What we think about the price of an asset largely reflects whether we are a buyer or a seller of it. Most of us don’t have barrels of crude lying around but we do need to put fuel in our cars. We’re naturally inclined, therefore, to think the oil price is too high. On the other hand, most people in the UK of my age live in our own homes so we’re pretty relaxed about house price inflation. Our children may not be. It all depends on which end of the telescope you’re looking through.
The stock market is a curious hybrid from this perspective. Many of us are both buyers and sellers of financial assets. Many are likely to own a portfolio of shares and bonds in our pensions or other savings but, if we are still working, we may be looking to add to our investments. Looking at what we already own, we want the market to be high. From the point of view of the investments we wish to buy, we’d prefer it to be lower.
As the US stock market dips into bear market territory this week – down more than 20pc from its recent high – we are, understandably, conflicted. But you wouldn’t know it from the media’s market coverage, which is written from the perspective of people who already own assets. A fall in the market tends to be presented as a bad thing. But it could just as easily be seen as an opportunity.
This opportunity is potentially even greater than the headlines suggest. The S&P 500 may be 20pc lower, but the Nasdaq index is 30pc off its peak. Both are averages, and there are plenty of individual shares trading at much greater discounts than these to their recent highs. Parts of the market are starting to look like a very interesting contrarian opportunity.
To get a sense of its scale, I ranked the 800 or so US shares that you can trade on our UK investment platform according to their performance over the past six months. Half of them, around 400, have fallen by more than the S&P 500 index so far this year. There are currently 140 trading 40pc or more below their recent peak. About 90 stocks are down more 50pc. Just since January, in other words, they have halved in value, or worse.
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These are not small or obscure stocks that you have not heard of. The household names that you can buy for less than half what you would have paid last Christmas include: Facebook-owner Meta (down 51pc), Covid vaccine maker Moderna (57pc down), payment systems giant PayPal (a 60pc discount), Netflix (72pc lower) and crypto platform Coinbase (down 79pc).
Needless to say, the fact that a share has fallen is no guarantee that it is cheap, merely that it is cheaper than it was. True contrarian investing is not just ferreting around in the rubbish bins for what other investors aren’t interested in. The reason most investors are not contrarians is that it is hard work and may create a greater short-term exposure to volatility. uncertainty and underperformance. Listing the shares that have underperformed is the easy bit. Working out whether the fall is an over-reaction is harder. Hard but essential. Because a share that has fallen by 50pc can still fall by another 100pc.
There is very often a reason why a share has fallen out of favour. And it is not always evident in the published data. My initial glance at the 17 shares that made my list of out of favour household names, revealed only three which could not show both rising revenues and profits (or falling losses). The market is famously a discounting mechanism, pricing in the future. The recent falls in these share prices may be telling us to take these rises in revenues and profits with a pinch of salt.
Markets over-react in both directions because, while share prices are determined in the long run by fundamentals, in the shorter term they can diverge far from them. Investors may have been much too optimistic during the pandemic, in an environment of persistently low interest rates. And they may be too pessimistic today as growth slows and financial conditions tighten.
There certainly is a case for contrarian investing. Bubbles and panics are an unavoidable feature of stock markets. Deep-seated cognitive biases mean investors are particularly prone to major decision-making errors. We can over-emphasise the importance of negative events, we can extrapolate the recent past and anchor on earlier price levels. We may assign the wrong probabilities to events, suffer from over-confidence, are influenced by group dynamics and fall victim to the contagion of ideas. The list of our potential mental shortcomings as investors is endless.
And if the market’s overshoots a systematic contrarian approach, applied consistently over time, can deliver outperformance. Buying the cheapest stocks, whether measured against earnings, cashflow, book value or dividends can pay off in the long run if the price improves. If we can find the stomach to do it. It’s a great deal easier to say it than to do it.
So, I don’t know whether Pinterest (down 52pc), Under Armour (off 57pc), Peloton (76pc down) and Crocs (68pc below its peak) will turn out to be good investments. I suspect that some will and some won’t. But I would be very surprised if the anxiety seeping through the rest of the market this week has not already been well and truly priced into a basket of the most friendless stocks.
Originally published by Tom Stevenson, investment director at Fidelity International.