What Is A 'Stock Picker's Market,' And Are We In One Now?

The stock market is going great guns, with the S&P 500 having gained roughly 14 percent in the year-to-date period. The major indexes are hitting fresh highs session after session, with earnings proving to be the most recent catalyst.

Even as the overwhelming sentiment is exuberance, there have been discussions about whether the current market offers an opportunity for stock pickers.

What's A Stock Picker's Market?

To understand what a stock picker's market stands for, an understanding of dispersion is essential. A market is well dispersed when stocks do not move in unison but instead head in different directions.

Dispersion in a market is said to be low when all stocks move in tandem.

Low dispersion is seen as a function of stimulative central bank policy that keeps volatility in check, wariness among investors following the financial crisis and the rise in prominence of passive index-based investing.

A well-dispersed market is often referred to as a stock picker's market, which is characterized by low and stable multiples.

Active fund managers, who conscientiously do the homework in picking stocks that have the potential to beat the market indices are at an advantage in a stock picker's market.

A passive fund simply tracks the performance of an index, whereas an active fund includes holdings cherry-picked by an individual or a team of stock pickers.

See also: Being Penny-wise: All You Need to Know About Penny Stocks

Are We In A Stock Picker's Market Right Now?

Correlation among stocks has currently hit a post-financial crisis low, according to an article on CNBC, quoting data from DataTrek Research. This offers an opportunity to spot price variances and pick stocks that outperform popular indices such as the S&P 500 Index and the Dow Jones Industrial Average 2 Minute.

The 11 S&P sectoral classes are showing only a 41 percent correlation with the broader index, according to DataTrek. The correlation dwindles to 37 percent, if technology stocks, which are highly correlated with the major averages were excluded.

The CNBC report also pointed out that the number was close to a perfect 100 at one point in time.

According to SPIVA Statistics, as of June 30, 2017, about 44 percent of the large-cap funds outperformed the S&P 500 Index over the past year compared to about 18 percent over the past three years as well as past five years.

"While passive strategies clearly have had the upper hand from 2009-2016, historically there has been a clear cyclicality in the leadership between the two," the FT reported, quoting Andrew Folsom, a senior investment analyst at Wells Fargo.

"We could be in the early stages of an ‘active versus passive' regime change."

The SPIVA report also showed that 52.5 percent of all funds outperformed their benchmarks over the 12 months ended June 30, 2017, a notable improvement over the previous ten years, when less than 15 percent outperformed.

Implications For Investors

Passive investors, who prefer to go along with the flow, have this argument in their favor. Over the long term, passive funds generate more returns than active funds, especially with respect to widely followed large-cap stocks, which have less pricing inefficiencies for a stock picker to exploit.

"Your probabilities of success with an active manager are better in high-yield bonds than government bonds, in emerging markets rather than developed, and in small-cap equities rather than large cap," MarketWatch said, quoting Steve Lipper, a senior investment strategist at Royce & Associates LP.

"Because there are more small companies and less analyst coverage of them, managers can more easily find values there than they would be able to in the large-cap space."

Meanwhile, some attach very little significance to the stock picker's market. Even in a stock picker's market, one cannot be assured of superlative returns all the time, according to Forbes contributor Rick Ferri. One can end up with a bounty only he/she is lucky enough to choose a winning fund. There is an equal probability of losing all the investment dollars, if he isn't fortunate enough.

Whether it is active or passive investing, it all boils down to one's predisposition toward risk and return. For risk-averse investors, passive investment options such as ETFs could be a safer bet. Active investment suit the brave hearted, who are willing to assume disproportionate risk in the lookout for that one alpha opportunity.

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