Investors tend to focus on the near term—basically six months ahead; but such short time frames tend to make investors miss the forest for the trees.
As we explain below, winners historically haven’t persisted indefinitely, losers usually haven’t failed forever, and reversion to the mean is a powerful, fundamental concept that underpins our long-term investment strategy.
A 20-YEAR LOOK, BY DECADE
Currently, popular investment strategy suggests that “winning” is all about the US and secular growth tech stocks. Is that likely to remain the case?
Have a look at the charts below. The one on the left shows the annualized returns by major stock index for the past decade, and the one on the right shows the same information for the prior decade.
Chart: Annualized Returns by Major Index
Source: Bloomberg and CornerCap
Are the winners the same by decade? Quite the opposite:
- Region: The US has been the top region to invest in for the current decade (represented here by the S&P 500 and Large Growth US indices) but was the worst in the prior one. In contrast, Emerging Markets have been the worst currently but were #1 in the prior period.
- Size: Large stocks have been the winners for the past ten years (measured here by the S&P 500, a blend of Growth and Value), ahead of small stocks by 1% annualized, yet small stocks thumped large stocks dramatically in the prior decade by a full 5% annualized.
- Style: Growth stocks have been king for the current decade (measured here by Large Growth US index) but were the dogs of the prior ten years. In contrast, the value style (Large Value US index) was dominant then, while lagging now. Comparing the difference in performance, growth beat value by an annualized 3% in the past decade but lost by 4% in the prior one.
A clear pattern emerges. No one group stayed on top indefinitely. First usually went to worst, and worst went to first. This held true across geographic region, stock size, and investment style. We call this “reversion to the mean,” and it is a key principle to which we adhere in our investment strategy.
In our view, to succeed, investors must be willing to exit (or at least reduce exposure to) the clear winners and position themselves for the (inevitable?) rebound in areas that are currently out of favor. This is the concept of “value investing” at its core.
IT ISN’T THAT EASY THOUGH
The challenge, of course, is predicting when the winners and losers change trajectories. It’s difficult to do that accurately. Our approach is to measure extremes unemotionally, which we do through our Fundametrics® research system. It requires patience and willingness to go against the grain. It means “being there” before the rebound happens.
WHAT OUR RESEARCH TELLS US NOW
- Investors are currently defaulting to the US and Growth sectors, especially tech. These stocks have very high expectations based on the narratives being put forward by and about them, and they are overpriced in our view. The average tech winner trades at 67-times earnings, and as high as 179-times; several of the top performers have NO POSITIVE EARNINGS forecasted. We recommend avoiding such stocks. When we buy tech stocks like semiconductor manufacturers, we look for more reasonable valuations with meaningful growth outlooks based on a range of data-based factors—not speculative narratives.
- In the Growth vs. Value style spectrum, we are now at the extremes we last saw in the dot-com bubble 19 years ago. To us, now as then, the best opportunity lies where investors least expect it. Our portfolio strategy is currently more weighted to the Value opportunity, based on our research into what we call “value spreads.”
- We maintain a diversified portfolio for most clients, consistent with their specific investment objectives and risk tolerances. That means that we have exposure to various regions, sizes, and even styles. We look to rebalance actively away from winners and toward those groups that are out of favor.
So, what do we think will be the top performer in ten years? Will it be today’s clear winners? You can probably tell our answer.
Past performance is no guarantee of future results, and all investments are subject to risk of loss.