In the last 12 months, the stock market has enjoyed one of its greatest-ever rises; the FTSE 100 is 2500 points higher than its low point on March 3 2009. However, it is not just the size of the rise in the market that's notable. There have been two other curious features of the rally.
First, it's been a great time for stock-pickers, because shares' returns have been positively skewed. For example, in the 12 months to March 15, 60 out of 102 stocks in the FTSE 100 rose by more than the index's 44.8 per cent. Such outperformance is unusual.
What's more, many more FTSE 100 stocks have done exceptionally well than have done exceptionally badly. Across the 102 stocks in the index, the standard deviation of price changes in the 12 months to March 15 was 68.6 percentage points. However, only one stock (Resolution) did one standard deviation worse than the median stock (Experian), whilst 12 stocks did one standard deviation better. Ten stocks did half a standard deviation worse than the median, whilst 29 did half a standard deviation better.
This means that if you had picked stocks at random 12 months ago, there was a better than evens chance that would would have beaten the market. Take, for example, the 10th worst stock in the index - United Utilities. It rose 17.1 per cent in the year to March 15, under-performing the index by 27.7 percentage points. However, the 10th best stock - Anglo American - rose 139.8 per cent, beating the index by over 90 perce ntage points.
A stock-picker with an unbalanced portfolio and only average luck would therefore have out-performed the index handsomely; a random picker had an equal chance of picking United Utilities or Anglo American a year ago.
A second odd thing about this recovery is that high-beta stocks have done even better than one would expect. For example, in the five years to March 2009, Barclays had a beta with respect to the All-share (based on monthly returns) of 1.7. You'd therefore have expected it to rise by 79.2 per cent, given the All-share's 46.6 per cent rise in the year to March 15. In fact, it rose 372.9 per cent. This is not an isolated example. Of the 10 highest-beta stocks in March 2009, nine subsequently did better than their beta predicted; the exception was Lonmin, which rose just 59.5 per cent. On average, these 10 rose 200 per cent - that is, they tripled in price - compared to the 97.4 per cent gain predicted by their betas.
There might be a common theme linking these two curiosities - and indeed, the sheer scale of the rise in the market. The connection is disaster risk. A year ago stocks such as Barclays, Prudential or Vedanta were carrying not just market risk (the danger they'd fall a lot if the market fell), but disaster risk too - the danger that they'd be almost wiped out by a financial cataclysm. They were priced lowly to reflect this danger. As the danger of catastrophe has receded, so these stocks have gained a double boost - once from disaster risk being priced out, and again from the ordinary beta effect.
Because the FTSE 100 has a disproportionate number of stocks which carried some disaster risk - banks, resources stocks and highly-geared firms - so a disproportionate number have done well in the last 12 months.
If this theory is right, it could have a slightly unpleasant implication for stock-pickers. With disaster risk now largely priced out, the potential for many stocks to significantly beat the index is a lot less. That suggests that stock-picker s might find the going tougher in the next few months.
Written by: Chris Dillow
