Playing Our Game
Published On: September 1, 2017
Written by: Ben Atwater and Matt Malick
Benjamin Graham, the famous value investor, Columbia University professor, author of The Intelligent Investor and mentor to Warren Buffett, wrote “Investing isn’t about beating others at their game. It’s about controlling yourself at your own game.”
Within the Standard and Poor’s 500 large cap stock index in 2017, the stocks with the highest price-to-earnings ratios, the lowest dividend yields, the highest price-to-sales ratios and the most international revenues are dramatically outperforming. Looking at another large cap index, the Russell 1000, the 100 highest yielding stocks are down an average of 7.4% in 2017, while the other 900 stocks in the index are up an average of 8.2%. At least this year, investors are actually punishing companies that return cash to shareholders through dividends.
This is not abnormal though. In extended bull markets, at extremes, performance tends to push toward the irrational. Prices usually go too far in one direction and timing a reversal is impossible. Vanguard founder Jack Bogle said “The idea that a bell rings to signal when to get into or out of the stock market is simply not credible. After nearly fifty years in this business, I don’t know anybody who has done it successfully and consistently. I don’t even know anybody who knows anybody who has.”
Accepting that you cannot time the market doesn’t concede that you cannot understand it. Having perspective helps you wait for things to come your way.
Reinforcing the market performance attribution above is the iShares S&P 500 Growth ETF (IVW), which has returned 15.03% year-to-date versus the iShares S&P 500 Value ETF’s (IVE) return of 3.13%.
But when it comes to performance anomalies in 2017, large cap growth and value are just the tip of the iceberg. This year the iShares S&P 500 ETF (IVV) is up 9.45% while the iShares Core Small-Cap ETF (IJR) is down 1.05%. This is a major divergence that has some investors worried (small cap can be a leading indicator for large cap performance). Others argue that small cap is only down because the dollar is plummeting and the probability of tax reform has dwindled. (Smaller companies often sell their goods in dollars while obtaining their inputs and / or inventories overseas. They also tend to pay higher tax rates than their large cap peers.)
Although few strategists predicted it, the dollar is down some 9.9% this year versus a basket of major currencies. This has led to a surge in emerging market stocks, with the iShares Core MSCI Emerging Markets ETF (IEMG) up 26.93% (about a third of this return is currency translation). Emerging market companies often borrow in dollars and therefore owe less money every day the dollar falls, creating a boon for their businesses.
All the while, U.S. energy stocks (usually a coincident indicator of emerging market stocks) are falling apart. The iShares U.S. Energy EFT (IYE) is down 17.3% this year.
The energy collapse is part of a larger trend, a mammoth decline beginning in July of 2008 that continues now. For most of this time, emerging markets followed the fall in energy and they have only substantially diverged from that relationship this year. As with all investment trends, though, this one is cyclical. Energy rallied forcefully from January 1999 to July 2008 and before that stumbled from September of 1990 to January of 1999. As we write this, it feels like energy stocks will never go up again.
Another odd relationship is between the extremely low unemployment rate and the performance of retail stocks. The unemployment rate fell from 4.7% coming into January to 4.3% as more people found jobs (rising slightly to 4.4% in today’s employment report). These additional workers would traditionally spur retail sales, but the SPDR S&P Retail ETF (XRT) has crashed almost 39% year-to-date. The default explanation is Amazon, but one has to wonder if something more isn’t happening, like healthcare and education costs crowding out middle class spending.
The final oddity we will point to is the yield on the 10-year Treasury, which was almost unanimously expected to rise in 2017. It started the year at 2.45% and has since fallen to 2.138%. So much for higher interest rates, yet again.
Even the Pink Panther would notice that things have gotten out of whack. What to do now? Wait. We come full circle with another investment quote, this one from Warren Buffet’s partner and the Vice Chairman of Berkshire Hathaway, Charlie Munger. “Waiting helps you as an investor and a lot of people just can’t stand to wait. If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.”
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