Haven, not so safe?

Funds rushing to safety, thereby raising a potential risk of crowded trade in safe haven stocks.

The end-game for crowded trade is never cozy. It eventually crumbles and that too in a crucifying manner. We all know that. We don’t need to go too far into the history to get a sense of what happened to such trades. 2017 was one such year where momentum in small-caps slowly morphed into consensual crowded trade where fear-of-missing-out went berserk to create a bubble in that space. In crowded trade, momentum builds in a self-feeding fashion to set-off a bubble. This is probably is what we are witnessing in the select set of stocks in the name of flight to quality amid a brutal bear market in the broader space.

The role of business media in pumping up the buzz can never be under estimated. In 2017, one celebrated small cap fund manager (no prizes for guessing) got the disproportional airtime when small-caps were sizzling to scary levels. Of course, he fell into the seductive trap of new found media attention. Now, it is the turn of coffee-can clubs, who come in prime times and glorify investing into gifted names that are quoting at obscene valuations. Their glib talk, of course masks the fact that this is nothing but hiding in safe havens in the name of quality. They are now larger than life heroes for the business media in general and for the investment community in particular. Sun is shining on them now. What will bring down the binge in the so called crowded trade of quality (few handful of names that even the barber in the neighborhood would tell you how they will not lose money for you) is anyone’s guess.

Investors who chase the crowded trade have reasons to smile as they are proved right in the short-term. More so, when the contrarians get crushed month after month. But they fail to understand that the surest way to under-perform in the long-run is to fall into the trap of being seen smart in the short-term. Cycles after cycles show that contrarians have the last laugh, though they will have to survive the onslaught (having the stomach to digest notional losses and having the ability to pick the “quality” stocks from the beaten down space) by not only staying the course, but also by having willingness to look stupid in the short-term. That is not easy for institutional money managers, esp. when they are measured on daily NAVs. They have few options than joining crowded chorus.

Here is the table which explains the degree of insanity in the valuations of those gifted and glorified ones (TTM PE has expanded sharply for these).


Even momentum investors should be worried to touch these stocks at these scary valuations, however tempting it could be to hide. Having said that, it is not that they will stop rising or will correct in a hurry. Sometimes, the party can go on for long, esp. when there is premium for quality in a polarized market. The more they go up from here, riskier they will become and harder the correction that will ensue in this segment. While price correction may not be substantial, extended time correction can’t be ruled out in this space when optimism returns to the broader space.

It may not be out of place to end this note with this quote from Howard Marks.

“When everyone believes something is risky, their
unwillingness to buy usually reduces the price to the point
where it’s not risky. When everyone believes something
embodies no risk, they usually bid it up to the point where it’s
enormously risky.”

Happy Value Investing!!