With only one trading day to go in December, the S&P 500 is up 6.55% for the month. If stocks hold onto their gains it will be the best December for the stock market in almost two decades. And since Ben B. first floated the idea of printing a few billion more dollars in August, stocks have gained more than 20%. He must be delighted.
Investors are buying stocks indiscriminately—the riskier the better. Investor sentiment is at multi-year highs. Brokerage analysts are bullish, investment managers are bullish, and individual investors are bullish. The mantra on the street is “don’t fight the Fed.” Stocks are a win-win. If the economy sours, Ben will print more money. If economic growth improves, that’s good for the stock market too. The speculative fervor is disturbing.
I can’t disagree with the logic of the stock market bulls. Economic data is, in fact, improving and monetary policy is the most accommodative in the history of the United States, but when everybody is bullish, the good news is often already priced in. There are many risks that could derail this recovery or snuff out the stock market rally.
I continue to invest with a balanced approach and a focus on dividends and interest. It is a strategy I have followed for decades and one I advise for my subscribers and money management clients.
For some hard data on just how speculative this rally has been, I’ll leave you with an insight from John Hussman. Hussman is the portfolio manager of the Hussman Strategic Growth Fund.
Ned Davis Research tracks a set of “factor attribution” portfolios, which measure the performance between the top 10% of stocks ranked by a given factor, and the bottom 10% of stocks as ranked by that factor. The factors are things like market beta, dividend yield, 26-week momentum, and so forth. Essentially, these factor portfolios track the return of hypothetical portfolios that are long the top 10% and short the bottom 10% of stocks based on any given variable.
The performance of these 133 factor portfolios over the past 13 weeks offers tremendous insight into the extent to which the Federal Reserve has encouraged speculative risk. Investors are chasing stocks with the greatest exposure to market fluctuations, commodities, credit risk, small-cap risk and volatility. Conversely, securities demonstrating reasonable valuation, stability, quality, or payout have been virtually abandoned by investors. Here is a sampling:
|FACTOR||FACTOR GROUPING||13-WEEK RETURN|
|Raw Materials Beta||Commodity Sensitivity||17.47%|
|Credit Spread Beta||Macro Economic Sensitivity||14.66%|
|Small vs. Large Beta||Style Sensitivity||12.54%|
|Silver Beta||Commodity Sensitivity||10.87%|
|Sigma Risk (Volatility)||Risk||10.73%|
|Operating Cash Flow Yield||Valuation||-4.02%|
|Value vs. Growth Beta||Style Sensitivity||-5.87%|
|Return on Invested Capital||Profitability||-6.61%|
|10-Year T-Note Beta||Macro Economic Sensitivity||-9.55%|
|High vs. Low Quality Beta||Style Sensitivity||-15.70%|
The problem with this outcome is that the speculative factors being rewarded over the short-term have nothing to do with the characteristics that have historically been rewarded over the long-term. Despite various periods where valuation is out-of-favor, value has been the clear winner over time. Moreover, it has been destructive to discard valuation in preference for chasing momentum and relative strength after the fact. In contrast, chasing high beta or momentum has conferred no durable benefit for investors. Here is a sampling of 10-year factor returns:
|FACTOR||FACTOR GROUPING||520 WEEK RETURN|
|Operating Cash Flow Yield||Valuation||20.26%|
|Sales / Price||Valuation||19.68%|
|Market Cap||Liquidity and Size||19.10%|
|EBIT / Enterprise Value||Valuation||15.00%|
|Free Cash Flow / Enterprise Value||Valuation||10.49%|
|Silver Beta||Commodity Sensitivity||-1.04%|