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Katsenelson, CFA
Chief Investment Officer
Active Value Investing Net of Fees performance is after the deduction of management fees, after reinvestment of dividends, interest and other earnings (recorded on accrual basis), and after the deduction of broker fees and commissions.
S&P 500 market average includes reinvestment of dividends but are not adjusted for any transaction costs.
Past performance is not necessarily indicative of future results and is only one of several factors which should be used in evaluating a professional investment organization.
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We are used to thinking about secular (longer than 5 years) markets in binary terms:
OR
bursts of occasional bravery lead to stock appreciation, but are ultimately overrun by fear that leads to a subsequent descent
Active Value Investing: Making Money in Range-Bound Markets
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So far markets have gone sideways hell of a ride, but still sideways
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Secular Bull and Sideways Market Cycles Were Not Caused by:
As Long As: Inflation Remained Reasonable / Deflation Was Absent / GDP And Earnings Growth Remained Positive Market Was Either Bull Or Sideways.
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SIDEWAYS MARKETS
Sideways Markets: P/E Contraction + Earnings Growth = Low Returns Bear Markets: P/E Contraction + Earnings Decline = Negative Returns
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Bull Markets Start at Below-Average and End At Above-Average Valuations. Range-Bound Markets Start at Above-Average and End at Below-Average Valuations.
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Market
Bull Range-Bound Bear
Economic Growth
Good (Average) Good (Average) Bad
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In a perfect world where humans have no emotions stock market appreciation = economic growth = earnings growth = 5-6%
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P/E + EPS = 0% + 6% 6%
Sideways Market
Returns are NOT new average, not average, but below average:
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Interest rates and inflation are very important but they take a second seat to market psychology. They ultimately determine the length and the extremes of market cycles.
Interest Rates Move from Zone 1 Zone 2 1982 If interest rates /inflation were higher, secular range-bound may have ended sooner at higher valuation Zone 3 Zone 2 Zone 2 Zone 3 Zone 2 Zone 1
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If interest rates /inflation were not that low, secular bull may have ended sooner at lower valuation
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Valuations need to stay below average for a while (see next slide).
Real earnings growth will be lower in the future due to higher future taxes, higher interest rates (caused by government borrowing), consumer deleveraging sideways market may last longer than we expect. High inflation will shorten sideways market duration, but final P/E will be lower as well. If nominal earnings growth doesnt materialize in the future (3,5,10 years), earnings decline we are set for a secular bear market
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Dont buy for the sake of being invested. Dont lose money by making marginal decisions. In the absence of good stocks to buy, be in cash. The opportunity cost of cash is not as high as in a secular bull market.
Increase your margin of safety: Fewer (better) stocks will be in your portfolio. Favor dividend-paying stocks. Dividends were 95% of the return in previous range-bound markets. (Warning: dividends are part of the analytical equation, not the equation.) Look overseas -- increases return without increasing risk.
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Throw money at stocks, and youll do much better than in bonds or cash. In general, the fewer decisions you make the better off you are (buy and forget).
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Investment Management Associates Inc. 7979 E. Tufts Ave, Suit 820, Denver, Co 80237 303.796.8333 / www.imausa.com
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