I know I'm cheating a bit here. In building a U.S. technology "Growth at any Price" (GAP) Index and measuring its performance relative to the S&P 500, I'm picking stocks where I know what performance until now will look like.
That said, there is a ton to be gleaned from this chart and some important inferences as to equity market leadership going forward.
The index is an equal weighted measure of four of 2013's highest flying stocks – Facebook Inc., Netflix Inc., LinkedIn Corp. and Amazon.com Inc.. In each case, valuation multiples were and are stratospheric – higher than anything a reasonable investor concerned about value would consider.
From the beginning of 2013 until the end of February this year, the S&P 500 generated an impressive 31.4 per cent return. But expensive as the underlying stocks were, the Growth at Any Price Index blew away the benchmark for the period, increasing by 272 per cent.
The GAP Index has endured painful 33 per cent correction since the March 5 peak, but the brave investor who bought these stocks in early 2013 still holds double the amount invested and remains well ahead of the S&P 500.
So what can we learn, beyond the fact that traders with a quick trigger finger over the sell button can make a lot of money from market hype?
One thing is that technology stocks, particularly those in new areas like social media and digital streaming, are not that sensitive to valuations. They're still dangerous and not suitable for risk-averse investors, (as the performance since March indicates) but recent patterns reaffirm that value-based investing approaches don't work very well in the sector.
More importantly for the average investor, the relative performance of GAP stocks and the S&P 500 may indicate a rotation in sector leadership. In short, attractive valuation levels are being rewarded in the market moreso than in the recent, post-crisis past.
I would view this trend, if it continues, as very positive for investors. When hot stocks become popular and reach insane valuations levels, this is often a sign that overall earnings growth is scarce. In other words, investor assets gravitate towards speculative momentum stocks because nothing else is moving higher. Until they blow up.
A market where performance is driven by valuations is far more intelligible, safer and navigable for investors. Rather than buying Amazon.com at over 500 times trailing earnings and praying there's more upside left, investors can generate strong returns by owning more attractively valued companies with downside protection.
We'll see. It certainly is a good time for investors to reduce holdings in high valuation, momentum stocks and start sifting the market for companies cheap on price earnings, price to cash flow and EV/EBITDA. I'll be helping out with this endeavour in the coming days.
Scott Barlow