“The times they are-a-changin'”
January 21, 2021
Market Summary – 4th Quarter, 2020
“The slow one now will later be fast, the order is rapidly fadin’
And the first one now will later be last, for the times they are-a-changin’.”
– Bob Dylan, 1964
It was with some bemusement that we took in the latest news of Minnesota native, Bob Dylan. During his ascendency in the early 1960s, he was considered a counterculture hero – the rebellious “voice of a generation.” In recent weeks, it was reported that Dylan sold much of his music catalog to a corporation for a reported $300 million. It showed us that Dylan thinks a lot like we do at MPMG, recognizing that it all comes down to price.
Some will look at Dylan’s transaction as a sellout. After all, the new owner of the rights to his material is likely to try to cash in on the investment by licensing the music for commercial and other purposes. It is likely that Dylan had an emotional connection to his music, not unlike the way investors sometimes are reluctant to part ways with a favorite stock. He may have realized that what he owned was a great asset, but he was able to distinguish between his emotional tie and the value that he could generate by selling his music library. Dylan appeared to appreciate that every asset has its price.
The market rotation that’s blowin’ in the wind
2020 was a year where the winds of the market shifted. An 11-year bull market that was driven primarily by pricey growth stocks came to a crashing halt in February and early March. But even pandemic-fueled market declines couldn’t slay those previously red-hot stocks.
The market’s rebound that began in mid-March was again led by the same handful of expensive, mega-cap stocks (Facebook, Amazon, Apple, Alphabet/Google, Microsoft and Netflix). Investors’ renewed interest in these select stocks came at the expense of the rest of the market, particularly value stocks, and extended a sustained performance advantage for the growth side of the market since 2007. By many measures, growth style investing outperformed value style investing by the widest margin in history1. By the end of summer, the environment for value was as bleak as it could be.
Yet beneath the surface were indications that the times, they were-a-changin’. It began to take the shape of a potentially sustainable trend by the end of 2020. Although growth stocks enjoyed a significant advantage over the course of the year, it was a different story from September through December. Led by its best month ever in November, the Russell 1000 Value Index turned the tide in the final four months of the year. Value stocks gained 9.21 percent versus 1.48 percent for growth stocks.
More investors appear to be following Bob Dylan’s lead by realizing that every asset has its price. By some measures, value stocks are cheaper now (relative to growth stocks) than at anytime since 2000. The price/earnings ratio stands at 17x for value stocks versus 34x for the aforementioned six mega-cap stocks2. These valuation comparisons suggest significant upside potential for value stocks, in our opinion. The six mega-cap stocks, along with four other large companies that comprise the top 10 stocks in the S&P 500 Index, now account for more than 27 percent of the total value of the index3.
The risk of excessive valuation? “Lost” periods in the market
Since 2009, with the possible exception of last year’s short-lived bear market, investors may have thought that investing was easy. Simply investing in “the market” was rewarding, because the dominant, household name stocks we’ve already talked about represented a significant part of the indexes and kept going up in price. As the COVID-19 pandemic created an emphasis on work and schooling at home, these same companies were positioned to benefit. In 2020, just three stocks – Apple, Amazon and Microsoft, accounted for more than half of the S&P 500’s 18.4 percent gain. In the meantime, the 470 smallest stocks in the index contributed absolutely nothing to that gain4. This was the case even though most of these business still performed reasonably well, a fact that was basically ignored by investors.
Will investing remain as easy as it’s been for more than a decade? Not likely. Investors who follow the herd by relying on “market returns” risk being set up for disappointment. The markets have endured a number of “dry” stretches in the past nine-plus decades – extended periods of time where returns were non-existent.
These three periods alone represent nearly half of the years in the market going back to 1928. Each lost period was preceded by investor mania for a concentrated group of stocks that drove their prices up to unsustainable levels. Investors who were caught in these market droughts ignored concerns about valuation and paid too much for stocks at the wrong time. Times like these can be damaging to long-term wealth accumulation and put investors in a difficult position.
But not all investors are destined to suffer the same fate. Those who more nimbly navigate the market can find abundant opportunities in tertiary stocks that have not participated in the market’s mania. These stocks, at much more attractive valuations, are less prone to significant downturns that often befall their more popular counterparts.
The difference that price can make
A fear for many investors given the record levels that stocks have reached in the midst of a pandemic-hobbled economy is that stocks may be in for a rough patch. If that’s the case, investing won’t be as easy as in the recent past, but discerning investors can still find opportunities. History shows that value style stocks can offer protection from the risk of temporary downward trends in the market, while also providing significant upside potential.
Consider the recent “lost decade.” From the start of 2000 through 2009, the cumulative total return of the S&P 500 Index was a loss of 9.1 percent. By contrast, the Russell 3000 Value Index gained more than 32.8 percent during this time. This demonstrates how critical it is to pay attention to value at a time when the market is extremely expensive. Longstanding MPMG clients may fondly recall the rewards of savvy stock-picking, patience, and paying the right price for an asset (even while the herd is doing otherwise) during what was a “lost decade” for many.
Navigation, not avoidance
Rather than trying to time when to get in or out of the market, investors should embrace this rotation and navigate their investments within the markets.
2020 marked an unprecedented time for the world. With fear and uncertainty on the rise, there seemed to be strong arguments to get out of the market. Along with the pandemic, we were dealing with an uncertain economy, civil unrest, a heated presidential election and ongoing trade tension with China.
Yet all too often, the idea of taking a break from stocks has generally proven to be a faulty decision for investors. The result can be that jittery investors miss days, weeks or months when markets unexpectedly turn around and generate strong performance.
2020 was a year when investors were particularly susceptible to the hazards of market timing. The impact of the dramatic bull market was stunning for some. If investors tried to time their way in-and-out of a volatile market, they risked missing some significant upside. In fact, the ten best days for the market in the past year occurred in a span of a little over a month, from March 2 until April 8. During that time, daily performance of the S&P 500 varied up-and-down fairly dramatically.
By missing the ten best days from the market’s peak early in 2020 (on February 19) through December 31, an investor not only sacrificed a positive return of 11 percent enjoyed by those who stayed the course, but would have actually suffered a loss of 37 percent.
2020 is a prime example of why timing can be a dangerous game. There was plenty of bad news throughout the year that could have prompted the urge to “sell.” Yet those who kept their cool came out significantly ahead of those who tried to read the tea leaves and time their entry into and exit out of the market.
Investors are better served trying to navigate the opportunities that are always present in the market. That includes capitalizing on what appears to be a potential change in leadership. By avoiding the few popular stocks (or the indexes in which they are overrepresented), which are likely, sooner or later, to face a period of underperformance, investors can position themselves in stocks that are more likely to lead the next market wave. The patient, discerning investor who has the courage to move in a different direction from the crowd stands to be duly rewarded.
Looking back on 2020
The past year is often cited as one that people are anxious to forget. The challenges facing the world were unprecedented in our lifetimes, and yet, somehow, life went on. Here were some of our key observations in our previous newsletters of 2020:
1st Quarter – “Our Finest Hour”
We were in the very early stages of the COVID-19 pandemic, and so much was unknown at the time, but projections were scary. The stock market had already suffered a sudden and dramatic drop. Investors were understandably concerned, but we emphasized our confidence in the combination of scientific ingenuity and technology to help us overcome the coronavirus. Our confidence in the markets was also supported by expectations of unprecedented fiscal and monetary stimulus to stem the tide of the economic consequences of the pandemic. Rather than fear the challenges that lie ahead, we foresaw real opportunity for investors.
2nd Quarter – “The Year That Shattered America”
To many, the unsettled environment of 2020 brought back memories of another historical year – 1968. Like now, that was a time of riots in the street, a divided country, a heated election season and even a health crisis. We noted how headlines, many negative or even frightening, were a distraction for investors. At the same time, it was important to remember that the stock market is a discounting mechanism, less concerned about the headlines of yesterday or today, and more focused on what lies ahead. We again expressed confidence that the economy would benefit from the significant stimulus from both the federal government and the Federal Reserve. This amounted to trillions of dollars, an amount that isn’t easily comprehended, but, quite simply, represents an unprecedented level of liquidity. We tried to make it easier by illustrating the enormity of “trillions” in different terms (i.e., one trillion seconds equals 31,710 years).
3rd Quarter – “…and the Home of the Brave.”
Although stocks had bounced back from a short but wicked bear market in February and March, fear was still a key driver of investor sentiment. We pointed out that there was little reason to dread possible market reactions to risks that were already well telegraphed – these were likely already priced into the market. What tends to knock markets for a loop were “unknown unknowns”, the out-of-the-blue circumstances that catch investors off guard. We noted the fruitlessness of trying to predict when such negative events may occur and the benefits of taking a brave stance by daring to own stocks that were out of favor, but offered real value and upside potential.
A look ahead
The general consensus is that 2021 represents a year of change. That’s obvious on many levels, but a factor we repeatedly cited in 2020 remains consistent – there’s still a lot of stimulus at work, with more likely to come – both monetary and fiscal. This is true not just in the U.S., but worldwide. In the meantime, a large segment of the population can expect to be vaccinated, likely by the 3rd quarter of 2021. Some state of normalcy will return, but more important, flagging morale will be given a boost, which is likely to be reflected in economic activity. A panel of economists recently projected Gross Domestic Product growth of 5% in 20216. That would be the fastest rate of economic growth since 1984. Consumers have spending power and should provide a strong boost to the economy. Business spending will likely follow suit.
We appear to be on the precipice of the next economic upturn. Companies that benefit from it – primarily cyclical names – stand to be rewarded, particularly given many of these investments can be bought for an attractive price. It’s critical to position your portfolio to be a beneficiary of massive stimulus and its potential inflationary impacts and avoid the risks of owning overvalued assets. The times they are-indeed-a-changin’…..but profitable opportunities with manageable risk are abundant. Some things never change.
MPMG featured in The Wall Street Transcript
MPMG is pleased to announce that its portfolio managers were recently selected to be featured in The Wall Street Transcript. Since 1963 The Wall Street Transcript has interviewed the CEOs and senior executives of public companies, Money Managers handling billions of dollars of assets, and Equity Analysts from leading investment banks around the world. In this interview, the portfolio managers discuss MPMG’s investment philosophy, some of the trends that they see shaping the investment landscape, and a historical perspective on the merits of a patient, value-driven investment process. A copy of the full interview will be posted on our website at www.mpmgllc.com.
1Lynch, Katherine, “Value vs. Growth: Widest Performance Gap on Record”. Morningstar, Jan. 11, 2021. Russell 1000 Value Index versus Russell 1000 Growth Index. S&P 500 Value vs S&P 500 Growth.
2Hobson, Mellody and Rogers, John W. Jr., “How To Understand This Crazy Year in Investing – and What to Do Now”, The Wall Street Journal, Dec. 11, 2020.
3S&P 500 Fact Sheet, December 31, 2020.
4Scheid, Brian, “Driven by big tech’s pandemic gains, S&P 500’s 2020 surge masks uneven recovery,” S&P Global Market Intelligence, Jan. 4, 2021.
5Based on S&P 500 Index from 1928-2020. Source: MacroTrends.
6Levisohn, Ben, “The Stock Market’s 2021 Surprise: A Booming Economy and Tepid Returns”, Barron’s, Dec. 20, 2020.
Established in 1995, Minneapolis Portfolio Management Group, LLC actively manages separate accounts for individuals, families, trusts, retirement funds, and institutions. Our proven value-oriented investment philosophy has created long-term wealth for our clients.
Visit our website at: www.MPMGLLC.com
Although the information in this document has been carefully prepared and is believed to be accurate as of the date of publication, it has not been independently verified as to its accuracy or completeness. Information and data included in this document are subject to change based on market and other condition. All prices mentioned above are as of the close of business on the last day of the quarter unless otherwise noted. Market returns discussed in this letter are total returns (including reinvestment of dividends) unless otherwise noted.
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