The big money doubted Apple this year. Oops.
"It's been a really confusing year," Kim Forrest, an analyst at Fort Pitt Capital Group Inc., which oversees about $1.7 billion in Pittsburgh, said in a phone interview. "There have just been a handful of stocks that drove the market and Apple was obviously one of them. It's been tough."
Aversion to the iPhone maker is turning out to be one of the worst blunders in 2014 for money managers, who are trailing benchmark indexes by the most in almost a decade. Shares of the world's largest company rose four times more than the Standard & Poor's 500 Index as Chief Executive Officer Tim Cook's product plans eased concern over the company's future growth.
Investors who clung to winners from the first five years of the bull market, from Internet companies to small caps, got burned in the sixth as chipmakers, utilities and dividend shares rallied. In many ways, 2014 was the year of the hated stock. One of the best things you could've done was own companies with the highest short interest and the lowest analyst rankings, according to data compiled by Bloomberg. Such a strategy would have steered you to Exelon and Micron Technology, with average gains of 26 percent since January.
Going against the grain now would lead you to buy energy shares, the industry whose 2014 loss is triple the next worst- performing group in the S&P 500. That's what Bill Nygren is doing after his $6.7 billion Oakmark Select Fund beat 97 percent of its peers this year. Nygren bought Apache Corp., a Houston- based oil producer, during the energy selloff as crude went from $107 a barrel to $58 in the past six months.
"Unloved companies tend to be the most interesting hunting ground for future outperformance," Nygren, based in Chicago, said by phone. "The reason that Intel and Microsoft were able to do so well is that they were so unpopular."
Like their colleagues in the bond market, many equity managers entered the year believing economic growth would pick up and interest rates rise. They avoided defensive stocks such as power generators and loaded up on retailers and other industries that benefit when Americans spend money on nonessential goods.
Instead of rising, yields on 10-year Treasury notes fell to 2.08 percent from 2.88 percent a year earlier, as central banks from Europe and Japan boosted monetary stimulus in a bid to spur growth. That fueled a surge of at least 20 percent in utilities and REITs, two groups whose dividends are among the highest. Consumer discretionary shares rose half as fast as the rest of the market.
Along with Cupertino, California-based Apple, Intel in Santa Clara, California and Redmond, Washington-based Microsoft, account for 22 percent of the S&P 500's 154- point advance so far this year after rallying an average of 34 percent. None was a consensus pick of money mangers, according to data compiled by Goldman Sachs.
As a consequence, eight of 10 funds focusing on large growth stocks are trailing their benchmark, the second-highest proportion since 2004, data compiled by Chicago-based Morningstar Inc. show. About 87 percent of funds that purchase the biggest value shares gained less than their benchmark measure, as did almost 90 percent of the mid-cap funds.
"I never thought I'd get that many basis points out of Apple and Microsoft," said Bob Doll, manager of the Nuveen Large Cap Growth Fund that counts the two stocks as the top holdings and is up 12 percent this year. "What a shame for someone who said they really like it but then underweight it."
At various points in 2014, the year was shaping up as the hardest in a decade to find stocks that generated alpha, the fund-industry term for gains above the market's return. During the 12 months through September, only 30 percent of companies in the S&P 1500 posted gains that exceeded the large-cap gauge, the fewest since 1999, data compiled by Leuthold Group LLC show.
Compounding the challenge, 2013 proved a poor blueprint for 2014. Apple rose 5.4 percent last year, its second-worst return in a decade, while Amazon.com Inc. rose 59 percent and Twitter Inc. more than doubled after going public. Those two are down 23 percent and 42 percent in 2014.
The Dow Jones Internet Composite Index, which soared 54 percent in 2013 and 417 percent in the first five years of the bull market, is little changed this year. The Russell 2000 Index of smaller companies, up 37 percent last year and 236 percent since March 2009, has fallen in 2014.
Chipmakers are up 31 percent, the most among the 24 industries in the S&P 500, as investors anticipate a pickup in technology spending.
"Everything needs semiconductors to run on and you need high-tech nuts and bolts," Michelle Clayman, chief investment officer at New Amsterdam Partners in New York, which manages $1.6 billion, said by phone. "A lot of the new techs have been based on dazzling concepts and promises. It's really hard to figure out who are going to be winners."
Most professional investors decided Apple euphoria was wearing thin after the shares trailed the market in 2013 by the most in 13 years. As Cook unveiled plans to update core products and introduce a mobile payment system and smartwatch, Apple shares surged, beating the S&P 500 by the most for any largest American company since Microsoft's 49 percent outperformance during the Internet boom a decade ago.
"An active manager has to be able to justify the fee beyond the fee an index fund provides," Marshall Front, chief investment officer and chairman of Chicago-based Front Barnett Associates LLC, said by phone. "If they're underweight Apple, it may indicate they're fearful there will be a hiccup in the stock and it'll have a disproportionate impact on the fund's performance. So they keep the weights to the market or below to keep diversification."
Among some 278 funds that are benchmarked to the S&P 500 and have at least $500 million in assets, only a fifth hold Apple shares more than their representation in the index, according to latest regulatory filings compiled by Bloomberg. These funds have returned an average 8 percent this year, compared with 6.1 percent from those that have no stake.
Shares of Intel and Microsoft were trading at a discount to historic valuations at the start of the year as concern grew that a consumer shift toward mobile devices would hurt their businesses in personal computers. Intel shares were valued at about 14.1 times earnings in January, a 38 percent discount to the 20-year average. Microsoft had a multiple of 13.5, compared with a historic mean of 28.1.
Demand for PCs fared better than forecast and the shares rallied. Worldwide shipments fell 1.7 percent in the third quarter, IDC Corp. said in October, a smaller decline than the 4.1 percent drop that the market researcher had predicted.
Albert Nicholas's $3.1 billion Nicholas Fund was aided by gains from Microsoft, rising 12 percent this year. The fund avoided energy shares, an industry that posted the market's second-biggest gain by climbing 12 percent from January through June and then tumbled 25 percent for the worst losses.
"Momentum trades are going to open you up to more downside risk," Nicholas, who has run the fund since 1969, said by phone. "You're going to have to be a good stock picker, which is always true but is even more important today, since in a general sense we're in a high market."