Crowding, Coronavirus and being Contrarian
Gareth Walsh
Gareth Walsh

Even before the Coronavirus, the word “crowd” had a negative connotation a lot of the time – swathes of people doing the same thing as you, but their presence was an inconvenience. The crowd made your task or activity a little more troublesome and less pleasurable. Christmas shopping springs to mind for me!

Then on the other hand, in packed sports stadiums and concerts, the bigger the crowd, the better the experience. You would be disappointed if the noise and bustle wasn’t high enough to generate a great atmosphere! The crowd during the event was an essential part of the experience. Afterwards it reverted to being a problem as you tried to get home, or to a restaurant or pub. We are fickle creatures.

 

Nowadays, crowds are something to be feared…and sorely missed.

The massive changes to our life and social distancing have meant that crowds will not be allowed to return for some time.

We all know that the current covid-19 world is proving very challenging for businesses that depended upon large gatherings. The key question for investors now is how quickly they will return to 80% or 100% of their previous activity levels. How will the competition be affected? Will underlying demand be greater or diminished by higher levels of unemployment? This will vary stock by stock, and as in the past, we expect the strong to get stronger.

There is a different type of crowding referred to in financial markets. Crowded trades are viewed as an investment that everyone knows about and already has a position in. Therefore, who is the marginal buyer (or seller) to drive the price further?

Well, there have been long debates about “crowded trades” or following the herd in the stock market. We go back to Warren Buffet’s mantra of being greedy when others are fearful, and fearful when others are greedy – effectively taking the opposite position to the crowd and taking a contrarian view. Mr Buffet, as a value investor, is looking for the undervalued business that has fallen out of favour with the crowd.

Intuitively, more interest in buying a company should push the price up, so therefore “crowded buyers” should be positive for prices? Well yes, they are and a stock that is deemed to be a crowded trade can remain so for years, delivering very healthy returns for investors. Also, some are worthy of being crowded, and consistently deliver quality earnings to justify their popularity. We look at the large cap US tech companies such as Microsoft that fit the bill of being both crowded for years and delivering earnings to justify it.

However, there is consistent evidence that during inflection points, large falls and periods of high volatility, highly crowded stocks underperform less crowded stocks. Therefore, crowding is an important risk tool when building your portfolio.

Crowding is not easy to quantify, but we can attempt it by looking at measures of ownership, sentiment and expectation. Historical low volatility can underestimate risk and highlight crowded stocks, remember we are looking to identify future volatility!

Is the company priced for perfection or distress? The share price reaction after earnings report can be very insightful, did the stock fall after a good report? Did the stock rise after a dreadful set of figures? These can be good indicators of ownership and expectations. Often crowded investments can be more correlated to each other than the market. Are stocks moving on news from another company with no real world read through?

In the immediate aftermath of the dramatic selling in March, funds poured into the perceived survivors and winners of the lockdown. Consumer staples such as Reckitt Benckiser (Dettol, Cilit Bang) and Proctor and Gamble (Fairy liquid, Pampers) did very well, alongside the tech names that enable remote working such as Amazon, Google and Microsoft. Later in the cycle the best performing stocks became travel companies as the reopening trade began. In a month period the cruise liner Carnival was up 25% when previous winners such as Walmart were up less than 1%. Crowded trades are really the modern term for what is fashionable to invest in.

My personal view on this is not necessarily to avoid crowded trades, momentum can be your friend for many years of investing. Ideally, we want to identify a crowded trade to quantify risk and reveal when a stock has been oversold or overbought for timing our buy and sell levels.

The danger of the crowded trade is being caught up in a stock that you are not comfortable owning if the events pan out against you. Without the robust business model and balance sheet you can be left with an ever-declining asset.

Another of Warren Buffet’s quotes:
“Only when the tide goes out do you discover who’s been swimming naked.”

Gareth Walsh is a Senior Portfolio Manager at Cantor Fitzgerald Ireland.

Contact details for each individual team member can be accessed here on our website should you wish to speak with a Portfolio Manager or Account Executive.

Warning: Past performance is not a reliable guide to future performance. The value of your investment may go down as well as up.