Primary Financial
Weekly Market Update provided through Vantage Advisors
Jan. 25, 2016
The Market’s Wild Ride – Digging Through the Rubble
For those who enjoy rollercoaster rides, participating in the global equity and commodity markets recently has given investors some real thrills. We have written extensively on the thrills and chills of the market – the fundamental drivers of downside movements and the potential sustainability of these drivers. Items driving the markets include:
• Worries about collapsing oil prices – the socio/political and economic risks which come with this type of move
• Worries that China’s economic growth rate is declining more than many believe (and the fact that nobody can tell what exactly is happening within China’s economy)
• The Fed has started raising interest rates – if and when they continue their rate increase march, how quickly will it unfold
And finally, the real worry that seems to be driving prices downward, is if the world is entering an economic recessionary period.
If we stay out of recession, which is our current view, are there asset class investments which make sense now that prices have been discounted over the last few weeks? The purpose of today’s piece is to outline the current stock market environment and come up with some fresh thoughts.
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What’s Happening
Below are recent price returns of various capital markets – over various periods of time.
|
? Last Week |
Year to Date (as of 1/22/2016) |
Trailing 12 Months |
S&P 500 Index |
+1.41% |
-6.71% |
-7.57% |
EAFE Index (foreign stocks) |
-2.92% |
-11.56% |
-14.69% |
Brent Crude Oil Prices |
+11.26% |
-13.63% |
-33.63% |
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What the data above doesn’t show is the incredible daily price volatility most markets experienced so far this year. As an example, from the first of the year to the "intra-day" low reached on Jan. 20, 2016, the S&P 500 index declined by 11.3 percent! The three-day rally ending on Jan. 22, 2016 retraced almost half of that decline.
But the real tell of the tale is what the market has done since the highs reached on May 22,
2015. To the intra-day low reached last week, the market had corrected by 14.7 percent from its all-time highs. So, as an investor, if you believe your portfolio hasn’t done well over the last year, the severe downturn in the main equity markets may be one of the culprits.
Will this downward thrust in pricing end? Of course…it always does eventually. Most severe bear stock markets occur prior to, and during, an economic recession. According to our friends at Ned Davis Research (NDR), bear markets which accompany an economic recession (seven recessions dating from 1968 to 2008) show an average decline in stock prices of 29.7 percent. These are true bear markets – and markets which investors need to sidestep as much as practicable.
Current economic evidence suggests, that while the possibility of the United States slipping into recession is higher than normal, our "base case" is still calling for a rather lethargic positive economic growth environment. At this time, we don’t believe the U.S. economy is going to slip into recession within the next 12 months.
So, with that being said, it makes sense for investors to view drawdowns as we have witnessed so far this year as opportunities to move capital towards markets, rather than away from markets. The question is – which way to turn? Let’s dig through the recent market rubble and offer a suggestion.
Value Oriented U.S. Stock Exposure – Earnings Momentum a Key
One can think of the structure of the U.S. equity market as companies whose stocks are primarily value-oriented opportunities or growth-oriented opportunities. One group of opportunities tend to outperform the other over long periods, but over very long periods, the two tend to perform pretty much in line with each other.
It has long been our impression that one of the primary macro-drivers of equity style preference has been earnings (economic) momentum. In the type of environment which the world has faced over the last number of years (slow growth), growth is scarce and investors tend to "pay up" for growth stories. As can clearly be seen from the chart below, the Russell 1000 growth index has handily
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outperformed the Russell 1000 value index on balance since 2007 (top clip). That is the story of how and when growth companies’ stocks have outperformed value stocks and visa-versa.
The bottom clip of this chart depicts the expected earnings acceleration rate for S&P 500 operating earnings, expressed as either earnings deceleration or acceleration. When earnings growth is accelerating, value investing has tended to handily outperform growth strategies!
Copyright 2016 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/.
Growth Has Outperformed Massively- Time for a Turn?
Next, it is instructive to understand the degree of underperformance of value to growth styles over the last 15 years, on balance. We would like you to focus your attention on the bottom clip of the chart below. This chart shows the MSCI Value Index (red line) movement since 1975. The dotted line in the lower clip is the relative strength of the Value Index to the MSCI Growth Index. A couple of observations are appropriate. Most of us know value has underperformed growth for quite some time – this chart suggests underperformance started in the 2006-2007 time frame (see bottom clip of chart) and has continued to date.
But it is also very instructive to understand the cumulative underperformance (relative strength) is at the same low level last seen in the year 2000! What did the value style do relative to growth from
2000 to 2007? It outperformed by more than 2700 basis points.
Copyright 2016 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/.
Can we see a market correction of 15 - 20 percent this year? Of course. But since the yield curve is positively sloped, if we see this type of correction, our best guess is it will prove to be short-term in nature (the average bear the market has experienced during a period when the yield curve is positively sloped is less than half the duration and 50 percent less vicious as when yield curves are negatively sloped).
Last, it is good to know from a construction standpoint why value has underperformed growth. If one takes a peek at the construction of the value index as compared to the growth index, one will find the two top weighted sectors in the growth index are technology and consumer discretion. These two sectors make up a whopping 48 percent of that index. Over the last two years, these two sectors have provided
a return of 20.2 percent. The two most heavily weighted sectors in the value index are finance and
energy. These sectors comprise 43 percent of the value index. These two value sectors have provided an average return of -11 percent over the last two years. So it is easy to understand that energy and finance stock performance have driven the underperformance of the value-to-growth scenario.
A Driver for Outperformance
Consequently, oil prices are a major driver of outperformance of the value style of investment. Now, let’s talk about investor sentiment towards oil prices.
We don’t know where oil prices are going, but we do know investor sentiment is currently at 20 percent bullish (see chart below, the bottom clip). As can be seen from the red line, investor sentiment is even
lower today than it was during another low in 2002. How have oil prices responded in the past when investor sentiment towards crude has been this low?
|
Period of Severe Sentiment Recovery |
Oil Price Change During Recovery |
|
Sept. 2003 – Aug. 2005 |
+135.1% |
|
Dec. 2008 – Apr. 2011 |
+260.9% |
|
Jun. 2012 – May 2014 |
+32.2% |
|
Feb. 2015 – Jun. 2015 |
+25.1% |
|
Average Price Change |
+113.3% |
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Copyright 2016 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/.
As can be seen from the data above, historically when investor sentiment towards crude oil prices becomes this bearish (below 30 percent bullish) oil prices rally upwards, foiling the attitude towards crude. Now, this time around, the picture may indeed be different. But we’ve found over the years that "this time it’s different" are words many investors eventually regret uttering. So the main, real driver of value underperformance to growth over the last two years on an economic sector standpoint (oil and energy companies) may indeed see a brighter day in 2016 than was the case in 2015.
Let’s sum it up. Value investing tends to outperform during times of accelerating earnings growth rates. We suggest we may indeed see that occur in 2016, as compared to growth rates in 2015. The degree of underperformance of value relative to growth is as deep as it was in the year 2000, following which value outperformed growth by a whopping 2700 basis points over a multi-year period. Lastly, the oil sector -
the villain of recent value underperformance - may indeed see better days in 2016 as compared to last year.
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Vantage Investment Advisors,LLC www.vantageadvisors.com
Weekly Commentary Page 6
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Stage May Be Setting
As we work our way through the growth scare which the market is currently experiencing, eventually value oriented investment strategies will be positioned to outperform growth strategies. If you are interested in taking advantage of the downward shift in stock prices which has occurred over the last few months, but are unwilling to directly buy oil and commodity exposure, investing in value oriented strategies may be the way to go.
We will be back next week.
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