By Ned Montag, CEO
As we look back at the markets of 2024, there are some impressive trends to note. In 2022, markets closed down around 20%; in 2023, they closed up 24-25%. 2024 showed nearly identical results to 2023, up just beneath 25%. Both years have been impressive but the story behind the story is a bit familiar: the number of stocks participating in those gains has shrunk considerably, meaning the gains came from a large minority of names whose capital-weighted quality carried them. The Mag 7, like comic superheroes, delivered again. More than 70% of stocks (that’s 350+) failed to outperform the index itself. The gains are not evenly spread among all 500. Like a lopsided tire, they are heavily tech-focused and lumpy. So what’s that about and how does that work? It has to do with the big getting bigger and perhaps success growing into excess.
Many professional investors may agree, in theory, that the price of a stock should roughly correspond to the “intrinsic value” of that business. By “intrinsic value,” they would likely mean either the present value of all future cash flows that such a business could produce for its owners or, perhaps, the price that a knowledgeable investor would pay today to own the entire business. Either way, the intrinsic values of most businesses tend to increase earnings, which in turn, tend to grow at a reasonably consistent rate.
But even in the case of stocks whose businesses are steady, well-researched, and well-understood, such as Netflix and Meta (Facebook), the price can gyrate wildly above or below intrinsic value as the mood of the market swings from euphoria to despair, and back again. This is what springs to mind when characterizing the price action of many of the stocks driving the 2023 and 2024 S&P 500 index gains. Netflix shares traded at $336 in 2020, doubled to $682 in 2021, plunged to only $175 in 2022, ended 2023 just below $500, and traded in the range of $900 a year later. Meta stock presented the same rollercoaster ride, swinging from $159 in 2020, $362 in 2021, $90 in 2022, and then $630 in December of 2024. What on earth is going on here?
One key reason for this phenomenon is the market’s relentless pursuit of stocks with strong price momentum. Many studies, performed by both academics and professional investors, show that once a stock makes a strong price move higher, that price trend will very often persist for at least a year thereafter. Investor Wesley Gray, co-author of the book Quantitative Momentum, outlines a system of buying stocks with the strongest prior 12-month momentum, expecting that those stocks will produce superior returns for up to 12 months forward. Many investment professionals are aware of the persistence of price rises among the market’s best performers, so they develop strategies to “chase” these stocks higher, sometimes to dizzying valuation levels. If enough investors with cash to invest believe that a strategy will drive a stock higher, it will indeed do so, at least until the investment funds run out. (We recommend Quantitative Momentum for those interested in further details.)
A second reason stocks can exceed the current value of their businesses is a psychological phenomenon called “recency bias.” Psychologists have observed that the human mind tends to ascribe excessive importance and meaning to events that have happened recently and are therefore remembered most vividly.
Thus, we get excited about recent news without always remembering the lessons of history. (Elections and professional sports are full of this.)
Recency bias is not restricted to influencing investment decisions; it has also been detected when judging the value of exam answers and job interviews. A 2017 study by researchers Evgeny Antipov and Elena Pokryshevskaya identified recency bias as an influence in judging the winners of singing contests such as New Wave or Eurovision. Their work showed that singers who performed later in the competitions (or very early, known as “primacy bias”) received, on average, higher scores than contestants who performed in the middle of the order. (How many times can you get “blown away” by a performer and still bring “new or objective enthusiasm” to the next one?)
Entertainment reporters have become aware of the effects of recency bias and some song competitions have changed their procedures to randomize the order of performance in recognition of this bias.
Regarding investing, it is remarkable how the stock of a chronically poorly performing company can blast higher, at least for a time, on the basis of one good earnings quarter or perhaps the announcement of a new business contract. As investment mentor Ben Graham once reputedly said, “in the short run, the market is a voting machine, but in the long run, it is a weighing machine.”
A stock’s price can ascend rapidly due to manifestly good news, but it is the investor’s burden to determine whether that new, bullish outlook is due to reasons that are durable or only temporary. If the sharp gains are due to developments that are almost certain to last, such as the price gains of the technology giants in anticipation of gains from artificial intelligence, buying the stocks even after large prior gains can work.
On the other hand, many momentum investors got stung badly in 2020-2021 by overpaying to own strong momentum stocks such as Zoom, Teledoc, and DocuSign. These businesses seem on the verge of hyper growth due to the COVID pandemic, only to see their business trends and stock prices revert to past norms when the pandemic was solved. Our conclusion is that, for lay investors, following the mantra of “buying low”, not high, can be a safer approach.
In the meantime, owning the stocks of businesses that are clearly essential to the operation of the economy, both tomorrow and ten years from now, should prove to be a rewarding, albeit unexciting, strategy. As always, thank you for your trust in our services.
Sources:
- All earning/ returns as reported by Factset 1/2/25
- Quantitative Momentum: A Practitioner’s Guide to Building a Momentum-Based Stock Selection System
- Order effects in the results of song contests: Evidence from the Eurovision and the New Wave
- Quote by Benjamin Graham
The information provided is for illustration purposes only. It is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action to be taken. Any securities identified were selected for illustrative purposes only. Specific securities identified and described may or may not be held in portfolios managed by MONTAG and do not represent all of the securities purchased, sold, or recommended for advisory clients. The reader should not assume that investments in the securities identified and discussed were or will be profitable. Nothing in this document represents or should be construed as a solicitation or recommendation to buy or sell any specific security.
These analyses have been produced using data provided by third parties and/or public sources. While the information is believed to be reliable, its accuracy cannot be guaranteed. MONTAG employees do not provide legal or tax advice. For specific legal or tax matters, you should consult with your own legal and/or tax advisors. There are risks associated with investing in securities. Investing in stocks, bonds, exchange traded funds, mutual funds, and money market funds involve risk of loss. Loss of principal is possible.
