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2020 was an exceptional year for expensive stocks!
A fascinating research piece produced by GMO (managers of $60 billion +) highlighted that in 2020, value stocks returned their worst 12-month performance in history. What’s more, the spread between value stocks and the market is at a historical gap.
The pain for value investors does not stop there. It has been a terrible 14-year run for value stocks. It’s the worst period ever.
Interestingly, a report produced by Man shows that stocks with nosebleed valuations still lag the market over time. By a lot.
Here’s the chart:
As Man points out, the biggest companies in the S&P 500 are trading at near historically expensive levels. Can those valuations be justified?
Possibly in a few cases. But not for most.
The median stock among the high rent district of over-priced shares under-performs the market by 65% over five years. Due to some big winners, the average performance is 28% over the same 60 months.
If you’re not in the right big winners, then you risk falling behind severely.
However, value is just one factor to consider.
Limiting oneself to one factor seems somewhat, well, limiting.
If value falters in a given year, then there goes your year. Meanwhile, other strategies perform just fine, indeed.
There were plenty of other factors to be used, in conjunction with value, to boost returns in 2020.
We believe this will continue to be the case in future years.
At Active Alts, we consider value, but also earnings quality and momentum, among other factors. An asset can be cheap but in a death spiral toward implosion. The use of other factors helps filter this out.
One is momentum. Strong buying power in positive trends reinforces the move higher. While value can be a death trap, the trend can be your friend.
There were plenty of quality stocks priced right in positive trends in 2020. Not only that, the risk/reward ratios were fantastic.
That is Active Alt’s wheelhouse.
Based on decades of experience, these situations present themselves in virtually any market environment.
Active Alts operates two strategies to navigate through all market conditions.
The long-only, Active Alts Focused Momentum Strategy was up 79.60% in 2020. What’s more, 2020’s performance was achieved with an average exposure of 74.87%.
In the fourth quarter, the strategy turned in a performance of 22.16%, with an average exposure of 55.09%.
Quality, momentum, value, and risk/reward. Those are the factors, when combined into one cohesive approach, are the engine that powers the Active Alts Focused Momentum Strategy.
The Active Alts Long / Short finished 2020 up 25.91%
That same GMO report, published December 8, 2020, is decidedly bullish on the long /short space in the future. The historical spread between value and the market is likely to revert to the mean.
This bodes well for tactical stock pickers.
Want to know more about the Active Alts Focused Momentum Strategy and the Active Alts SentmenTrader Long / Short Strategy?
As the market climbs higher, investors are borrowing more and more on margin to pad their gains.
Greed is in full force.
Take a look at this chart, courtesy of Advisor Perspectives, that shows investor credit balances since 1995.
Negative balances are not yet to new highs, but they are close and surging.
In the past, there have been peaks in negative balances right before a significant ass-kicking in the market. That is why we watch sentiment so closely.
First, the period of February 2000 shows a peak. Then stocks imploded. Second, a peak formed in June 2007. Then a butt-kicking ensued. Third, the mother of all peaks formed in May of 2018. By Christmas, the markets were a massacre. Lastly, just before COVID hit, negative balances were creeping up again.
So, here we are near new highs in both the markets and margin. The risk is that as investors unwind these positions when they flinch, the market plummets faster and harder.
A swift decline will create significant opportunities to snap up great stocks at low risk.
We saw this opportunity in early 2020. The Active Alts SentimenTrader Long / Short strategy was positioned conservatively heading into 2020, jumped into stocks near the lows and rode that trend for the rest of the year.
Back in the 1990s, if you were in Economics 101 at university and suggested that interest rates would be zero or negative (particularly when there was full employment), you would have received a big, fat “F” on your report card.
That’s where we are.
As the chart from Bloomberg shows, global debt yielding negative rates has exploded. The chart just as quickly could be the stock price of the latest money-losing, cash-burning, initial public offering.
It is out of control.
Of course, the trend is your friend until the end when it bends. This trend could continue. Negative rates could indeed be the new normal.
However, when markets move this far from normalcy, they are vulnerable to nasty corrections. Typically, people are surprised. We know from the current market sentiment that the masses are leaning in a historically bullish direction.
The market could push up rates. Rates could go up for reasons we don’t even expect. Firstly, we could have a currency crisis. It does not even have to be a key currency. Back in 1997 and 1998, the Asian Crisis started with the Thai Bhat. Secondly, it could be war. Recent times have been relatively peaceful. A significant conflict could cause disruption. Thirdly, a new U.S. administration and its policies could throw a wrench in the works and disrupt the credit markets.
Low rates have pushed stocks up to new highs.
New highs do not mean more risk. Again though, we are not in normal times.
Low interest rates have distorted the markets.
Going back a century, the cyclically adjusted earnings yield on stocks sits around where it was before two brutal market crashes.
Is this time different?
It also means that the margin of safety is razor-thin right here right now. We are only a few months from the COVID lows, but we are a long way from the markets’ lower risk position back then.
The Active Alts SentimenTrader Master Key was defensive going into 2020. Then, near the lows, it turned very bullish. It’s not signaling something historic.
The Master Key unlocks the mystery of how to position yourself in the market. The Master Key has been developed based on decades of experience as well as world-class research from SentimenTrader.
The stock market remains on fire. We have been bullish on the market at times this year. Especially during the major low after the COVID fallout and a couple of other times when stocks became too oversold.
The more this rally runs though, the riskier it gets. We are now in full pause mode.
One of the most worrisome factors is the quality of the rally recently.
The less profit a company makes and the more cash it burns, the better is does.
Take a look at this chart:
Stocks losing money and burning cash are up over 40% year to date. Meanwhile, profitable, cash generating companies are under-performing the Russell 3000 benchmark.
We know from our own testing that while maoney losing, cash burning companies can have periods of big runs, it’s not a sustainable are of the market for investment.
The trend is also concerning when looking at new offerings.
The ratio of IPOs with negative versus positive income is exploding. The current situation blows away the Internet Bubble.
A low quality rally.
Money-losing IPOs on fire.
Market sentiment through the roof.
Bears completely in hibernation.
Valuations are pricey.
While the trend higher can certainly continue, we are more and more skeptical that these gains will be sustained. When these factors swing back the other way, the losses are likely to be very ugly.
Want to protect your capital or even profit when these market factors swing back around? Give Brad a call to discuss how to position your portfolio based on his proprietary research developed over decades.