Category Archives: Historical Lessons

When It Comes To Growth Or Value, Have Your Cake And Eat It Too

It’s extremely common to hear investment commentators talk about “growth” and “value” as though they are polar opposites. But Validea CEO John Reese says not to buy that false notion.

“When it comes to investing’s great ‘either/or’ – that is, the growth or value debate – you can have your cake and eat it, too,” Reese writes for Canada’s Globe and Mail. “That’s because the great growth versus value debate is, in fact, a false choice. … Confining yourself to either value stocks or growth stocks is only limiting your portfolio’s potential. At certain times, you’ll be able to find more attractive growth-type picks; at other times, the market will be offering more value-type plays. Having a portfolio of growth-focused and value-focused stocks can also help smooth your returns over the long haul, since the two styles take turns leading the market.”

Reese says the “fallacy of the growth-versus-value notion goes even deeper. … That’s because implicit in the debate is the idea that any given stock is either a value stock or a growth stock, and that’s just not true.” He highlights a pair of stocks that currently get approval from the growth strategy he bases on the writings of renowned quantitative investor James O’Shaughnessy — and a separate value strategy he bases on O’Shaughnessy’s writings. One of them: AXA, a Paris-based financial company that’s involved in life insurance, property and casualty insurance, asset management and banking.


Value Portfolio, Meet Big Mo’

Much like a shot of nutrient-rich wheatgrass can add a “power boost” to your morning smoothie, a shot of momentum can add a big boost to your value investing portfolio, Validea CEO John Reese says.

The idea of focusing on hot stocks may make value investors, who tend to find bargain-priced stocks amid the beaten-down members of the market, cringe, Reese writes in his latest for Canada’s Globe and Mail. “But value stocks aren’t always falling. Nor are red-hot stocks always expensive,” he says. “While they are often portrayed as polar opposites, value and momentum are really two separate concepts. Value metrics give you a snapshot of what a stock’s valuation is at a given time, regardless of whether the stock has been rising or falling. You’ll find plenty of cases in which a stock is so cheap that it can get quite hot for an extended period, and still be undervalued.”

Reese says those are the kinds of stocks you want to key on. He discusses the research of quantitative investing guru James O’Shaughnessy, noting that O’Shaughnessy’s rigorous testing of various strategies has shown that the best approaches historically have included both value and momentum variables. He also cites other studies showing that a combination of value and momentum strategies has been very effective not only in the US stock market, but also in global markets for a variety of assets.

“The idea of combining value and momentum in a single stock-picking strategy makes a lot of sense,” Reese writes. “Momentum is a powerful force in investing. We human beings have a tendency to follow the crowd, which means today’s winners tend to keep winning. The problem occurs when the crowd pushes the winners far past fair value – tech stocks of the early 2000s are probably the best example of that. At some point (and there’s no way of telling precisely when), momentum won’t be enough to keep a vastly overvalued stock rising; when that happens, it’s often as though investors realize that the emperor has no clothes – that the stock is worth nowhere near what people have been paying it – and the trend can reverse. Before you know it, all of your gains can be wiped out. When you combine momentum with value, however, you avoid the risk involved with those high-flying, overpriced stocks, while still getting the benefit of the market’s momentum.”

Reese looks at a trio of stocks that currently have both strong momentum and attractively priced shares, and which also get strong interest from his “Guru Strategies,” which are based on the investing approaches of Warren Buffett, O’Shaughnessy, and other highly successful investors. Among the stocks he highlights: JetBlue Airways, which passes his Peter Lynch-based model.

Don’t Get Spooked By Value Stocks

Value stocks may have underperformed growth stocks for several years now, but Validea CEO John Reese says investors would be wise not to pronounce value investing dead anytime soon.

“Given that it’s Halloween season, it seems appropriate that value stocks are starting to stage a comeback in the United States,” Reese writes in his latest column for Canada’s Globe and Mail. “Much like the villain in a scary slasher flick, value stocks have been beaten, battered and, by many, presumed dead. They’ve been losing to growth stocks since mid-2006, marking the longest stretch of imbalance in the growth/value cycle in more than three decades,” according to Credit Suisse.

Reese says that in theory, value investing should in fact “have been killed off a long time ago.” Given the amount of studies that show value investing wins over the long haul, and the length of time that those studies have been fairly well known, the value advantage should by now have been arbitraged away, he says. But, despite value’s recent struggles, that’s not the case. “In fact, even people who invest in value funds don’t take advantage of the premium that value stocks tend to earn,” Reese writes. He offers data showing how value fund investors underperformed the funds in which they invested by a significant margin from 1991 through 2013. “Alleged ‘value investors’ weren’t helping close the gap between value and growth returns – they were actually adding to the gap by ditching their funds and buying hot, expensive picks and letting cheap value stocks get cheaper,” he says. “And lower prices mean better prospective returns for value stocks when the value/growth leadership switches back to value.”

Reese says that sticking to value stocks is difficult, because many of them are the types of stocks that have negative headlines hovering over them. But, he says, that’s why they earn a premium over the long haul, and why the value premium isn’t likely to die. If you stay disciplined and focus on value, history shows you can beat the market over the long term, he says.

Reese looks at a trio of value stocks that his Guru Strategies are high on right now. Included among them: Pilgrim’s Pride, which gets strong interest from his David Dreman-based strategy.


A Disciplined Market-Timing System That Nearly Doubled The Market Over Four-Plus Decades

Trying to time the market often leads to big problems for most investors. But Validea CEO John P. Reese says that, in the hands of a highly disciplined investor, a rules-based market-timing strategy can yield stellar results, as it has for him.

“With market timing, the danger is less about the activity itself and more about how you go about it,” Reese writes in a column for Proactive Advisor magazine. “Many market-timers have little knowledge about how the market moves over time, they jump in and out of stocks or indexes based on what everyone else is doing. Their decisions are based on emotion rather than research or logic — and that usually leads to trouble.”

Reese, on the other hand, developed his timing model after he thoroughly back-tested 16 different market-timing strategies. “The strategy that showed the best results was an asymmetrical timing model,” he says. “On the sell side, the market has to close below certain key technical levels and selling needs to be accelerating, which will show up when a shorter-term moving average crosses below a longer-term moving average. The buy trigger is less stringent –it only requires the market to close above a certain shorter-term technical level. As a result, the strategy has a bias toward being in the market and not selling too quickly.”

Reese’s back testing shows that a disciplined investor who invested $100,000 in the S&P 500 in 1971 and then moved in and out of the market based on the strategy’s signals would have had just over $3.7 million by the end of August 2015, compared to $2.1 million for an investor who bought and held the index.

While the strategy has worked exceptionally well over the long haul, Reese says it can be a difficult one for investors to follow. “Because it waits for a significant uptrend to be confirmed before buying, it may not capture a portion of the gains that occur early in a bull market – and those are often quite strong,” he writes. “In addition, testing shows there is a 60% chance the buy/sell signal will be wrong. The long-term data indicates it is worth it to deal with the head fakes, but seeing consecutive incorrect signals as the market advances higher can be difficult for even the most disciplined investors.”



Market Volatility Could Derail Momentum Stocks

Momentum investors beware — the recent rise in market volatility could make for challenging times for momentum stocks, while quality growth plays could emerge as the market’s new leadership group, according to a report in Barron’s. Momentum investment strategies invest in companies exhibiting strong price momentum, but that momentum may or may not be supported by the underlying fundamentals, which can lead to declines when they fall out of favor. According to Bank of America strategist Savita Subramanian, “momentum stocks traded at a 50% premium to the market before the selloff, versus a historical average premium of 20%”, but once momentum stocks peak in a particular market cycle, they fall, on average, 27%. One indicator investors can look at is the CBOE Volatility index, or VIX, says Subramanian. Once the VIX moves over $25, momentum stocks have tended to underperform the market by a wide margin and it currently hovers just above that level.

So where do investors go when momentum starts to underperform? Growth companies could be one group that starts to take the lead. “When there’s a scarcity of growth in the economy, investors go to names they know can grow on their own,” says Joe Fath, manager of the $45 billion T. Rowe Price Growth Stock fund. Below is a list of some growth companies he thinks may be worthy of consideration.

barrons table

Dalio Sees Significant QE Before Significant Rate Hike

Hedge fund guru Ray Dalio says he expects the Federal Reserve to make a significant quantitative easing move before it makes a significant interest rate hike.

“To be clear, we are not saying that we don’t believe that there will be a tightening before there is an easing,” Dalio writes in a recent post on his LinkedIn page (h/t MarketWatch). “We are saying that we believe that there will be a big easing before a big tightening. We don’t consider a 25-50 basis point tightening to be a big tightening. Rather, it would be tied with the smallest tightening ever.”

Dalio says that the risks of the world being “at or near the end of its long-term debt cycle are significant”. Being at the end of the long-term debt cycle means interest rates around the world are near zero, spreads are low, and debt levels are high, he says, and central banks have a limited ability to ease — all while many people have a dangerous bias to the long side. He says those secular factors should outweigh short term debt and business cycle factors –which the Fed seems to be weighing more heavily — that would typically mean a tightening phase is due.

Despite the very limited ability to ease at this point, he thinks easing is the path the Fed needs to take. “While we don’t know if we have just passed the key turning point, we think that it should now be apparent that the risks of deflationary contractions are increasing relative to the risks of inflationary expansion because of these secular forces,” he writes. “These long-term debt cycle forces are clearly having big effects on China, oil producers, and emerging countries which are overly indebted in dollars and holding a huge amount of dollar assets—at the same time as the world is holding large leveraged long positions.”

Dalio says that, while the Fed has been more focused on short-term business cycles than the long-term debt cycle, it will react to what happens going forward. He seems to think that will mean more quantitative easing before we hit a significant tightening phase, but he also says that he is worried that the Fed will feel that it must stick to its guns and follow through with the tightening it has been discussing.

Nygren: Relax, and Rebalance

Much of the speculation about the reason for the market’s recent plunge has been that investors are downright scared about China’s slowing growth. But top mutual fund manager Bill Nygren says the sort of correction we’ve seen recently is simply a part of life when you are investing in stocks. And from a long-term investing perspective, he does not think China’s slowdown will have as big an impact as many believe.

“I think sometimes we just forget that the market doesn’t really need a reason to have a 10% correction, which we basically had over the past four trading days,” Nygren tells Morningstar. “They occur pretty frequently–about once every year and a half, on average, historically–and they are really nothing for investors to worry about as they are pretty common.”

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As for China, Nygren laid out some interesting numbers regarding its slowdown’s possible impact on the US. “For long-term investors … where we’re trying to estimate the value of a business five to seven years from now, it’s hard to imagine China being important enough to cause a 10% reduction in values,” he explained. He says China accounts for about 16% of world GDP, so a 5% to 10% change in Chinese output would represent a 1% hit to global GDP, and an even smaller impact on US multinational firms. “We’re seeing this as increased opportunity of values falling substantially less than prices,” he says.

Nygren says that, historically, the stock market has been the best investment vehicle, even though there are periodic corrections and bear markets. And, he says, no one has found a way to time those declines. He says investors should use the recent market declines as a chance to rebalance their portfolios. “Over a long period of time, the best way for an individual to make sure that they can sleep at night and get through these tough periods is to have a balanced portfolio and use large moves in the market–either direction–to frequently restore balance to that portfolio,” he says. “If you don’t do that, the market is taking your portfolio out of that balanced position and giving you more risk exposure to a sector that’s already performed well and maybe getting extended. So, I think most investors should take a deep breath, know that equities are good long-term performers, and take a look at their portfolio and see if they can take advantage of it.”

Nygren also talks about the pros and cons of rising interest rates as they pertain to bank stocks, why he is high on some industrial stocks, and why he thinks investors are overreacting to oil price declines, creating opportunities in oil stocks.

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