Crap total returns, but closer to normalcy

Confounding, uncertain and volatile markets have left many investors wondering what glimmer of hope to hold on to. It isn't yet evident to investors, but in some respects the market is returning to normalcy. Since 2009 the markets have rewarded stocks whose characteristics run counter to historical norms. Over the last several decades, it has been shown empirically in many academic studies that investing in cheap stocks, high quality stocks, dividend payers, and high momentum stocks have outperformed over time. Unfortunately for active managers, those themes have struggled to play out with consistency since the bear market bottom in March 2009. Many investment managers have blamed Quantitative Easing for their own lack-luster performance over the last few years.

Given the drubbing the market has received, I thought it would be interesting to check on the performance of a few of the broad themes mentioned above--quality, value, and yield-- on a year to date basis. As I mentioned on January 4th, it may just be about time for fundamental factors to return to their historical prominence for stock picking. Below are a series of charts showing calendar year excess returns of the best (high) / worst (low) based on these themes back to 2010. The returns are "excess", which means they are relative to an overall market return of -8.4%.

One of the more remarkable trends of the last few years has been the underperformance of Dividend Yield. Stocks with high yield have underperformed the market for the last four calendar years (2012-2015). Looking back to 1970, that had never happened before in consecutive years. Interestingly, a swift reversion has occurred so far in 2016 as investors flock to safety in the global rout. Dividend stocks with high yield are outperforming the market by 6.9% so far in 2016.

Another interesting trend has been the outperformance of growth-oriented stocks (low book-to-price). Classically, the distinction between value and growth stocks has been heavily predicated on the book-to-price ratio, which measures the company's assets minus its liabilities in relation to share price. Book-to-price has really struggled as an investment factor over the last few years as can be seen in the chart below. Normally, one could expect the orange bars to generate negative excess return, but instead, expensive stocks outperformed in 2013, 2014, and 2015 by 12.1%, 6.9%, and 11.3%, respectively.

Finally, stocks with high quality metrics have added little value over the last few years, and at times have acted exactly contrary to historical norms. One would expect stocks with high quality of earnings, high strength of balance sheet, and high and consistent earnings growth to perform well. This has been the case broadly back to 1964. When you divide Large Stocks into two buckets, High and Low Quality, based on these metrics, the spread in return between high and low is almost 5% from 1964-2015.

The overarching theme of this market is that the presence of uncertainty and the absence of persistent monetary stimulus from the Fed has required investors to fall back on the underlying fundamentals of the stocks they invest. For a number of reasons, that is a very good development for patient long-term investors.


* Data Notes: Sourced from Compustat, Thomson QA. Large Stocks is an equal-weighted universe of stocks with a market cap greater than the Compustat Universe average. High(Low) represents best decile of a particular factor, where high is interpreted as a strong ranking. Dividend Yield represents stocks falling into the top quintile by the factor.