Has the bull market erased bargains?
I was listening to an investing podcast the other day and heard an interesting conversation. The guest pointed out that during the internet bubble of 1999, there were a significantly higher number of bargains than there is today. The guest further lamented that in the current environment, the bargains aren’t as widely available as they were back then.
This is an important point. As discussed in my previous post, growth has trumped value for some time now, which is a historical aberration. The disconnect will certainly end, but it’s difficult to say when and how it will happen.
The resolution in the early 2000s of the value-growth disconnect was the ideal situation. The broader market entered a tailspin for nearly three years, but value experienced a significant bull market at the same time, seemingly disconnected from the carnage that took place in large cap stocks.
This is obviously how I would like to see the current situation shake out, but I suspect that the value bull market of the early 2000s was due primarily to the number of bargain stocks that were available because everyone was fixated over the likes of Qualcomm, Cisco, Amazon, Redhat, etc.
I decided to take a look at the data for myself. I looked at the number of earnings bargains available in 1999 and compared them to today, as well as a few other points in time in recent market history. The universe of stocks I looked at was the S&P 1500. The data is below.
Bargain Availability Through the Years
Bargains were available in 1999, but certainly not to the extent that existed during the financial crisis. In 1999, there were 102 stocks with an earnings yield over 10%. As a group, they returned 18.10% in 1999. The number rose to 171 in 2000, and the return was 32.47% for that year. This occurred while the S&P 500 experienced a decline of 10%.
By 2005, the number of stocks yielding over 10% shrunk to 50 and the group returned 8.26% that year, slightly below the S&P 500’s return of 11% that year.
Obviously, the greatest moment in history to buy value stocks was early 2009. At the beginning of 2009, there were 474 stocks (nearly 1/3 of the universe) with an earnings yield over 10%. As a group, they returned 62.78% throughout 2009.
The number of bargains shrunk to 158 in 2012. The population shrunk as we emerged from the financial crisis, but bargains were still more plentiful than they were in the 1999-2008 period. As a group, they returned 10.26% in 2012 and 50.96% in 2013.
Today, the number has shrunk to 64. This is lower than 1999, but it hardly seems as if bargain stocks are no longer available. They are still out there, they are still behaviorally difficult to buy, and this suggests to me that the value premium will remain alive and well. However, I think that the low availability makes it unlikely to value’s resurgence will play out like it did in the early 2000s.
That ’70s Stock Market
The key question is how all of this will play out. History suggests that bigger populations of bargain stocks bode well for future returns. It’s not an iron clad rule that you could plug a formula into, but that’s the general trend.
This suggests that value is limited but not eliminated in today’s market. It also seems unlikely that we will experience a resurgence of value as incredible as that of the early 2000s when value experienced a bull market while the broader market declined.
I would like to believe that this will occur again, but I doubt we will be that lucky.
I think a more likely scenario for the next shakeout will be something more like the 1970s. The late ’60s and early ’70s was one of those times (like the late ’90s and today) where growth trumped value and the S&P 500 soared.
In the early ’70s and late ’90s, everyone preached buy and hold while it worked and few practiced it once times became tough. In all of these eras, popular sentiment was that value investing was dead and that everyone who wasn’t buying sexy growth names was a relic of the past who just didn’t understand how magical the new era was, paying 50 times earnings makes sense because . . . Copy machines/dial-up-internet/smart phones/blockchain, it’s a new era, markets are so efficient and competitive these days, blah blah blah.
When the shakeout went down in the ’70s, value stocks fell with the broader market. They didn’t experience a bull market like they did in the early 2000s.
For a good look at value returns during this period, I took a look at this analysis of the simple Ben Graham strategy over at Alpha Architect. I also thought a good record to examine were the annual returns of Walter Schloss, whose strategy focused on low price-to-book names. Below is a snapshot of the 1970s from the perspective of the S&P, Walter Schloss and the systematic low P/E low debt Ben Graham strategy.
As you can see, in the 1970s, value delivered the highest returns, but the road was bumpy. Unlike the early 2000s, value didn’t go up while the broader market declined. Value stocks went down with everything else.
During the 1973-74 bear market, Walter Schloss held up better than both the broader market and the systematic Ben Graham approach (a variation of which I’m following with my portfolio). I suspect that Walter Schloss’ decent performance in the recession of 1973-74 is due to his zero exposure to the Nifty Fifty and I also suspect that he held a significant amount of cash.
Walter Schloss was a classic Graham investor focused on asset value. If the bargains weren’t available, he didn’t buy them. This allowed him to experience only single digit losses during the 1973-1974 period.
The systematic Ben Graham strategy didn’t hold up as well, but I think that’s likely because it was fully invested while Walter Schloss was not.
I don’t know what the future holds, but I do know that buying expensive hyped up stocks is dangerous, regardless of how seductive it looks in the throes of a late bull market. Value will outperform growth and the broader market over time, but the road will be rocky and require patience. In investing, I think patience and discipline are more important than any other characteristic, including intelligence.
While I would love to see a repeat of the early 2000s value bull market, I don’t think we will be that lucky. Due to the fewer bargains available today than were available in the 1999-2000 period, I think a repeat of the 1970s is more likely, which was painful at times, but ultimately rewarding to those who had the patience to stick with a value approach and the discipline to avoid the sexy glamour stocks.
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