A Turn Toward Value?
In December, 2000, market forecasters did not see 9/11 coming in 2001. Gurus in December, 2019, did not have a pandemic on their radar screen as they opined about 2020. Both examples highlight the fact that prognostication is a dicey business. Yet we strive to look forward.
The S&P 500 stock index hit an all-time high of 3702.25 on 12/08/20. The index is composed of 500 stocks, yet through the third quarter of 2020, 42% of the total return of the index was concentrated in its top five stocks by market capitalizaton─Facebook, Apple, Amazon, Microsoft, Google...companies that benefited from “work from home” mandates related to Covid-19. The Big 5 made an outsized contribution to the YTD total return of the index through September 30 of +5.6%. Without the Big 5, the return was a negative -1.8%.
Growth stocks, like the Top 5, have been in vogue for some time. A growth stock is one that investors anticipate will grow at a rapid rate, potentially outperforming a given market average. Often such companies reinvest earnings to accelerate growth, and dividends are not a factor in investor buying decisions. Over time, speculative behavior tends to drive growth stock prices upward as they sell for ever increasing price/earnings (P/E) multiples. Value stocks are those generally trading at lower P/E multiples, below what they are estimated to be worth. The idea, pioneered by legendary investors such as Benjamin Graham and John Templeton, is to “buy bargains and hold for the long term.”
Are we looking for “a turn toward value” in 2021 or beyond? Eschewing predictions, what we do know is that no market trend lasts forever. Eventually P/E ratios reach ludicrous extremes, and markets adjust to a new reality. Often some unforeseen black swan event like 9/11, a global pandemic, or credit bust, for example, pops speculative bubbles and value assumes leadership for a time. Such trends, growth outperforming value, or value outperforming growth, can last a decade or longer. Observations by James Cullen, CEO of NY-based Schafer/Cullen Capital Management, are useful, potential danger signs.
Currently the top five holdings dominating the S&P 500 index are Alphabet (Google), Apple, Amazon, Facebook, and Netflix. This “concentration currently exceeds the concentration of the Nifty Fifty (1960s) and Tech Bubble (2000) market peaks.” Plus, over the last four years, the public has been coming back into the market in droves, often pursuing index investing via ETFs (exchange traded funds), bolstered by new free trading platforms like Robinhood. As money pours into indexed ETFs, fund managers are forced to buy stocks like the big five, further expanding price/earnings multiples due to increased market demand. “Value” is not part of the buying equation. Passive investing has increased concentrations in the most popular stocks, especially in tech sectors.
Record low interest rates are fueling speculation, and margin debt “has reached all-time highs, much higher than in the early 1970s and the late 1980s.” Opines Cullen, “This combination of new market speculation and extensive margin debt is a dangerous combination.” Cullen also sees a “red hot new issue market” (IPOs) as indicative of speculative froth. On 12/11/2020, the Wall Street Journal headlined above the fold, “Airbnb Stock Price Skyrockets In Market Debut as IPOs Boom.” One market guru proclaimed, “People are just compelled to be invested. Even if you don’t like the valuation of some of these companies, you know they’re likely to keep going up, at least in the short term.” Does that seem like risky behavior to you?
Algorithms are hot, automated computer implemented instructions that sense market movements and trends and trigger buy-sell actions designed to capture upward price movements or hedge risk on the downside. Great theories, until they don’t work. One “all weather fund” triggered a 97% loss for a NY worker’s pension fund in the 3rd quarter, dropping the fund’s value from $330 million to $9 million.
Cullen cites the presidential election cycle as favoring a turn toward value. “History shows that the year after the election has typically been the most challenging for the market, but the best for value.” More than half of the 14 recessions we’ve had in the last 70 years started in the year after a presidential election. Value outperformed growth in all 14 recessions.
Since we have not been fans of market timing as advisors and investors ourselves, nor have we played guessing games, we have always counseled diversification. Portfolios may contains elements of growth, growth at a reasonable price (GARP), value, relative value, etc. All portfolios should be tailored to your risk profile, with adequate safe money reserves so you can ride through market dips. There are risks in every market cycle, as well as pockets of opportunity. A portfolio review should be a top line new year’s resolution!