Optimism, Pessimism, and Future Returns.
Whew—what a relief! 2023 proved to be a very profitable year for most public market investors, as shown below.
Capital Markets: Navigating Choppy Waters
Whew—what a relief! 2023 proved to be a very profitable year for most public market investors, as shown below.
Calendar 2023
|
|
Russell Top-200 Growth
|
46.6%
|
S&P 500
|
26.3%
|
MSCI All Country World
|
22.2%
|
MSCI EAFE
|
18.2%
|
Russell 2000
|
16.9%
|
Bloomberg High Yield
|
13.4%
|
Russell Top 200 Value
|
10.6%
|
MSCI EM
|
9.8%
|
Bloomberg Aggregate
|
5.5%
|
Bloomberg Commodity
|
-7.9%
|
MSCI China
|
-11.2%
|
Consumer Prices
|
3.3%
|
The dominance of the Magnificent Seven has been well documented, although it is interesting to observe the degree to which a strong year-end advance left many areas with solid gains for the year. Nevertheless, 2023 in many respects mirrored the trends of the last decade.
10 Years (ann) Ending 12/31/2023 | |
Russell Top-200 Growth
|
16.1% |
S&P 500
|
12.0% |
Russell Top-200 Value
|
8.5% |
MSCI All Country World
|
7.9% |
Russell 2000
|
7.2% |
Bloomberg High Yield
|
4.6% |
MSCI EAFE
|
4.3% |
MSCI EM
|
2.7% |
Bloomberg Aggregate
|
1.8% |
MSCI China | 0.9% |
Bloomberg Commodity | -1.1% |
CPI (10 years ending 12/31/23) | 2.8% |
A pessimistic mindset following 2022’s losses was clearly the wrong perspective for the year ahead. Should we be similarly suspicious of any optimism born from 2023’s gains?
Due to the simple fact that we base investment decisions on rigor, history, and patience to produce a high probability of longer-term success, engaging in the admittedly attention-grabbing matters of near-term market-direction speculation has never been of interest. To be blunt, we are afraid to risk making a forecast where our odds of success are at best the same as a coin toss.
Two great quotes come to mind when thinking about future investment outcomes.
Invest for the long haul. Don’t get too greedy and don’t get too scared.
It is always easiest to run with the herd; at times, it can take a deep reservoir of courage and conviction to stand apart from it. Yet distancing yourself from the crowd is an essential component of long-term investment success.
One way to think about recent gains is to attempt to identify those that reflect a justifiable (i.e., durable) adjustment in price. In other words, does this increase reflect a correction of a prior discrepancy between price and fundamental value? Or does the increase merely reflect growing optimism for the future and/or investor willingness to pay an ever-increasing premium for a perception of comfort and safety?
Take the Magnificent Seven. On an equally weighted basis, this group posted a stunning 107.0% return for the year, while the return was 75.7% on a capitalization-weighted basis. Presently, we have earnings growth data from September 2022 to September 2023 totaling just under 19% overall. Expected earnings growth for the next twelve months is approximately 25% on an equally weighted basis. Simply put, regardless of which of these figures we use, multiple expansion (i.e., optimism for the future) defined the story of last year.
Why is optimism a dangerous foundation for investment decisions? Unfortunately, despite the positive connotation commonly attached to such an outlook, reality rarely matches hope—subsequent results are predictably disappointing as future outcomes fail to live up to lofty expectations. The Seth Klarman quote above captures this point well, as does the chart below.
OUTCOMES: CYCLE, RINSE, REPEAT
When history and logic collide in this way, the wise take notice. Yet, there is more to the story, as a wide array of public equities trade at what appear to be very compelling valuations—this is not merely relative to indices such as the S&P 500, but is in fact true on an absolute basis.
Considering the gap between smaller and larger companies merely on an index basis, the current discount levels are stunning.
Ultimately, this is a tale of two markets. On one hand, we have the Magnificent 7 priced at nearly 40x trailing earnings—this is the ultimate “what can go wrong?” valuation. On the other, we have scores of beaten-down stocks both inside and outside the US trading at what seem to be exceptionally low valuations1.
On balance, we continue to believe that monetary policy is on a slow yet undoubtedly erratic path towards normalization thanks to higher structural inflation. This introduces many less familiar but well-documented risks that investors will have to face whether they like it or not. Given that everyone, including us, lack foresight into the future, the primary factor worth considering is the strong tendency of low valuations to create a wider array of scenarios in which equities produce acceptable returns.
THE EVIDENCE SPEAKS: LONG-TERM SUCCESS THROUGH RIGOR AND RESEARCH
- Valuation, like investing, is a complex subject. On one hand, low valuations are easily observed via single-digit price/earnings ratios, mid-teens free-cash-flow yields, etc. In other instances, a company may be on a path to significantly higher future earnings that the market has not yet accounted for. In these instances, traditional valuation metrics may look expensive but could prove otherwise if the earnings growth materializes.
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Crewcial Partners LLC is a Securities and Exchange Commission registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any securities. Past performance is not indicative of future results, and investments involve risk and are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed here.