ActiveValueInvestinginRange Bound/Sideways/Markets

VitaliyN.Katsenelson,CFA y
/directorofresearch/
I M A i I InvestmentManagementAssociates,Inc.
1 CONTRARIANEDGE.COM/IMAUSA.COM/VITALIY@USA.NET/303.796.8333
Weareusedtothinkingaboutsecular(longerthan5years)marketsinbinaryterms:
OR OR
2
Thereisanothertypeoflongtermmarket CowardlyLionorRangeBoundMarkets
or or
burstsofoccasionalbraveryleadtostockappreciation,butareultimately
overrun by fear that leads to a subsequent descent
3
overrunbyfearthatleadstoasubsequentdescent
ActiveValueInvesting:MakingMoneyinRangeBoundMarkets
DowJonesIndustrialAverage1900 2006
Thebearmarketswereactuallyrangeboundmarketsandhappenedthetime
4
CopyrightKevinA.Tuttle2007
4
Sofarmarketshavegonesidewayshellofaride,butstillsideways
DowJonesIndustrialAverage2000 2009
5
SecularBullandRangeBoundMarketCyclesWereNot Causedby:
Economy
or
Economy
Earningsgrowth
Interestrates or Interestrates
Inflation
Valuation
TheyWereCausedby:
6
AsLongAs:InflationRemainedReasonable/DeflationWasAbsent/GDPAnd
EarningsGrowthRemainedPositive MarketWasEitherBullOrRangebound.
7 Note:RealGDPgrowthwasextremelystablethroughoutallsecularmarkets
ThereIsAVeryTightRelationshipBetweenInterestRatesAndP/EsDuring19602006
8
TheRelationshipBetweenInterestRatesandP/EsIsExtremelyWeakBetween1900 1960
9
InterestRatesIrrelevant?
No But well get back to this subject in a couple of slides No,Butwe llgetbacktothissubjectinacoupleofslides
10
Bull,BearandRangeBoundMarketsHappenWhen
Market EconomicGrowth StartingValuation(P/E)
Bull Good(Average) Low
RangeBound Good(Average) High
Bear Bad High
11
StockMarketMath
EarningsGrowth EarningsGrowth
+ +
Price Price
+ +
P/E P/E
Price Price
++
Dividends Dividends
==
TotalReturnfromStock(s) TotalReturnfromStock(s)
OR OR
EarningsGrowth EarningsGrowth
++
P/E P/E
++
Dividends Dividends
==
12
==
TotalReturnfromStock(s) TotalReturnfromStock(s)
WalMartATypicalRangeBoundMarketStock
2001 - 2009
13
SourcesofReturnExample:WalMart
14
SourcesofReturn:SecularBullMarkets
15
BullMarkets:P/EExpansion +EarningsGrowth =SuperReturns
SourcesofReturn:SecularRangeBoundandBearMarkets
16
RangeBoundMarkets:P/EContraction +EarningsGrowth =LowReturns
BearMarkets:P/EContraction +EarningsDecline =NegativeReturns
JapanesebythebookBearMarket Japan
17
BullMarketsStartatBelowAverageandEndAtAboveAverageValuations.
RangeBoundMarketsStartatAboveAverageandEndatBelowAverageValuations.
Today
18
19
BullMarketsStartatBelowAverageandEndAtAboveAverageValuations.
RangeBoundMarketsStartatAboveAverageandEndatBelowAverageValuations.
Today
20
BullMarketsStartatBelowAverageandEndAtAboveAverageValuations.
RangeBoundMarketsStartatAboveAverageandEndatBelowAverageValuations.
Today
21
MarketPsychology
New average
End of Bull Market
P/E +EPS =
New average
expectationsareNOT
met P/Estopped
expanding
R B d M k t
P/E +EPS
0% +6% 6%
ReturnsareNOTnew
average,notaveragebut
belowaverage:
Range Bound Market
P/E + EPS = -6% + 6% 0%
22 22
Interestratesandinflationareveryimportantbuttheytakeasecondseattomarket
psychology.Theyultimatelydeterminethelengthandtheextremesofmarketcycles.
Interest RatesMovefrom
Good/Bad for
P/Es
Reason
Zone1 Zone2 GOOD Movetonormalcy
Zone2 Zone3 BAD Riskofinflation
Zone3 Zone2 GOOD Movetonormalcy
Zone2 Zone1 BAD Riskofdeflation
Ifinterestrates/inflationwere
highersecularrangebound
mayhaveendedsoonerat
highervaluation g
Ifinterestrates/inflationwere
23
/
notthatlowsecularbullmay
haveendedsooneratlower
valuation
StillintheRangeBound/Sideways/Market?
Valuationsarestillhigh(aboveor averageatbest)
Real earningsgrowthwillbelowerinthefutureduetohigherfuture
taxes,higherinterestrates(causedbygovernmentborrowing),consumer
deleveraging rangeboundmarketmaylastlongerthanweexpect.
Highinflationwillshortenrangeboundmarketduration,butfinalP/E
willbeloweraswell.
Ifnominalearningsgrowthdoesntmaterializeinthefuture(3,5,10
years),earningsdecline wearesetforasecularbearmarket
24
ShouldIBeInBondsInstead?
90%OfReturnComesFromAssetAllocations,
TrueOrFalse?
25
BullMarkets:StockDoOutperformBondsHandsDown
26
Throwmoneyatstocks,andyoulldomuchbetterthanbondsorcash.Ingeneral,thefewerdecisionsyou
makethebetteroffyouare(buyandforget).
RangeBoundMarkets:StocksDominanceIsNotSignificant
27
Assetallocationisnotasimportantasstockselection.
90%OfReturnComesFromAssetAllocations,TrueOrFalse?
Bullmarkets True
Range bound markets False Rangeboundmarkets False
Additionalpoint:Fedisprintingmoneyfasterthanyoucanreadthis.Inthelongruninflation
willrise badforbonds.
28
Conclusion:StockSelectionMattersALot!
InvestingasyoudidduringsecularbullmarketwillNOTwork.Youranalysisandstrategy
needstobemodified.
29
BriefSummaryofStrategyandAnalysisforTodaysEnvironment
Bebuyandsellinvestor.Buyandholdisinthecomma(seenextchart).Time
(price)stocksthroughastrictbuyandsellprocess.Buywhenundervaluedsell
whenfairlyvalued.
TimeStocksNotTheMarket:Markettimingisverydifficult.Intheshortrun
emotionsareinthedriverseat.
Dontbuyforthesakeofbeinginvested.Dontlosemoneybymaking
marginaldecisions.Inabsenceofgoodstockstobuy,beincash.Theopportunity
costofcashisnotashighasinthesecularbullmarket.
Increasemarginofsafety:Fewer(better)stockswillbeinyourportfolio.
Favor dividend paying stocks. Dividends were 95% of the return in previous Favordividendpayingstocks.Dividendswere95%ofthereturninprevious
rangeboundmarkets.(warning:dividendsarepartofanalyticalequation,notthe
equation.)
L k i t ith t i i i k
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Lookoverseas increasesreturnwithoutincreasingrisk
SecularRangeboundMarketsIsComprisedOfManyCyclicalMarkets
31 5 Bull+5Bear+ 1 RangeBound
ThankYou!
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