Here’s a massive insult for investors who have managed to do well at a time of extreme volatility for the S&P 500 and the broader stock market in general. Analyst Adam Parker of Morgan Stanley says they’ve been “acting like cockroaches, reversing course when the winds changed direction in mid-February.”
He explained that cockroaches travel on the wind and then reverse course whenever the wind changes directions.
“Their adaptability has enabled cockroaches to survive nuclear explosions and even function for long periods of time with their heads cut off,” he wrote in his Apr. 4 U.S. Equity Strategy report titled “Do You Wish You Were a Cockroach?” “Most investors want to survive, but prefer to keep their heads on during the process.”
He goes on to say that investors who have done well this year are following “the cockroach mindset” by “reversing course when the winds changed direction in mid-February.” Indeed, these “cockroaches” may have largely avoided the nuclear explosion that happened in February when the S&P 500 was diving.
However, he also notes that the market fundamentals haven’t changed enough to warrant the huge reversal in stock prices, which is an important and good point despite the “cockroach” insult.
Bearish or bullish on the S&P 500?
Parker believes that while the consensus is “structurally bearish,” many investors are “tactically bullish” as it appears that the wind will keep moving positive “for a while.” He added that hedge fund exposure appears to be the main influence on investors right now as they try to figure out when the rally will screech to a halt.
But as the S&P 500 has rallied to close in on its all-time highs, he thinks investors believe the risk-reward profile is better than it was. He disagrees with this view, questioning how investors can believe that volatility will continue and also stay bullish after a rally. He also said the market movements suggest that investors don’t expect to see the February lows again this year, but he believes that a plunge will come much earlier than most expect.
He concludes: “The cockroaches will turn around as soon as the wind blows in the other direction, which is likely to happen in the second quarter. It is hard to forecast what will cause it, but we think it is prudent to expect the S&P 500 will pull back some from today’s levels. We don’t want to be cockroaches, even though that has been the right strategy year-to-date.”
Contrarian views sometimes warranted
You might recall that a short time ago, Adam Parker also suggested that investors just do the opposite of what they think they should do. And then he went on to give suggestions about what he thought investors should do.
While it’s true that his views are running contrarian to the rest of the market, and this is still the case in this latest research report, it seems that this “cockroach mindset” is no anomaly. Investors who generate alpha in the S&P 500 and the rest of the stock market do so by betting on which way the wind is blowing or whether it will keep blowing in that direction. Or even better, by betting that the wind is about to shift directions. But we would argue that money can only be made in the S&P 500 and the stock market by being carried along by the wind. The key though is to shift before the market shifts by predicting its movements, which Parker should get credit for doing if he’s right, cockroach comments aside.
True, in some cases a contrarian view ends up being the predictive one and thus is called for. So Parker is probably correct in his view that the time to be cautious is likely coming very soon because the S&P 500 has returned to near-highs (or “just a few NYC-sized cockroaches from its all-time high,” he wrote). And there’s a lot to be said for investor euphoria which resulted in a massive break from fundamentals as we have seen with several popular stocks over the last couple of years. Indeed, what goes up usually comes down when we’re talking about the stock market, especially if it’s not tied to fundamentals.
At any rate, here are Morgan Stanley’s current recommendations: