In my prior article about breakouts, I missed out on a chance to speak about the recent change in market structure, and what it means for all of us as investors.
Let’s go back in time a few decades. When I think about back then it felt like, most investors bought stocks, collected their dividends, and let things play out over multiple years. Of course, there were story stocks, stocks that moved rapidly and captured investor attention, but most stocks were boring and prosaic. As a result, most investors took a long-term view of things, buying shares and sort of forgetting about them.
As investor timeframes have condensed, investing became more aggressive in my view. No longer could you buy something cheap and wait for someone to notice. Instead, you had to buy something that would go up, and go up immediately. A valuation-based market evolved into a momentum-based one, and price suddenly meant everything. As an institutional investor, you had to keep up with your competitors. This was then accentuated by passive investing, which periodically re-weights indices, often based on market cap—hence companies that are appreciating in price tend to be the ones that receive endless waves of passive buying. Finally, the 24-hour financial news media would latch onto whatever stock that was making new highs and spin stories about why it would go higher, bringing in droves of retail investors, who were not only valuation-insensitive, but seemed to prefer buying new highs.
I believe this creates a highly reflexive and Pavlovian feedback loop, and the rules are increasingly simple: buy stuff that’s going up, don’t ask questions about valuation, and instead focus on narratives. Can the media spin this?? Will the story run out of runway?? Is there enough blue sky to make investors dream?? If the narrative can run, then you can rest assured that as it makes new highs, others will be forced to buy shares, while passive keeps re-allocating to whatever is going up fastest.
I’m not going to say that buying new highs didn’t work a century ago, in fact, it worked quite well. That’s simply how human psychology and markets have always functioned. However, I’m going to posit that new highs didn’t rocket a share-price with quite the same intensity as they do today. Instead, there was more of a give-and-take on the way higher, and the process played out over years, instead of months.
The converse of a momentum driven market is that downside momentum keeps feeding on itself. Of course, Paul Tudor Jones had this all figured out decades ago, but it’s always been a bitter pill to swallow for us value guys. I actually remember a time when something got so cheap that you could buy a downtrend and with some patience, you’d get paid for your analysis. Sure, it might take a few quarters, but valuation mattered. I increasingly think it matters less. There just isn’t a mechanism in place to arrest a share price in decline. To start with, passive is simply spraying the screen with shares as it re-weights to buy more of what’s going up. Then, you have all of the funds who’ve been preconditioned not to buy new lows. That strategy hasn’t worked in over a decade, and anyone who’s tried to buy new lows has been shredded, hence who’s going to buy?? If anything, active investors are going to keep selling new lows.
Of course, the company can buy back shares, and we’ve seen massive buybacks in companies trading for mid-single digit earnings multiples, but that’s a slow process that plays out over years. In the past, something that was cheap would attract investors and put a floor under the valuation, but as most investors stopped caring about value and instead became fixated on price momentum, the floor melted away. As a result, a surprising number of my value investments culminate in the company getting acquired as the price gets too cheap, and Private Equity takes advantage of the new market structure.
Returning to my narrative, I’m surprised at how many guys still want to short something when the valuation seems irrational, as if two or five times irrational is impossible. I’m also not surprised that certain stocks go up every day. If the narrative is reverberating in the news, and the shares are making new highs, then the shares are probably going to keep making new highs. That’s just how market structure has evolved. Eventually, the structure will evolve again, but for now, this is the structure. You can fight it, you can argue with it, or you can take advantage of it.
Going full circle and returning to my post “On Breakouts,” it should be no surprise that investors, especially in today’s market, love breakouts. New highs lead to newer highs. Investors have been rewarded for chasing and penalized for not chasing. No one wants to own a great story that’s stuck in the range. Instead, they’ve been conditioned to wait until it “breaks out” and then they simply chase, and keep chasing. Sure, all their friends are also buying at that moment, leading to rapid price discovery, and the need to increasingly pay a higher price to get their position on, especially as sellers have been conditioned to never sell breakouts, but that’s the market environment that we’re in. Market structure has been evolving for over a decade, but that evolution has accelerated since COVID. No longer can a fund report a down quarter, or even a down month. Instead, as a portfolio manager, you’re supposed to be producing Alpha every single month, or you get redeemed. This performance pressure is forcing guys to chase what’s in motion, even if it is incredibly risky to overpay for stocks, as we learned during 2022’s tech crash.
I still do things the old ways, but I’ve also evolved. I buy cheap stocks, waiting for someone to notice. However, I try to do that only once a stock has stopped trending lower. I try to buy big bases of stability with a strong macro tailwind, as I know that will likely produce the breakouts that everyone loves to chase. I refuse to pay more than yesterday’s price, just because it validates my work. I can accept that I’ll have bad months or even a bad year as I buy something with fundamental momentum, but without price momentum. I want to be front-running the “breakout boys” and fully positioned before they start paying up. I also have the patience to know that sometimes this takes a while to play out.
The game has changed, and I think that I’ve evolved with it. I also know that when the breakout comes, it’s time to sit back and watch… In this new market, I believe one of the worst things you can do is to sell new highs. Just let it trend…