“History doesn’t repeat itself, but it often rhymes.”
– Mark Twain
What exactly is the best, or at least the most well-known, barometer of U.S. Large Company equity performance? The answer: Despite its many faults (more about those in a moment), most people who routinely traffic in such things would point to the S&P 500 Index. So, with the S&P currently hovering at or near bear market levels (a decline of 20% or more from the Index peak), the breathless anchors at CNBC and elsewhere would have us believe that the sky is falling in Chicken Little fashion. OK, the 2022 sledding has been a bit rough, and the reasons, e.g., inflation, rising interest rates, are not to be taken lightly. But, the math behind the S&P 500 suggests that the Index isn’t always the best indicator of what’s going on out there. In fact, there is another Large Company stock market in 2022, and so far the sky over that stock market has not been falling. Some background…
The S&P 500 Index above all else is a price momentum index in the sense that stock-price trends tend to persist and, because the S&P is capitalization-weighted, the weightings of the S&P’s best performers tend to become larger and larger as those trends persist. So much so that, from time to time, a very small number of stocks can account for an ultra-large portion of total Index performance. Late last year, for example, Apple, Alphabet, and three or four other Growth/ Technology favorites continually were accounting for 20-25% of Index performance. Therefore, as more and more dollars flowed into these favorite few, they kept on truckin’, and the S&P 500 Index appeared to be in great shape even as most S&P 500 stocks already had peaked and had started hitting the skids. So, anyone focusing solely on the Index ended up with a muddled picture of just what the U.S. Large Company equity market is and how that market in fact was performing. We’ve seen this movie before.
Late-1999/early-2000… yet another Brand New Era, i.e., the Internet era, is upon us. In that era, however, the caution-to-the wind crowd wasn’t dabbling in cryptocurrencies, NFTs, and electric vehicle start-ups in someone’s garage. Instead – and the business models in many cases were a source of unintended comedy – anything having to do with the Internet was being bid up to ever-
higher prices, and a lot of the euphoria spilled over into the then-Growth/Technology stocks of the S&P 500 Index. As their prices were bid higher and higher, valuations went up and up, and this ever-narrowing list of late-90s/early-00s market favorites accounted for a strikingly disproportionate share of total Index performance. That’s what we in the business refer to as an unsustainable situation, and the many, many excesses were bound to be wrung out at some point. And, wrung out they were. Growth/Technology and the Index Growth/Technology was supporting finally broke in November 2000, and the next few years were tough for the S&P as the Index, which had been driven to unsustainable heights by a mere handful of stocks (in momentum fashion), struggled to get back on track.
But, what about the other market, i.e., the unloved, mispriced, forgotten Nottinghill stocks of that earlier era? Ah, that’s where the story gets interesting. Our flagship equity strategy during those years was the 20-stock Value Plus approach, many of whose stocks may have been proud members of the S&P 500 Index, but not of the Index’s Growth/Technology sector. Oh, our clients partied all right (1997-1999…19.66% per year, net-of-the-management fee), but they sure didn’t party like the S&P 500 Index (27.56% per year).
Then, of course, the music stopped, however, our portfolios were devoid of the Growth/ Technology stocks that had kept the Index elevated. The Value Plus stocks were the stocks of that other market. Over the next three years, as those late-90s Growth/Technology excesses were wrung out of the S&P 500 Index, the Value Plus strategy came in at -4.43% per year, also net-of- fee, versus -14.55% for the Index. (Not that we ever are completely satisfied with a negative number, but an oft-stated belief around here is that the only thing better than good relative performance in a down market is a 20% year.) By the way, the above 1997-1999 and 2000-2002 comparisons are associated with the Value Plus portfolio composite, and are included in a number of Independent Accountants’ Reports from that era. In other words, we kept score as usual, but then somebody else reviewed our work.
Please believe us, our purpose in providing these comparisons is not to show how brilliant we were in that long-ago period. (Also, please keep in mind that, for a number of reasons, e.g., the S&P’s more growth-oriented character versus the value-oriented character of our work, the S&P 500 Index was not then and is not now our benchmark.) The purpose instead is to illustrate that one Index’s bear market is not necessarily that of another and to show the clear advantages of not being in the storm’s epicenter as the stock market’s excesses are wrung out, often viciously wrung out.
So, where does that leave us? The favorite few of the Growth/Technology world have stumbled badly this year, and the S&P 500 Index is hovering near a bear market-like decline of 20%. Meanwhile, the buy/sell disciplines that we hold near-and-dear, i.e., a focus on stocks that are cheap in terms of corporate earnings, dividends, and corporate assets have ensured good portfolio representation in that other market. The time period, of course, is ridiculously short, and getting the economy back on track ultimately may lead to some pain down the road for all stocks. But, the stocks of that other market kept us largely above the fray in 2000-2002, and so far anyway are serving us well this time. It pays to stay away from the storm’s epicenter: the place where the prior period’s excesses are being wrung out. We know because we’ve seen this movie before.
*************
The overall messages above are not unlike those of last year’s “Déjà Vu All Over Again?” (June 7, 2021). In this Perspective, however, we discuss how the ever-narrowing Growth/Technology leadership mentioned in “Déjà Vu…” essentially has hijacked the Index, as that leadership had done in the period from 1997 until mid-2000. The result in both cases: a stock market in seemingly good shape when in fact the market’s overall health was deteriorating. The aftermath in both cases: a market seemingly in really bad shape when in fact a whole range of stocks was/is hanging in there pretty well. Go figure.