How to Pick the Winners (EP.371)

Episode Summary

Executive Summary: Ben and Michael covered summer life updates, portfolio construction, market leadership, bond and ETF flows, housing and rates, consumer behavior, and media/tech trends. They mixed data-driven commentary with personal anecdotes to argue that investors are behaving better, bonds look attractive again, large-cap winners have been unusually dominant, and housing remains constrained by rates and incentives.

Main Topics: Small-cap vs. large-cap performance (Priority: 5/5): They discussed Michael Semblist’s analysis showing that small-cap underperformance has had real earnings and margin reasons, especially the strength of large-cap tech and broader large-cap profitability. Portfolio construction and diversification (Priority: 5/5): They cited Vanguard-style simulations showing that owning more stocks increases the odds of outperforming a benchmark, reinforcing the logic behind broad diversification and closet indexing. Bond fund inflows and improved investor behavior (Priority: 5/5): They argued that strong inflows into bond funds reflect better investor discipline, advisor influence, and a recognition that bond yields now offer more attractive starting points than in recent years. Housing market weakness and rate sensitivity (Priority: 5/5): They revisited housing data, mortgage rates, and structural incentives such as step-up basis and capital gains exemptions that may keep older homeowners from selling. Consumer brands, pricing, and earnings disappointments (Priority: 4/5): They used Lamb Weston and Nike as examples of companies hurt by pricing mistakes, changing demand, and strategic missteps after the pandemic. Media, social platforms, and algorithmic outrage (Priority: 4/5): They criticized Twitter/X’s For You feed, discussed Elon Musk’s influence, and noted how social media algorithms amplify outrage and toxicity. Entertainment, nostalgia, and movie/theater trends (Priority: 3/5): They talked about DVDs, IMAX, Deadpool & Wolverine, older movies seen too young, and the continued appeal of premium moviegoing experiences.

Key Arguments: Large-cap outperformance was not random; it was supported by superior earnings growth, free cash flow margins, and dominant tech performance. Owning more stocks generally increases the probability of beating a benchmark, even if it lowers the chance of huge upside, because it reduces single-stock risk. Bond allocations are becoming more attractive because yields are materially higher than in the prior decade, creating a better margin of safety for investors. A lot of the improvement in investor behavior comes from advisors and 401(k) rollovers into low-cost index and bond funds. Housing activity remains weak because higher mortgage rates, affordability constraints, and tax incentives all reduce turnover. Many brand-name companies are struggling because they raised prices too aggressively and misread post-pandemic consumer behavior. Twitter/X has become more polarized and algorithmically harmful, with the For You feed amplifying the worst content. U.S. workers are richer than many realize, as wages in even lower-income states exceed wages in most developed countries, partly because Americans work more hours.

Data Points: S&P 500 concentration: 3 stocks contributed to 49% of the S&P 500 gain in the first half of 2024 - YCharts Advisor Pulse discussion Fixed income ETF inflows: $150 billion through July - U.S.-listed fixed income ETFs had record inflows through this point in the year Taxable bond fund share of inflows: Nearly 90% - Share of net U.S. fund inflows in the first half of the year VOO annual inflow record: $50 billion in July - Vanguard S&P 500 ETF set a record for annual ETF inflows Money market fund assets: $6 trillion-ish - Referenced as still sitting in money market funds despite strong equity and bond flows Bloomberg Aggregate yield: Around 4.8% - Used to argue bonds now have a better starting yield than in the low-rate era AGG assets under management: $112 billion - Assets surged as investors moved back into fixed income AGG AUM rise: $75 billion at the beginning of 2023 to $112 billion now - Illustrates the rebound in bond fund demand Yield on the Bloomberg Agg in the pandemic: As low as 1% - Showed how much bond starting yields have improved since then Small-cap / large-cap valuation spread: Gap nearly shut on year-to-date performance - Despite years of small-cap underperformance, the spread narrowed quickly in 2024 Netflix historical drawdowns: 63%, 74%, 82%, and 74% - Example of a great company with multiple severe drawdowns that recovered Netflix long-term returns: 32% per year all time; 26% per year over the last 10 years - Despite the drawdowns, the stock compounded strongly IMAX Deadpool & Wolverine opening: $36.5 million - Largest IMAX opening weekend since 2022 Deadpool & Wolverine total opening weekend: $444 million - Strong box office performance mentioned in recommendations Deadpool & Wolverine IMAX share: 9.3% of domestic box office on approximately 1% of screens - Evidence that premium formats capture outsized demand U.S. gas price: $3.50/gallon - Near the long-run average since 2004 Oil inflation-adjusted peak: $696 in 2008 peak terms - Chart kid Matt’s inflation-adjusted oil comparison Energy spending share of personal consumption: About 4% now versus 10% in the 1980s - Used to show energy is less of a burden on household budgets today Annual existing home sales: Worst since 1995 - NAR slide showing housing market weakness Demographic turnover over two years: 7 million babies born, 3 million marriages, 1.5 million divorces, 7 million turned 65, 4 million died, 6 million new jobs, 50 million job switches - Used to argue housing demand/turnover eventually has to move Wage comparison: Only Luxembourg and Switzerland have higher wages than the lowest-wage U.S. states - Economic Innovation Group study comparing U.S. states with developed countries

Pivotal Quotes: "The whole point is that they're cheap, but they're cheap for a reason." — Ben: Discussing small-cap valuations and whether the discount can persist "If you want to increase your odds, that makes sense." — Michael: Reacting to the Vanguard-style portfolio simulation showing broader diversification improves the chance of beating the benchmark "We are disappointed by our fourth quarter performance." — Lamb Weston management quote: Reading the company’s earnings-call opening before noting the stock fell sharply

Implications: Listeners should expect continued debate over market breadth, a stronger case for bonds, and ongoing housing constraints. Advisor-led behavior and low-cost index adoption may keep improving portfolios, while algorithms and pricing missteps remain major risks for consumers and companies.