It is just a matter of time.  This massive build up to over 40% is unusual, only happening three times in our 50-year history and is always followed by a long-term period of outperformance for the broad market and value stocks.  While we may not have hit the ultimate peak, we are in the rare stratosphere that demands attention.

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