“The most contrarian thing of all is not to oppose the crowd but to think for yourself.”
Market Returns & Outlook
First, at the time of writing, both the S&P 500 and the NASDAQ indexes reached record highs. June YTD returns of the major indexes tracked by Trajan Wealth are illustrated in the table below.
With that said, every year, the financial columnist John Authers of Bloomberg publishes a jocular annual report of an imaginary investment firm called Hindsight Capital, which, as Mr. Authers describes, “is the most successful hedge fund of all time and uses the one strategy guaranteed to beat all others, all of the time; hindsight. The firm places its trades in full knowledge of how they will end up.”i Unsurprisingly, Hindsight Capital delivers consistently superlative returns.
Unfortunately, we can’t replicate Hindsight’s strategy by going back in time and investing all your capital in the “Magnificent Seven” (Apple, Amazon, Microsoft, Meta, Alphabet, Nvidia, and Tesla) at fractions of their current valuations. Hindsight is a useful tool insofar as we can learn from history. Without the aid of time travel, however, extrapolating solely from hindsight can lead towards a risky approach for evaluating investments and deciding on asset allocation.
| Index | 2Q YTD TR (%) | June, 2024 |
|---|---|---|
| US Large Cap - S&P 500 | 15.29% | 3.59% |
| US Large Cap – Tech Heavy NASDAQ | 18.57% | 6.03% |
| International Equity – MSACWI ex US | 5.69% | (0.09)% |
| US Small/Mid Cap – Russell 2500 | 2.34% | (1.50)% |
| Bloomberg Aggregate Intermediate Bond Index | (0.71)% | 0.95% |
Magnificent Seven YTD Returns & Current Valuationsii
| Stock | YTD Returns (7/5/2024) | Price Earnings (P/E) Ratio |
|---|---|---|
| Apple – AAPL | 17.3% | 35.0x |
| Amazon – AMZN | 31.5% | 54.5x |
| Microsoft – MSFT | 24.7% | 40.4x |
| Meta – META | 51.4% | 27.7x |
| Alphabet (GOOG) | 36.6% | 28.8x |
| Nvidia (NVDA) | 156.7% | 74.0x |
| Tesla (TSLA) | 1.1% | 113.1x |
| S&P 500 | 17.5% | 24.3x |
That said, extrapolating from hindsight is simple and easy; recent winners are likely to continue winning. There is more than a kernel of truth to this when it comes to markets, as hundreds of billions of dollars in momentum-based trading strategies are based on that simple principle. And beyond momentum trading, there could also be a structural reason that explains why even savvy institutional investors continue to pour in dollars into past winners, irrespective of whether the stocks look “rich” or expensive from a historical perspective and in relation to the overall index. This has much to do with how professional managers are evaluated; the underpinnings of which stems from performance not simply against a benchmark, but also relative percentile rankings amongst peers. To illustrate, consider the “Prisoner’s Dilemma problem” first framed by Merrill Flood and Melvin Dresher at the RAND Corporation. A quick recap…
Game Theory – The Prisoner's Dilemma Problemiii
Notice from the above payoff table that the dominant strategy for both prisoners is to cooperate and incriminate each other. The payoff from remaining quiet for both A and B is either 2 years (charge for the minor theft crime if the counterpart decides to remain quiet too) or 20 years if either one remains quiet but is incriminated by the other – the penal sentence structure essentially boiling down to 2 at best or 20 years at worst. Contrast that to the payoff to both for cooperating – either full clemency if the other remains quiet, or a reduced sentence of 10 years, if the counterpart too cooperates, resulting in a penal sentence of 0 or 10 years. Quite rationally, 0 or 10 years in prison is a preferable outcome for both prisoners than the alternative possibility of 2 or 20 years. Thus, by exercising their respective dominant strategies, both A and B end up cooperating and implicating each other, thereby receiving sentences of 10 years respectively, see the circled 4th quadrant in the above table. The “tragedy” for both prisoners is that had they been able to collude and trust each other, a better outcome would have been possible – neither exercising their dominant strategies by remaining quiet would have yielded 2-year sentences for each prisoner.
Top Holders of Magnificent Seveniv
| Stock | Top Holders – Institutions/Individuals | Mkt. Cap ($ Trillion) |
|---|---|---|
| Apple – AAPL | Vanguard, BlackRock, Berkshire Hathaway, State Street, Geode Capital | $3.47 |
| Amazon – AMZN | Jeff Bezos, Vanguard, Blackrock, State Street, FMR LLC, T Rowe Price, Goede Capital | $2.08 |
| Microsoft – MSFT | Vanguard, BlackRock, State Street, Capital Group, FMR LLC, Goede Capital | $3.48 |
| Meta – META | Vanguard, BlackRock, State Street, Capital Group, FMR LLC, Goede Capital | $1.37 |
| Alphabet (GOOG) | Vanguard, BlackRock, FMR LLC, State Street, Goede Capital, Capital Group, T Rowe Price | $2.36 |
| Nvidia (NVDA) | Vanguard, BlackRock, FMR LLC, State Street, Huang Jen-Hsun, Goede Capital, T Rowe Price | $3.1 |
| Tesla (TSLA) | Elon Musk, Vanguard, BlackRock, State Street, Goede Capital, Capital Group | $0.80 |
| S&P 500 | N / A | $44.08 |
Readers may wonder how the “Prisoners Dilemma” framework is connected to the stellar returns posted by the Magnificent Seven and what explains the continuing upward momentum in stock prices among the companies within this group, despite the high valuations illustrated in table 2. To answer these questions, we draw attention to the above table. Notice that apart from the founders, the largest holders of these stocks are large, institutional fund managers. Beyond this list, the next 20 holders also represent a “who’s who” list of institutional money managers; among whom the majority deploy “active” fund management strategies, with the twin objectives of (i) beating a (common) benchmark and (ii) jockeying for top peer group rankings in institutional manager databases such as Lipper.
Implications
Recommendations
i. Source – John Authers, Bloomberg, A Decade of Markert Wins for Hindsight Capital LLC (December 30, 2019).
ii. Source – Bloomberg as of Noon MST 7/5/2024.
iii. Credit – Merrill Flood and Melvin Dresher at the RAND Corporation.
iv. Source – Bloomberg as of 7/5/2024.
Udayan Mitra, CFA
Udayan is Trajan Wealth's CIO with over two decades of experience in the investment management industry. He earned a Bachelor of Science degree in Economics from the London School of Economics and an MBA in Finance from Rice University.
*Private assets may require accreditation. All figures are hypothetical and do not reflect fees. Past performance is not an indicator of future performance. Your results may vary.
