[The above appeared on the window of a Bookshop, “Bookends of Fowey” in Cornwall]. We don’t often do market commentaries in this blog, but after the biggest January gain for 32 years, it might be useful to look at what drove asset markets to such giddy heights, whereby nearly ALL asset classes went berserk. Once one pores over the fine print regarding performance, some interesting pictures emerge. The first is the economic backdrop, which does not appear overly helpful. Interest rate markets imply no more rate hikes, as the US economy appears to be slowing substantially, potentially taking the global economy with it.
Factor Based Investing
As our clients are well aware, EBI uses “Factors” within our portfolios to “tilt” our holdings towards those areas that exhibit a premium over and above that of the market for exposure to various specific characteristics. All portfolios have a tilt towards Small Cap and Value shares, but for the World Portfolios, we also employ Momentum, via iShares and Vanguard managed ETFs. It begs the question as to why we don’t use more “Factors”, which we shall attempt to address here.As the chart below describes, the growth of Factor Investing has been enormous, quadrupling in the last 6 years, as US investor interest has mushroomed.
The last year of the US stock market has seen some wild swings, but one thing has remained constant – Growth has continued to outperform Value, especially in the US, but Globally too. We are still no closer to seeing Value recover its poise and in USD terms, it has now lagged by c. 3.7% per year over the last decade. So, the “Value premium” has become the value discount, or so it seems. More recently, things have taken a turn for the bizarre; I came across this Bloomberg screenshot (from the Macro Tourist website), which shows the Factor returns over the last year from US markets, whereby the overall return is a function of the average return of the top Quintile performance minus the bottom Quintile (or top fifth of the sample versus the bottom fifth). The conclusions are rather depressing;
Value investing at its core is the marriage of a contrarian streak and a calculator. Seth Klarman- Hedge Fund Value Investor. We touched on this subject at the end of April, but thought it might be a good idea to look at the subject of present and future value discounting in more detail. Last week the Bank of England raised interest rates by 0.25% to 0.75%; although Mortgage rates moved at the speed of light, (I got an e-mail from HSBC telling me that my mortgage was going up 2 and a half hours later!), it appears that savings rates will be moving at a more sedate (or glacial) pace. Many of the newer UK house buyers have not seen a rate rise at all (as we have been stuck at or below 0.5% since 2009), and the effect on consumer spending and confidence is unclear.
“Better a diamond with a flaw than a pebble without.” ― Confucius We return once again to the subject of Value (last discussed c.18 months ago). In truth, not much has changed, except that the chart below now shows an underperformance of Value vis-a-vis Growth of c.4% per annum annualised compared to 2.73% over the period shown in the December 2016 blog post. This has left many (including ourselves) in a quandary. Nearly all of the arguments advanced in the previous blog are still valid (if not more so!), but it has not, aside from a brief 6-month recovery in the second half of 2016, amounted to much; if anything, Growth has recovered with renewed vigour in the last 3 months.
Entia non sunt multiplicanda praeter necessitatem.No more things should be presumed to exist than are absolutely necessary. (Occam’s Razor). One of the defining trends of recent years has been the rise of ETF’s /Index funds which have taken hold over the course of the period post the Financial Crisis. There have been a proliferation of “Factors”, or possibilities of Alpha generation, many of which turn out to be either useless (i.e. they never worked) or redundant (they don’t now). This study suggests that there have been 59 new Factors “discovered ” between 2010 and 2012 alone!
Ever since the “discovery of Fama and French’s 3 Factor Model to explain asset price returns, Investors have been seeking to modify and refine this methodology (as apparently 90% explanatory power was not enough!) In 2014, they added Profitability and Investment return but strangely remained silent about the phenomenon of Low Risk (i.e. Volatility) shares outperforming and the documented (since 1993, Jegadeesh and Titman) evidence supporting the inclusion of Momentum as an investment “Factor”. Some Hedge Funds have a whole raft of Momentum funds available, and it is now possible to buy these in ETF form, as both Ishares and Vanguard have launched product…
“I remember the ….. period as if it were yesterday (unlike yesterday itself)” – Albert Edwards, Soc Gen Strategist. It has been said that all one needs for bull market success is a long position and a short memory. It appears that despite the evidence of the sometimes disastrous attempts at merging two companies Corporate Executives still engage in pointless, expensive and economically dangerous acquisitions which seem to be motivated as much by ego as logic. So we come to the latest- Standard Life and Aberdeen announced this week that they will “merge”to form a new company (called “Staberdeen” by some wags).
“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one… Truth, when discovered, comes upon most of us like an intruder, and meets the intruder’s welcome… Nations, like individuals, cannot become desperate gamblers with impunity” Charles MacKay, Extraordinary Popular Delusions and The Madness of Crowds, 1841 Since the victory of Donald Trump, (equity) markets have been on a tear: there appears to be nothing to stop them, as optimism abounds. But there are some strange reminders of a past era, one that didn’t end well for Investors. Will history repeat – does it have to?