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The Perils of Consensus Investing: Key Takeaways

By Mohit Oberoi, CFA - Published 9 Months ago. 0 Comment
The Perils of Consensus Investing: Key Takeaways
  • In simple terms, consensus investing is flowing with the wind while non-conventional investing is taking a contrarian approach and also involves identifying overlooked opportunities.
  • Consensus investing can have multiple dimensions. These range from buying Apple’s and Amazon’s to looking at analyst’s consensus price targets before arriving at an investment decision. One can also consider the consensus macro view put forward by leading fund managers.

Consensus investing

Consensus investing is probably the easiest approach to investing. You can go right or wrong, but so would many other investors! Now, consensus investing can have multiple dimensions. On one level, one can have exposure to the most popular stocks. Looking at the US markets, FAANG, or Facebook, Amazon, Apple, Netflix, and Google (now Alphabet) pack has led the market returns over the last few years. The consensus view has broadly been right on investing in FAANG. Investors who did not invest in FAANG most likely missed on a big rally unless of course, they identified something really big. In this case, the consensus view was right FAANG.

Crowded trades

But then, such consensus investing themes often lead to crowded trades. Many times, when these crowded trades reverse, it leads to big pain. The last time we saw something resembling a reversal was in Q4 2018. Spooked by the US-China trade war, investors exited the big tech names especially Apple in the quarter. All said, the consensus view has been generally correct on investing in big tech.

Even in 2020, while US stock markets have tanked, Amazon and Netflix are hitting an all-time high. That again was a consensus view since these companies stand to benefit from the stay at home orders. After avoiding Amazon Prime for long, even I succumbed to my desire for some entertainment and took a subscription this month!

Consensus investing: Key fallacies

Another dimension to consensus investing would be to base the investment decision on a stock’s consensus price target. Now there are many fallacies involved here. Typically, analyst target prices are behind the curve. Analysts target prices are based on earnings estimates that often lag the price action. The metal and mining sector is a perfect example where stock prices run-up before the spike in underlying commodity prices.

In March, not many analysts updated their price targets even as markets crashed. To be fair, nobody had a sense of how severe the pandemic could be. But then, in general consensus price targets should not be the sole data point to make an investment decision. Need more proof? At the beginning of the year, energy stocks represented the highest upside potential among the S&P 500 sub-sectors. I would not dwell much time as everyone knows what happened to energy stocks this year.

Tesla’s example

Tesla is another example of going against the consensus price target. For the last two years, unless Tesla crashed in a short period, it has generally traded above its consensus price target. If you only invest based on consensus price targets, you might never buy Tesla. Just for the record, Tesla is up around 90% for the year. As for its consensus price target, they have increased “after” every spurt in Tesla’s stock price.

Macro-level consensus investing

On a macro level, the consensus view called for a stellar 2018, a crash in 2019, and a flat 2020. Sadly, all three have been squarely wrong. US stock markets closed in the red in 2018 thanks to Trump’s trade war. In 2019, most fund managers were shouting a recession and a market crash. On the contrary, what we had was one of the best years for US stock markets.

As for 2020, almost everybody called for a flat market. To be sure, even I held similar views. But then, 2020 is a black swan event. No one expected a deadly virus that originated from China to lock up millions of people and businesses across the world.

What’s the consensus investing view now?

After the sharp rally in markets, most fund managers are expecting a crash. This includes Jim Rogers, Jeffery Gundlach, Paul Tudor Jones, David Tepper, Stanley Druckenmiller to name a few. HNIs are also sitting on cash expecting markets to fall. Warren Buffett increased his cash position by around $8 billion in the first quarter. While the Oracle of Omaha does not talk of short-term price movements, you can read between the lines.

Would it be correct this time?

Given the macro weakness, US stock markets do look overvalued as the consensus view suggests. But then, with central banks and federal governments globally in a “whatever it takes mode” markets have continued to move higher. I would also place myself in the camp that believes that US stock markets’ risk-reward ratio looks unfavorable at this moment. There are several macro risks that markets are currently ignoring as I explored in a previous article.

Coming back to consensus investing, it is always better to look at the other aspects. After all, if analysts’ consensus price targets were always spot on, investing would have been much easier. A simple excel sort would have told us which stock would give the highest returns. But then investing is not that simple. Isn’t it?



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