Beware the Rocky Coast

While I do not consider myself a Twitter addict, I do have Twitter up all day on one of my monitors (of course we all have two monitors, it’s not the 90’s) to get current information and opinions on the financial markets, investing and the economy. I do not follow the people who sit at home and have 5,000 tweets about their cat or sports teams. You know who you are. I have been very selective in who I follow and prefer to read intelligent tweets rather than be prodigious in my own tweeting. Two of the people I follow are Patrick O’Shaughnessy, @millennial_inv and Ben Carlson, @awealthofcs.

Lately, both O’Shaughnessy and Carlson have been discussing the outperformance of growth (expensive, low quality) stocks over value (cheap, high quality) stocks. In a low-growth environment such as we are currently experiencing, investors will pay a premium for companies with revenue and earnings growth. On his web site, Carlson had a graphic which illustrated that any outperformance of growth over value, or value over growth, is typically temporary and can reverse itself at any time.

BLOG PIC 8.21.15









In looking at small-cap U.S. stocks, we see that value outperformed growth in 84% of 19 5-year rolling periods by an average of 4.87%. Yet in one of the rare periods when small-cap growth outperformed, 1995-1999, the difference for growth over value was a substantial 8.6%. This, of course, was the final blow-off of the dot com era. Overall, when small-cap growth outperformed small-cap value, the average margin of victory was 3.82% basis points.

As the length of the investing period increases (from one-year periods to three-, five- and 10-year rolling periods), value stocks tend to register a premium more frequently. Between 1990 and 2012, small-cap value stocks outperformed small-cap growth stocks in 57% of the three-year rolling periods, 84% of the five-year rolling periods and 93% of the 10-year rolling periods. You can see from this evidence how the length of the time period being reviewed affects the performance differential. Year-to-date, for example, small-cap growth (as measured by the Russell 2000 Value and Growth ETFs) has outperformed small-cap value by over 8%, but over the last month that tide has begun to turn, with value beating growth by almost 2.4%.

In Greek mythology, the Sirens were beautiful, yet extremely dangerous women who lured sailors with their music and voices to shipwreck on the rocky coast of their island. Homer’s character Odysseus was curious as to what the Sirens would sing to him, and so, on the advice of the goddess Circe, he had all of his sailors plug their ears with bee’s wax and then tie him to the ship’s mast. He ordered his men to leave him tied tightly to the mast, no matter how much he would beg to be freed. When he heard the beautiful song of the Sirens, he implored the sailors to untie him but they only bound him tighter. When they had passed out of hearing range, Odysseus was released. Others sailing on that same route were not so lucky.

As human beings, we are naturally impatient. The great American philosopher Homer Simpson, in particular, has a difficult time waiting for anything being cooked in the microwave, so has a stash of candy bars hidden in the sofa cushion. This often manifests itself in how we view investing. A year like 2015, which has been “violently flat” with the S&P 500 trading in a narrow range, is particularly difficult to endure. Impatience impairs the decision-making process, and suddenly the Siren Song seems more alluring. Investors are prone to make decisions about the markets based upon short-term moves. Doubt tends to manifest itself when anything in which you are invested underperforms, even in the short-term. You begin to wonder if certain investment philosophies are no longer relevant. We also try to look for patterns in market returns when there often are none.

Stay focused and patient with your investment process. Avoid making decisions based upon short-term movements in the markets. Don’t submit to the Siren Song of the current outperformance of a certain sector. The rocky coast is just waiting there to collect you.