Each December, my crystal ball shows shadows of what is to come in the new year. Ordinarily, it simply displays an inverted image of my countenance. Unfortunately, the message is this:
It won’t be as easy to make money in the markets as it has been.
To be sure, last year was horrible. However, even with 2022 factored into the equation, the trailing 10-year total return for the S&P 500 is 11.79% (annualized) through yesterday. That is roughly a couple of percentage points higher than the 100-year average.
While that might not sound like much, 2% represents real money when compounded over a decade or more.
Don’t get me wrong. I am not predicting a market Armageddon. Further, I am not suggesting anyone has to completely retool their 401K allocation. After all, the return on the S&P 500 will still be the primary domestic yardstick. Invest in a fund which tracks it, and you will get a so-called market rate of return.
The question is how to beat it.
- Since the end of 2008, all an investor has had to do is be “overweight” the technology sector.
- Through the end of November 2023, the annualized return for the S&P 500 was 13.69% over that 179 month time period.
- By comparison, the return of the Technology Select Sector SPDR (XLK) was a massive 19.85%.
If a 2% annual differential represents big bucks over time, imagine what 6%+ means. Let’s try more than doubling your money and then some. Intuitively, this shouldn’t last forever.
To be sure, the global economy will continue to consume technology at a feverish pace. All other things being equal, you would be wise to have a healthy slug of the stuff in your investment portfolio over the long haul. However, that doesn’t mean it will always outperform the broader market. Put another way, technology isn’t always cheap when compared to other investment alternatives.
To that end, consider the following.
- Through 11/30/2023, the average Price/Earnings ratio (P/E) on XLK is an eye-watering 35.33x. The average dividend yield is 0.87%, and the average Price/Book multiple (P/B) is a whopping 9.53x.
- By comparison, the P/E for the Energy Sector Select SPDR (XLE) was 10.00x. The dividend yield was a much healthier 3.70%, and the P/B was only 2.13x.
While this is admittedly an extreme example, with the exception of the communications sector, all other primary economic sectors are significantly cheaper than technology using traditional valuation techniques.
The kneejerk reaction to that last line is: “Norris, dude, you just stated tech is where the growth is moving forward. Why wouldn’t investors being willing to pay up for it? After all, you skate to where the puck is going to be, not where it currently is.”
Fair enough.
Let me explain my rationale thusly. Imagine you have $20 for lunch. What you really want is a club sandwich with fries. Unfortunately, with tax and tip, it is going to cost all of your money. By comparison, the daily special, a turkey & Swiss cheese with a side of chips, will set you back only $10. Ordinarily, it would cost $17.
Which one do you choose? While there are differences between the two options, are they great enough to warrant such a difference in price?
Frankly, I love a good club sandwich. Who doesn’t? Laughingly, there are two types of people in the world: those that like them, and those that lie about it. Still, $10 is $10, which is a pretty penny to pay for a slice of bacon (maybe two) and an extra piece of bread. Further, chips or fries? Honestly, both are fried potatoes.
As such, I would probably opt for the daily special 7-8 times out of 10 in this example. However, at that $17 price point for the turkey & Swiss? Brother, I am here to tell you, I am getting the club every single time. No question about it.
This is sort of where we are in the stock market.
So-called value investing has been out of favor for so long, and by such a discrepancy, there will have to be a reversion to the mean at some point. The only cloudy spot in my crystal ball is the timing. Is it next year or the year after?
In truth, if growth/technology outperforms value next year the way it has this year, I won’t be using silly analogies about sandwiches leading into 2025. I will be pounding my fist through the table, not on it. While that might hurt like nobody’s business, the money we will make will more than make up for it.
But just what are value stocks?
I will spare you the nerdy definition, and give you one for cocktail party conversation. This assumes you are discussing such things at cocktail parties, which I hope you aren’t. Here it goes: “the way the markets are now, you can think of value stocks as boring ‘old economy’ companies. These would include things like banks, insurance firms, the energy sector, pharmaceuticals and other companies which you don’t have to explain what they do.”
That isn’t perfect, but it will work well enough.
But…but…banks? Didn’t the banking sector almost fall apart this year? And what about the deluge of commercial real estate debt coming due over the next several years? Energy? Haven’t you heard about the shift to electronic vehicles and all of that jazz? Pharmaceuticals? Don’t you think Washington will eventually beat them up to drive down prices for the American consumer?
Hey, I didn’t think these pictures were the prettiest one in the gallery. I just said they were the cheapest, and cheap usually sells at some point. After all, most folks don’t have bare walls waiting for a Picasso to come into their price range.
Man, I am full of all kind of analogies today, aren’t I?
In the end, I will continue gazing into my crystal ball for more answers, and, yes, I really do have one.
This one, value over growth, is just the first shadow to appear in my crystal ball. However, it is pretty clear, pretty compelling and pretty different from what has worked so well over the last 15 years.
But, hey, buying an index fund will get you a market rate of return, and there is absolutely nothing wrong with that. However, exploiting this type of disparity will help you beat the market. If it doesn’t work immediately, don’t sweat it.
It is always better to be early than late.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this any every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
John Norris
Chief Economist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.