“Those who cannot remember the past are condemned to repeat it.”
– George Santayana
August snapped a nearly four year-long streak of consecutive months without a 10% correction in the S&P 500 Index. This ranked as one of the three longest streaks going back to 1965. We were prepared with snow-tire equipped portfolios that are structured with volatile markets in mind.
We welcome volatility in stocks and view it as healthy for the markets. Like overgrown forests susceptible to devastating wildfires, smooth markets driven by leveraged speculators become vulnerable and top heavy.
Historically the market has sustained a correction of 10% about once per year. There have been fourteen market declines of about 20% or more since World War II, or roughly one every five years. The average of those drops was approximately 30%.*
As investors, we are willing to accept these temporary declines to capture the long term uptrend of markets. In 1946 the price of the S&P 500 Index was 19. As of this most recent quarter’s end, the S&P 500 traded at 1,920.* Despite regular declines of meaningful magnitude, the index is currently 100 times higher than where it began seventy years ago.
Given the nearly four year-long hiatus from such corrections, the third quarter’s top to bottom decline of about 14% in the S&P 500 felt worse than it actually was. Volatility is normal and to be expected. Erratic market behavior creates opportunities for us as long-term investors, while wreaking havoc on speculators.
In last quarter’s newsletter, we touched on how the market continues to show meaningful divergence in performance among asset classes (U.S. stocks, international stocks, small stocks, large stocks, etc.) and styles (value, growth). Asset classes like small cap growth, heavily weighted toward exciting sectors like social media and bio-technology, continue to defy gravity and plod higher despite nosebleed valuations.
Small cap value companies, which are weighted toward industries viewed as boring, like insurance or equipment manufacturing, have realized negative returns over the last year. Even though these companies are far more profitable and relatively inexpensive from our point of view.
The divergence over the last year has us thinking about the performance of the markets in the late 1990’s and early 2000’s. High-tech fliers were a “must own” and “old economy” value stocks were destined for certain obsolescence. The tide turned in 2000 and proved to be fatal for many of the once high fliers. The mundane and inexpensive value companies had a banner year.
At Rathbone Warwick Investment Management we are value investors at our core. Despite the recent outperformance of the growth-oriented indices, we take comfort in our contrarian philosophy of buying what is inexpensive and unloved. Fundamental research shows these “value” factors tend to outperform over extended periods of time. With the humility to know we cannot predict short term market behavior, we work to control the risks we can and adhere to the principles of our long term strategy. Patience, discipline, and value will prevail.
*Behavioral Investment Counseling, Nick Murray, 2008