September 2013: Where Are The Bargains Now?

Posted by on Sep 23, 2013 in MFA Insights

As we write this, the US Stock Market appears to be on fire, with the S&P 500 gaining over 20%1 year to date and over 60% in the past 3 years!  During much of the four year plus stock market recovery since the lows of March 2009, money continued to flow out of stocks and into bonds despite the recovery taking place.  That sentiment has suddenly reversed in 2013 with positive flows into equity mutual funds and ETFs.  The “risk on” sentiment has provided price support for the broader equity market and helped to create a receptive market for a host of IPOs, most recently announced – Twitter.  When you look at recent returns, do you find yourself wondering why we even bother investing outside the US? 

Our approach to money management is tilted toward value investing on which Benjamin Graham literally wrote the book.  The first edition of The Intelligent Investor was published in 1934.  Graham described “Mr. Market” as indeed a strange counterparty – usually rational but subject to bouts of financial bi-polar disorder.  Most days the market will trade with you on a fair and rational basis.  But sometimes he shows up in a manic mood, overpaying for stock.  Other times he is depressed and doesn’t want to buy stock no matter how low the price.  One of Professor Graham’s core principles was that the market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap).  The intelligent investor is a realist who sells to optimists and buys from pessimists.  Our rebalancing discipline results in that “sell high, buy low” behavior.

On average US Stock prices can no longer be described as cheap.  Price earnings ratios are back above the historic norms, about 16 times today versus an average of 14 times earnings depending on the measurements used.  European stocks 2 have not risen as quickly and as a result are 30% cheaper when compared with their earnings.

There are no ‘do-overs’ in investing.  Once an investment has performed, we don’t get to request a prior year’s lower price.  We are rewarded for accepting in advance the uncertainty (the risk) of being wrong. 

The table3 on the following page attempts to stretch out our perception of return to 3 year increments. The first version of the chart shows the trailing 3 year cumulative percentage returns for indexes representing the three primary stock sectors around the globe:

We know what happened over the past three years.  As the table above shows, the US (Green) won that race, hands down.  Viewing the same series of three year returns, sorted by the highest returning sector to lowest, paints a different picture.  As you can see below, other (Non US) sectors have outpaced the US in most remaining three year periods (6 out of 8) over the last 24 years. 

By remaining diversified in the Red (Developed International, Non US) and Blue (Developing/Emerging, Non US), we are buying low somewhere, even if we are not sure at the time exactly which sector is cheapest.  Which color will be on top 3 years from now?  In all likelihood we expect it will be something that seems out of favor and cheap today.

We look forward to discussing your investments or touching base on other topics that affect your financial well being.

1 Cumulative 1 and 3 year returns for periods ending Sept 13, 2013.  Source Envestnet/Tamarac Inc.

2 Source Bloomberg online, Inyoung Hwang & Namitha Jagadeesh, August 12, 2013 online: “ European Stocks are Cheaper Than During Last Recovery”

3 Source CRSP data base, Returns Program Dimensional Funds.  Chart of three year periods of total returns from 1989 through 2013.  Returns are for unmanaged indexes. You cannot invest directly in indexes.  No guarantee of future results.