Breadth Thrusts & Bread Crusts: Wall Street is Stuck in the Past

JC Parets
May 27, 2021

From the desk of Willie Delwiche.

Wall Street is a trend following machine.

We all know the universal disclaimer: past performance being no guarantee of future results. 

But what has worked recently always gets a ton of attention from Wall Street. And for the past decade, buying and holding US large-cap stocks has worked. 

If you’ve benefited from that trend, you deserve congratulations. Deviating from the principles of diversification and putting all your investment eggs in that one basket has increased your return and reduced volatility. To some extent, the worse your behavior (relative to theory), the greater your reward.

There is plenty of historical data that says that was not supposed to happen. But it did. Price is price, and we don't argue with it. Lived experience takes place in the space between theory and anecdote. That is where most actual investment decisions take place as well.

But we can only celebrate the last victory for so long before getting ready for the next game. 

It’s now time to think about the impact of the trends of the last decade and consider whether they are still intact.

Three points to consider:

  1. An entire generation of advisors and investors now see the past decade as the norm.

    Even though it deviates from theory, it is their experience. That mindset is going to guide their portfolio positioning as we go forward. It makes for a built-in bias in favor of equities over any other asset class, the US over any other country, and expectations of persistent leadership from the Tech sector.

  2. The model portfolios used in the financial planning process and guide allocation decisions have de-emphasized areas that have lagged over the past decade.

    Remember, the business of Wall Street is all about following the trend. Within model portfolios, commodity exposure has been reduced, international equity exposure (especially Emerging Markets) has been pared back, and small-cap exposure has shrunk. Within this context, even overweights to these areas would have only a minor effect on the overall portfolio. Each yearly adjustment may be minor, but the effect over time is portfolios that do little more than reflect the trends of the past decade.

  3. The factors that fueled the gains of the past decade argue against expecting a repeat performance over the coming decade.

    Household exposure to equities is near all-time highs while valuations are near record levels. Inflation is showing signs of life and bond yields have turned higher. While price, breadth, and momentum trends help keep us in harmony with the market, these environmental factors help guide the development of our strategic positioning.

Investor mindsets and model portfolios may be well-equipped for the past. But it doesn't look like they are well-equipped for what lies ahead.

 

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