‘An index is a great leveller’ – George Bernard Shaw
I am fairly certain the Irish dramatist was making reference to an index in a book but his quote is equally applicable to the world of stock market indices.
Indices are the wonderful catch-all mechanism by which many investors judge the stock market and, by default, their investments. We have all seen the excitable TV reports and front page newspaper stories when an individual index pushes up or down through a major round number level. The rise and rise of passive investment – tracking a defined index – has only deepened this focus.
I learnt a lot about the differences between an index and investing a few years into my investment industry career. By the late 1990s, an almost annual ritual for investment thinkers and strategists was to call the turn of the once dominant Japanese stock market which had peaked about a decade earlier. Having, at that time, recently returned from a trip to the Land of the Rising Sun I too sensed an opportunity and duly invested some of my personal capital into a Japanese unit trust.
Suffice to say it was a bad call. The hustle and bustle of Tokyo continued to be a poor indicator of the broader direction of the Japanese economy and certainly did not capture issues which still continue to afflict the country today such as negative demographic trends. Six months or so after my visit – and my investment – i remember putting together a client report on global stock market performances and noting that Japan was bottom of the league table in either Sterling or yen denominated forms. Imagine my surprise then when i got my half-yearly investment status through a few days later…and noted my investment had actually made me some money.
A bit of investigation ironed out why there was this – surprisingly positive – conflict. Within the shabby overall performance of the Japanese index, a group of export-centred names had performed well – and the fund i had invested in was itself heavily exposed to this are of the stock market, hence the strong outperformance. An index is, after all, composed of a number of individual stocks and it is perfectly plausible for a stock picker to generate a quite differentiated performance.
I thought of all the above when over the weekend I read that within the (currently) all-conquering US stock market ‘just three stocks have been responsible for 71% of S&P 500 returns and 78% of Nasdaq 100 return’. No surprises for guessing that these names are centred on the technology/internet area…and that if you do not own them then your perceptions of and performance from the US stock market is likely to be impacted.
So is the moral of the story to pick stocks and not an index? After all the Global Dynamic Opportunities Fund makes a big play of buying individual shares. That would certainly be one interpretation but I would add another important filter: pick stocks for the right reason. A good theme backed up by a mis-understood and still good value story is still likely to outperform more ‘flavour of the day’ excitements. Funnily enough looking back with the benefit of hindsight that Japanese superior exporter theme held up for many years before finally succumbing to an ever-higher yen, a point investors in the highly excitable internet technology sector today may want to take onboard.
With over 180 large cap companies in America alone reporting this week – as well as a bunch of UK and European names – there will be plenty for investors in all sectors to ponder over upcoming days and weeks.