In recent times, the likes of Disney, Twitter and Hess Corporation are overweight relative to their industry medians while the likes of Citi and General Motors are underweight. What’s most interesting in the short-term window spanning November 2021 till January is that, in nearly every case, while the champions’ ratios are dwindling, the median ratios are rising slightly or holding steady. This suggests a strong diversification move.

In some cases, the ratios are egregiously high: Disney is at nearly 70 relative an industry median of around 24 while Tesla is 166 when the industry median is around 17. In an interesting bit of forecasting, Goldman Sachs’ strategists had predicted that the S&P 500 will likely net about 9% in gains for 2022. Given the diversification being seen, it can only be assumed that a net reallocation of capital from overweight stocks in each industry classification to those considered underweight is underway.

Note: The terms “underweight” and “overweight” are being used relative to industry median. There are plenty of arguments to suggest that even industry averages and medians are too high. On a practical basis, however, it should be assumed that no stock will come to rest anywhere close to ideal ratio efficiency any time soon. In other words, while ratios can be expected to be optimistic in the forward-looking horizon, it will be less unrealistic. Ratios of 70 and 166 simply lend more volatility to the stock trajectory, which cannot be assumed to remain eternally upward.

In Conclusion

The multidimensional “ratio cool-off” seen in recent times and the possible reallocation of capital highlights the possibility that market players have begun adopting a paradigm that is long overdue. Overvaluation leads to stock volatility that impacts the stability of long-term portfolio management. But it bears noting that the decay wouldn’t be a smooth one precisely because of overvaluation: any seemingly meaningful news about top-line stock results in short-term “bump” or “drop” followed by a correction. Nonetheless, as a whole, trends in apparent capital reallocation and ratio decay in this overvalued market would likely continue over the year.

On the tactical front, it is entirely possible for European investors to make plays without diminishing their existing holdings to take advantage of any short-term trajectory in top-line stocks in both directions. A variety of single-stock exchange-traded products (ETPs) built on top of leading “high-conviction” stocks that are seeing this decay are available across European exchanges and brokers to make a play on the downturns. A number of ETPs based on leading ETFs are also available. With new tools in the arsenal, it is now possible for traders to benefit from short-term trajectories while keeping intact their holdings in high-conviction stocks – if they choose to.