Small-cap value stocks are risky but they also historically produce jaw-dropping gains at the begining of bull markets, Mark Hulbert writes in the New York Times. Referencing academic research performed by professors Eugene Fama (University of Chicago) and Kenneth French (Dartmouth), Hulbert writes that small-cap value stocks (stocks with the lowest price/book ratios) “gained 17.1 percent, on average, in the first three months following the 13 market bottoms since 1969, equivalent to an annualized rate of 88 percent.”
We’ve started to see some signs of improvement in Validea’s value-based models as well, with our Piotroski, Dreman, Neff, and Graham models
Jeff Mortimer, chief investment officer of Charles Schwab’s mutual fund division, tells Fortune that the coming turnaround in the stock market will be a big one, and that investors should be building their positions now. Mortimer says that 47 percent of bull market gains usually come in the first 12 months, before many investors have summoned the courage to dive back into the market. Be aware that he doesn’t think we’re out of the woods yet — his estimate is that the “rough sledding” could continue for three to nine months — but his point is that the market will rebound before we’re feeling great about the economy. “Equity markets will have moved significantly higher before we read that the recession is over in the papers,” he told Fortune, which also digs through Schwab’s Equity Ratings system to find some of its top stock picks right now.
Warren Buffett stated in his recent New York Times Op-Ed that he had begun buying U.S. stocks for his personal portfolio, in which he previously held only Treasuries. Does that make him a market timer of sorts?
Morningstar’s John Coumarianos offers some interesting thoughts on that question, focusing his answer on the difference between value investors, like Buffett, and market timers or traders.
Value investors, like Mr. Buffett and others, look at investing as buying a piece of business, Coumarianos notes. These investors “think like a business owner and aim to purchase ownership units in businesses for less than those businesses are worth” and the timing element comes into play when you see a business trade below what you think the company is intrinsically worth. Conversely, a market-timer doesn’t care what the company does, what it is worth, what the fundamentals look like or anything else. They are really interested in the “psychology of market participants and what kind of supply-demand pressure that will create in the short-term than on the value of underlying businesses.” In the end, both strategies have a timing piece to them but the actual buy and sell decisions are based on a completely different set of criteria and understanding this difference is important to one’s overall investment approach.
A sign of how tough the market has been this year: Through November 24, every long stock fund tracked by Morningstar — that’s right, every single long stock fund — had lost ground in 2008. That includes 10,085 U.S. funds (which, on average, had lost 44.47 percent) and 2,912 international funds (which had lost an average of 51.01 percent).
The best U.S. performer: Embarcadero Alternative Strategies, which was down 1.55 percent. That was far better than the best international performer, Prasad Growth, which was down “only” 11.21 percent. (Click here for full list of fund returns.)
There were, of course, stock funds that had made money this year, but all were bear funds that used major short positions.
Jeremy Grantham, one of the few who saw the current credit crisis coming, provides some thoughtful comments on the crisis, asset bubbles, the stock market’s current valuation and how individual investors might consider looking at the equity markets right now. Speaking with Consuelo Mack on WealthTrack, Grantham (co-founder and chairman of GMO LLC), who has been bearish on the stock market for some time, says that for the first time in over two decades stocks look “reasonably cheap”. He also believes that going forward investors will favor large, blue chip companies over riskier types of stocks. But, while Grantham thinks stocks are attractively priced, he advises those investors with large cash balances to scale their way back into the market because in his estimation the market could easily see further losses should the current slowdown turn into a deep, prolonged recession.
Grantham also discusses two key challenges facing investors. One is known as the “curse of the value manager”. Essentially, he says, value managers are paid to buy cheap assets (and so they hang onto or add to their holdings in times like these when the market is falling), but they are also paid to unload expensive assets (and so they sell during periods like the late 1990s when stocks look expensive but may keep rising for a bit). The other is “regret minimization”, which involves the tension between buying too soon (and thus realizing shorter-term losses) and buying too late (and thus missing out on a significant rally). Grantham says he balances between these two tensions by scaling into the cheapest areas of the market to try and minimize this type of regret.
In Kiplinger’s Discovering Value column, Whitney Tilson and John Heins say there are two silver linings that have emerged from the market turmoil. The first is that the unprecedented market volatility might be the signal of a stock market bottom, and once that bottom is reached the market could generate some impressive gains. The second positive is that the downturn in the market has created some excellent long-term buying opportunities, and the columnists/money managers like larger caps like Berkshire Hathaway, McDonald’s, Wal-Mart and small/mid caps that have been hit by lowered earnings expectations and hedge fund selling.
Tilson and Heins conclude by giving an example from Mohnish Pabrai’s Dhandho Investor. Their point is a simple one, but one that is often forgot by investors. They explain that is there is a different between “uncertainty and risk” and just “because a company’s future is highly uncertain doesn’t mean an investment in it is risky. Some of the best potential investments are highly uncertain but have little risk of permanent capital loss”.
Warren Buffett tells Fox Business that he expects American job losses will continue to mount well into next year, and that unemployment will be well above the 6-6.5% range by mid-2009. “It’ll be considerably higher. … I wish it weren’t the case, but there is no way to change a negative feedback cycle like we’re in now in a month or two months.” Echoing the long-term optimism he showed in his much discussed Oct. 17 New York Times Op-Ed piece, however, Buffett says that “it will happen eventually and we will go on to new heights,” adding, “I’m not worried about five years from now.”
Buffett also offers some interesting takes on critics who have been pointing to Berkshire’s big drop this year, as well as those who say he acted too soon in the firm’s big Goldman Sachs investment.
Add a new piece of evidence to the notion that most active fund managers fail to beat their benchmark indices over the long haul: According to recently released data from Standard & Poor’s, over the five years ending June 2008, the S&P 500 outperformed 68.6% of actively managed large cap funds; the S&P MidCap 400 outperformed 75.9% of mid-cap funds; and the S&P SmallCap 600 outperformed 77.8% of small cap funds.
The data comes from S&P’s mid-year 2008 S&P Indices Versus Active Funds (SPIVA) Scorecard, which examines more than 3,500 unique fund portfolios, and, importantly, adjusts for survivorship; that is, it includes in its calculations those funds that did not make it through the full tracking period, something such examinations sometimes overlook.
The current SPIVA report has been enhanced and has broader asset class coverage, according to S&P. To see past SPIVA reports, click here.
No one beats the market all the time — not even the best investors in history — and this difficult bear market has been a perfect example. Yahoo Tech Ticker’s Aaron Task reports that many investors with exceptional long-term track records have (along with just about everyone else) been hit hard. A look at some top money managers’ year-to-date performances:
* Warren Buffett (Berkshire Hathaway): -43%
* Ken Heebner (CMG Focus Fund) -56%
* Harry Lange (Fidelity Magellan): -59%
* Bill Miller (Legg Mason Value Trust) -50%
* Ken Griffin (Citadel): -44%
* Carl Icahn (Icahn Enterprises): -81%
* T. Boone Pickens: Down $2 billion since July
* Kirk Kerkorian: Down $693 million on his Ford shares alone
Investment author Jon Markman says in his Nov. 19 “Trader’s Advantage” newsletter that the losses Warren Buffett and Berkshire Hathaway have recently incurred because of the plummeting market may be only the start of their problems. “If you want to talk about problems that are not fully discounted by the market yet, let me just throw one bombshell out there. … What if Berkshire Hathaway, the most respected insurance company in the world, were to suffer a large loss on derivatives, much like American International Group did?” Markman, a former financial reporter and columnist who wrote for the L.A. Times, CNBC, and MSN Money, asks.
“The details are a little fuzzy,” he continues, “so I need to do some more research, but it’s beginning to look like BRK chief Warren Buffett might have made a wrong-way directional bet on a long-term advance in the U.S. and foreign stock markets last year that could end up costing his firm a ton — as much as $20 billion by one estimate. His play, called “naked puts” in the trade, may have tangled up Goldman Sachs as well, which could be one reason that the two stocks are plunging in tandem this week like skydivers caught in each others’ nets. A derivatives loss of more than $10 billion, if it were to occur, would not sink Berkshire, but it would certainly tarnish Buffett’s reputation and, as a result, would result in a cut of the super-premium valuation that investors put on the company.”