In my last post we took a brief trip down memory lane to the wild-and-crazy 1990s, watching as semi-intelligent (“gromentum”) investors got their clocks cleaned when gromentum stocks collapsed in 2000-2002. We took that detour because I suggested that there is much to learn from that era today.
Ah, you are saying, how can this be? Who, today, is paying 100X earnings for companies?(1) Who is paying infinite multiples of P/Es?(2) Who is buying based on “eyeballs?”(3)
But these caveats miss the point. The point isn’t the absolute level of equity pricing today versus 1999, the point is the level of pricing versus prevailing economic conditions. In the 1990s, as I mentioned earlier, a constellation of happy events created an environment in which stock prices should have been high: the collapse of the USSR, the spread of free market ideas, the Cinderella economy, the advent of the Internet. True, crazed gromentum investors drove prices far beyond reason, but at least the underlying economic and geopolitical conditions were good.
Compare the “tens.”(4) The US economy is stumbling along at @ 2% annual growth, and that’s the best record in the entire developed world. China is crashing and taking the global economy down with it. Economic demand is so dismal that oil remains well under $35/barrel. And in this environment we have … a six-year Bull Market?
No, what we have a is a Fed/ECB/BOJ/BOE-fueled liquidity Bull Market that is completely disconnected from the underlying economies those banks are supposed to be caring about. So while it’s true that stock prices today aren’t as high as they were in the late 90s, they are astronomically high relative to prevailing global economic reality. (And if we look at prices through the longer-term lens of Shiller P/Es, prices at the end of 2015 were higher than at any time other than 2000 and 1929. Just saying.)
As everybody knows, thanks to Fama and French, over the long term value stocks outperform growth stocks, and with far less volatility. This means that investors who own value grow their wealth even faster than the return differential would suggest, due to the phenomenon of variance drain.(5) But during Gromentum Fever the opposite happens.
One of my Greycourt partners, Greg Friedman,(6) recently took a look at the relative outperformance of growth stocks versus value stocks since the Financial Crisis. What he found was exactly the opposite outcome: growth outperformed value every year, and by a cumulative excess return of about 1,000 basis points. This is a multi-Standard Deviation event that is going to unwind in a very ugly way, central bankers or no central bankers.
But in the meantime an amazing thing happens in such a manipulated market – semi-intelligent investors outperform intelligent investors. As Romain Hatchuel recently pointed out, anybody who invested 60% of their assets in the Vanguard S&P 500 Index Fund and 40% in bonds “would have outperformed the hedge fund index, the top five Ivy League endowments, BlackRock’s Global Allocation Fund, and Vanguard’s Wellington Fund since February 2009.”(7) Why? Because whenever a stock market goes up higher and faster than it should, gromentum investors shine. It doesn’t matter whether the price escalation is caused by greed (1990s) or central bankers (tens), the result is the same.
However, Gromentum Fever always proves to be terminal, and that diagnosis – that gromentum investors are about to buy the farm – is hard upon us, as is suggested by a raft of data points:
* Many of the best managers on the planet have grown tired of their carping investors and have given back outside capital to focus on managing only their own wealth.
* In 2015 retail investors pulled $207 billion out of active managers and put $414 billion into index funds. During gromentum Bull Markets, the easiest way to be a semi-intelligent investor is to buy a capitalization-weighted index fund.
* The US equity market has become so narrow that the only thing left that’s worth owning, even for semi-intelligent investors, is the “Nifty Nine” stocks: Facebook, Amazon, Netflix, Google, Microsoft, Salesforce, Priceline, Ebay, Starbucks. As noted by John Authors in the Financial Times, “Such a ‘narrowing’ of the market is a classic symptom of a lengthy rally – this one has lasted almost uninterrupted since 2009 – that is coming to an end.”(8)
* A team led by Elroy Dimson (Cambridge University and London Business School) concluded that a balanced equity-bond portfolio would return only 2% to 2.5% going forward. AQR’s similar study came up with 2.4%.
* When I launched this series of posts on the dangers of gromentum investing, back on December 9, I couldn’t have known that the first week of trading in 2016, a mere four weeks later, would be the worst first five trading days in the history of the US stock market (-6.2%). A blogger likes to be prescient, but that’s ridiculous.
But while gromentum investors outperform during irrational Bull Markets, all that outperformance, and more, goes away when prices revert. Gromentum investors got slaughtered in 2000-2002, and they will get slaughtered again in the tens. Semi-intelligent investors have two choices: fire your advisor, double down on gromentum and get poor quick, or switch to value while the switching is good. Intelligent investors, who have been out in the Fed-induced cold, need merely remain patient, which is what intelligent investors do. Just ask Ben Graham.
(1) Actually, Amazon’s P/E is currently @ 500X. Amazon’s market value is greater than the market value of Walmart, Target and Costco combined. Netflix’s P/E is over 400X.
(2) Theranos, e.g., but it’s still private. Private investors are every bit as susceptible to Gromentum Fever as public investors.
(3) Okay, you have me there.
(4) The period between 2000 and 2010 was known amongst us cognoscenti as the “noughties.” Several useful suggestions have been made for the name of the period from 2010 through 2019: the “tenners” (meaning that’s all we have left in our wallets after the Financial Crisis), or the “terrible teens” (alluding to the hard economic times we are enduring).
(5) In other words, because growth stocks are more volatile, they would have to return more than value stocks to grow capital as fast. In fact, they return less.
(6) Greg is Greycourt’s CEO.
(7) Wall Street Journal, 12/18/15, p. A17.
(8) 1/4/16, p. 5.
Next up: Wars of Detainder
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Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.
