9 Charts That Spell Disaster For Your Cousin's Stocks (2024)

Trying to beat the market is an entertaining activity.

You can try stock-picking yourself, or pick a professional portfolio manager.

It may look easy. Today, the trend is to pick within recent winners. Consider this: from 2013 to 2024, the top 10 U.S. stocks eclipsed the rest of the S&P 500 pack by a whopping 4.9% annually.

Why not start with the most depressing number?In 2017, Hendrik Bessembinder analysed the performance of 25,300 US Stocks, looking at lifetime stock returns from 1926 to 2016.Historically, just 4% of Stocks or c. 1,100 firms listed in America created 100% of net wealth for buy-and-hold investors. What about the other stocks?

6 out of 10 (14,600 firms)lost investors’ money. The next 3 out of 10 (9,540 Stocks) wereverylow-return stocksthat offset–on aggregate – those loses.So, on a cumulative net basis, 96% of stocks created zero investor wealth.

The winners are even more concentrated:

• Top 5 Stocks (or just 0.02% of all listed stocks) – ExxonMobil, Apple, Microsoft, General Electric and IBM generated 10.1% of investor wealth.
• Top 50 Stocks (or 0.2%) – captured 39.3% of wealth creation.
• Top 300 Stocks (or 1.2%) –generated 75% of wealth.
• Top 1,200 Stocks (or 4%) – accounted for 100% of net wealth.

The return from those winners was so astounding, that the wealth destruction of the losers pales in comparison (17% – so for each dollar they lost, the 4% winners generated 6 dollars of wealth!).

Indeed, there wereperiods when most stocks even outperformedpopular indices. So, why limit ourselves to Buy and Hold and not time the market?

Let’s have a look at the evidence behind market timing, but first, try to see if we can pick the handful of stocks that generate the exceptional returns that lift the overall market.

#2 Yesterday's Winners may Not be Tomorrow's

As you may have guessed, compounding plays a big role in those massive gains. But, in the long run, only a few of yesterday’s winners will significantly compound over time.

The below race animation shows individual Stocks’ relative market cap in the S&P 500 Index, with the logos of the TOP 5 winners from the first study. Firms like Apple, Microsoft, GE or ExxonMobil were consistently compounding returns for decades. These firms generated annualised returns of 10-12% since 1926. But they are an exception.

If you look at recent history, holding the recent winners was a winning strategy –the largest 10 stocks in the S&P 500 generated an additional 4.9% per year on average. But, this is an exception:

• According to GMO, since 1957, thean equal-weighted index of the remaining 490 stocks by 2.4% per year. Why? Tomorrow’s winners rise, and that’s where most of the wealth is generated.
• Here is another proof. Before last decade, what would have happened if you bought the best stock once it took the top spot?According to Ned Davis Research, between 1972 and 2013, theust 400%.

So, most of the time, yesterday’s winners are not the best picks to outperform in the long run. Why not catching the rising stars instead?

#3 THE STOCK MARKET IS A MINEFIELD

If you cannot spot the sucker in your first half hour at the table, you are the sucker, said Michael McDermott, from the movie “Rounders,” played by Matt Damon.Academic Researchconfirms, it’s likely to be individuals. Professional Asset Managers are doing better, at the expense of individual investors.Funds managed by professionals outperform the market by 1.3 percent per year. So, given active investing is a zero-sum game, individual investors are net losers.

The below pie charts represent 20-year track records vs. benchmarks. Selecting Active Long Dated Bond Funds may sometimesmake sense. But, in the long run, 8 to 9 out of 10 Active Equity Funds tend to underperform their benchmarks, after accounting for fees.

Finally, even if you look at the long years of outperformance, how will you distinguish between luck and skill of the few surviving portfolio managers?If you have enough monkeys flipping a coin, one out of them, simply because of luck, will come up with 10 heads in a row.

#6 So, Maybe You Can Time the Market?

Perhaps you’re one of those investors not panicking during sell-offs. Well done.But as an evidence-based investor, you want to squeeze out all the juice.Factors such as small cap value could deliver in the long run. But in the medium term, it may not work in your favour.

Slow and consistent underperformance – also called tracking-error vs the S&P 500 – can make you doubt.

There could be new narratives suggesting why past factors may not persist. The world 30 years from now will look a lot different. “Value” and “Size” may not be what they were in the 20th century.The underperformance may last20 years to see any benefit from a tilt.Value investors learned it the hard way.

If you abandon the strategy, then you permanently lock in the underperformance.

In the 1920s, the French mathematician Louis Bachelier first described the price behaviour of stocks in the paper Théorie de la spéculationasrandom.

Why?This makes sense, since currently available information is supposed to be already captured in the price. It alsomakes risk-adjusted outperformance unlikely.

Five decades later, Burton Malkiel popularised the concept of efficient markets hypothesis, in abookwe reviewed a few months ago. Today, most investors, including Malkiel, agree that market prices are often wrong.

However, it doesn’t make investors any more likely to succeed. Because no one knows for sure if prices are too high or too low.

In fact, based on his 2011 paper, efficient markets are compatible with Market Bubbles or Behavioural factors including the Momentum risk premium.

In any case, inefficiencies won’t make you likely to be able to exploit them.On top of biases, taxes and fees are the second-biggest reason why active investors underperform.Due to the last couple,95% of Emerging Market Portfolio Managers underperform their benchmarks. The highest for all geographies. Despite Emerging Markets arguably being the least efficient.

#9 Your Losses are LIKELY TO BE IRREVERSIBLE