On the Migration of Stock

This should be a brief article.  I remember back in 1999 to early 2000 how P&C insurance stocks, and other boring slower-growth industries were falling in price despite growing net worth, and reasonable earnings.  I was working for The St. Paul at the time (a Property & Casualty Insurer), and for an investment actuary like me, who grew up in the life insurance business it was interesting to see the different philosophy of the industry.  Shorter-duration products make competition more obvious, making downturns uglier. The market in 1999-2000 got narrow.  Few groups and few stocks were leading the rise.  Performance-conscious investors, amateur and professional, servants of the “Church of What’s Working Now,” sold their holdings in the slower growing companies to buy the shares of faster growing companies, with little attention to valuation differences. I remember flipping the chart of the S&P Supercomposite for P&C Insurers, and laying it on top of an index of the dot-com stocks.  They looked like twins separated at birth, except one was upside down. When shares are sold, they don’t just disappear.  Someone buys them.  In this case, P&C firms bought back their own stock, as did industry insiders, and value investors — what few remained.  When managed well, P&C insurance is a nice, predictable business that throws of reliable profits, and is just complex enough to scare away a decent number of potential investors.  The scare is partially due to the effect that it is not always well-managed, and not everyone can figure out who the good managers are. So shares migrate.  Those that fall in the midst of a rally, despite decent economics, get bought by long-term investors.  The hot stocks get bought by shorter-term investors, who follow the momentum.  This continues until the gravitational effects of relative valuations gets too great — the cash flows of the hot stocks do not justify the valuations. Then performance reverts, and what was bad becomes good, and good bad, but as with almost every investment strategy you have to survive until the turn, and if the assets run from the prior migration, it is cold comfort to be right eventually. As an aside, this is part of what fuels dollar-weighted returns being lower than time-weighted returns.  The hot money migration buys high, and sells low. Thus I say to value investors, “Persevere.  I can’t tell you when the turn will be, but it is getting closer.”

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