Mysterious Ways

by Scott Ronalds

When Bono and his mates in U2 sat down to write Mysterious Ways back in the early 90’s, it didn’t come without controversy. Apparently, the band’s frontman and producer argued intensively and struggled to build the idea into a song before The Edge (lead guitarist) stepped in to save the day with his signature chords.

I often get the chorus stuck in my head after hearing the tune.

It's all right, it's all right, it's all right
She moves in mysterious ways
It's all right, it's all right, it's all right
She moves in mysterious ways, oh

These days, I can’t help but relate it to the stock market. Without a doubt, she moves in mysterious ways. And like that heated songwriting session 30 years ago, there’s debate today over those moves.

The U.S. market (S&P 500 Index) has seen a nice uptick this year and is on track to turn in an excellent first half, up 15% as of June 20 (in U.S. dollars). Driving the gains, however, are just seven stocks: Apple, Nvidia, Microsoft, Amazon, Alphabet, Meta, and Tesla. The enthusiasm around artificial intelligence (AI) has helped propel these stocks and there’s likely an element of FOMO at play. The ‘group of seven’ have risen between 40% to 200% this year. The other 493 companies that comprise the broad index haven’t moved at all, in aggregate.

The American market, in the meantime, has become increasingly top-heavy. The biggest seven companies are all tech related and account for over one-quarter of the index.

Opinions abound on the situation. Many analysts argue that this isn’t healthy. When market breadth (the number of companies rising versus falling) is negative and leadership is narrow, the risks are escalated, so the thinking goes. Other professional investors contend that a rising tide lifts all boats and the stocks that are treading water now will eventually play catch up. Ride the momentum wave, in other words.

There are opposing views, too, on whether a recession will pour cold water on the recent rally. The argument goes that if the economy cools and corporate earnings shrink, stocks will be vulnerable, and the recent gains erased. Countering this belief is the notion that the market looks forward and has already factored in the impact of a slowing economy. We’ve noted repeatedly in our communications that the economy is not the market, and indeed, the two do not move in tandem.

We bring it all back to two things: diversification and valuation. Our managers don’t build portfolios that look like the index, so we’re not too concerned about the U.S. market’s changing look and the chatter around its makeup. Our focus is on making sure our funds are well diversified — by industry, geography, and style (growth and value). Equally important, we look hard at the price we pay for a company. If it trades at a big premium to its underlying value and future prospects, we stay away.

The result of our approach is that our clients’ portfolios continue to look much different than the market. We have a large position in one of the above stocks that’s been riding high, Microsoft, because our managers believe it’s a great business trading at a good price. But we don’t own the others, for reasons coming back to both valuation and diversification.

We watch with interest the moves of the market, but they don’t change our investment approach. Experience has taught us that chasing a trend or coming late to the party can have unwelcome consequences for your portfolio. The title of U2’s album is fitting in this sense — Achtung Baby.

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