We are at the point in the calendar when the “mid-year market overviews” start to appear, fast and furiously.  The theme this year has been how dominant FAANG stocks (Facebook, Amazon, Apple, Netflix and Google) have been in S&P 500 returns year-to-date.  The following post is typical of what has been peppering our Twitter timeline recently.

And then there was this story last week from CNBC.

You read this, seemingly every day, and you wonder why anyone buys anything else but FAANG.  While it makes for a fun headline, and an interesting two-minute segment on CNBC, the reality of course is different.

Netflix (until yesterday) and Amazon have indeed had spectacular runs in 2018, up 106% and 55% year to date respectively as of July 13th, and while they are the second and eighth best performers in the S&P this year, 99 other stocks have outperformed Facebook, 104 have outperformed Apple, and 129 Google in the same time frame.  What’s our point?  You don’t need to own FAANG to outperform.

More importantly, in spite of the FAANG headlines, correlations between stocks are now at their lowest level in almost a decade, and investors need to properly evaluate the implication.  We are moving into a period, likely to continue for some time, where stock picking has been and will be the most important characteristic if one wants to outperform benchmark indices.  How do we know?  We have three portfolios that own no FAANG, and those portfolios have been miles better than their benchmarks (and the S&P 500).  A fourth, which owns a teeny bit of FAANG (just two of the five names) and which uses the S&P 500 benchmark as its index, is also beating the S&P 500 by a wide margin.

As of Friday, July 13th, the S&P 500 Index is up 5.86% for the year-to-date period.  But, 244 of the 500 stocks in the index have lower year-to-date returns than the index and more than 200 actually have negative returns.  This should tell you that portfolio construction matters.  Most everybody has a spice rack in the kitchen, how it is used is up to the chef.

While stock selection has been a hugely important factor aiding portfolio performance this year, it is not the only one.  Asset allocation has also mattered.  Growth continues to outperform value, small stocks have outperformed large, and stocks have outperformed bonds by a wide margin (which is not as obvious an outcome as you think. . .).  While the S&P 500 is up nicely this year, its small stock cousin, the Russell 2000, is almost 2x better.  Also, the U.S. has clearly been the place to invest in 2018.  The MSCI All-Country-World-Index is only up 1.92% and the MSCI Emerging Markets index is down 5.66%.  The Barclay’s Aggregate Global Bond Index is down 1.41%, and gold is down 4.11%.

We continue to believe the period recently passed, where passive investment vehicles outperformed their active peers, will prove to be the anomaly.  We have written in the past about the problems with ETFs  https://cppinvest.com/problems-etfs-part-ii-junk-trunk/.  The return performance laid out above also frames the issue with passive investing.

We started out this piece saying one doesn’t need to own FAANG to outperform.  The table below is two media stocks.  One (NFLX) is a media darling that everyone talks about and the other (WWE) is an old-world media company that no one talks about.  The latter quietly executes relentlessly well.  We own the latter.  You don’t need to own FAANG to outperform.  As the bull market matures, stock picking and asset allocation become all-the-more important.