2021: The year of mean reversion

[7 min read]

Dear Reader,

At the start of the year — in the January issue of Crisis & Opportunity (now known as Greg Canavan’s Investment Advisory) — I wrote a subscriber-only report that called 2021 ‘the year of mean reversion’.

It began with two quotes:

“Many shall be restored that now are fallen and many shall fall that now are in honour.”

Horace, ‘Ars Poetica’

“You’re either a contrarian or a victim”

Rick Rule

‘The quote from Horace appears in Graham and Dodd’s classic, Security Analysis, first released during the Great Depression when markets and stock prices were, shall we say, very different to how they are these days.

‘I read that book in my 20s. It was tough going. But the Horace quote always stuck with me.

‘And Rick Rule’s quote is a favourite of mine too.

‘With one caveat…

‘You’re not ALWAYS either a contrarian or a victim. But there are certain times — when it seems everyone is in the same boat and betting on the same theme/outcome — that you have to keep this dictum in mind.

‘Because if you mindlessly follow the herd into hot stocks and sectors this year, you run a big risk of becoming a victim.

‘With these two quotes in mind, let’s do a little experiment to start the year.

‘Let’s create two portfolios…

‘One with the top 10 ASX 200 performers in the year to 8 January. Another with the bottom 10 performers.

‘It is my contention that the bottom stocks will outperform last year’s winners. In the words of Horace: “Many shall be restored that now are fallen and many shall fall that now are in honour”.

‘You can see the two “portfolios” below.

‘In my view, you’re going to see a “reversion to the mean”. That is, capital will rotate out of what’s popular and into last year’s underperformers.

‘To make a success of 2021, and avoid becoming a victim, you need to look at what underperformed last year and see if there is any evidence of change emerging. This could be on a stock or sector specific level.

‘Avoid the hot sectors and stocks and look for the lukewarm…with the potential to become hot in the future. Be prepared to not really like what you’re investing in…and to wonder whether the market will EVER think this is a good opportunity. Tomorrow’s winners are ALWAYS difficult to like in the early phases.

‘But by the same token, tomorrow’s losers are often today’s most popular plays. It’s just how the market works.’

Three months on, how is this experiment going?

Well, so far so good. 2020’s laggards are outperforming the winners. See for yourself. Here’s the bottom 10. So far, it’s generated a return of 5.75%.

And the top 10. It’s only just managed a positive return, 0.28%.

That’s a sizeable outperformance for only a few months of the year. And I think it will continue. While the Aussie market isn’t as saturated with ‘growth’ stocks like the US (specifically the NASDAQ) the top 10 does have some prime candidates.

I’m talking Afterpay, Netwealth Group, NextDC, Polynovo and Xero.

Which brings me to the March investment issue I published for Greg Canavan’s Investment Advisory subscribers just a few weeks ago. I wrote:

‘The (weekly) chart below shows the S&P 500 Growth index relative to the S&P 500 Value Index over a long period of time (nearly 30 years). The growth index measures stocks based on sales growth, the ratio of earnings change to price, and momentum, while the value index measures stocks based on book value, earnings and price-to-sales.

‘Over the long term, growth stocks clearly win out. That makes sense. A collection of “growth” stocks will create more shareholder value over time than a collection of “value” stocks.

‘But there are certain times when you have to be cautious about this view. Growth stocks outperformed in the late 90s relative to value and went nearly vertical in the final year, 1999. That ushered in a long period of underperformance for growth stocks.

‘A close look at the chart shows that since 2007/08, growth stocks have outperformed again. Then, in 2020, growth stocks went vertical compared to value stocks. In percentage terms, the relative move in 2020 was significantly larger than the move in 1999.

‘Anyone starting out in funds management in 2008 knows no different. It’s growth stocks all the way. As far as they’re concerned, value is dead.’

I bring all this up because I think it’s the most important thing to consider for long-term portfolio construction right now.

This is both a long-term AND short-term story.

Yesterday, Fed boss Jerome Powell basically told the market it wasn’t contemplating capping bond yields anytime soon. Yields edged up in response and rose again overnight.

That provided another hit to ‘growth’ stocks.

Why?

Put simply, growth stocks are very sensitive to bond yields.

Take Apple for example. It’s an amazing company. It generates huge amounts of cash flow. It’s not crazy overvalued in the way stocks were in the dotcom bubble. But it is vulnerable to higher bond yields.

That’s because its cash flows are considered so reliable as to be almost bond-like. Apple trades on a price-to-earnings ratio of 28.2 times 2021 earnings. That translates to an earnings yield of 3.54%.

With the 10-year bond yield heading towards 2%, does Apple’s earnings yield represent enough of an ‘equity risk premium’?

Probably not. Which is why Apple’s share price fell 3.4% overnight, contributing to a 3% fall in the NASDAQ.

As I said, this is a trend that is probably just getting started. Bond yields will likely keep rising in the short term, putting pressure on growth stocks, while the cash rate remains pinned to zero in the long term.

If you’re after a strategy that recognises this environment and gives you the tools to invest sensibly and avoid the growth crunch, I’d encourage you to listen to my ‘Life at Zero’ presentation.

Do you sit in cash and slowly watch your purchasing power erode?

Or jump into the market and put your capital at great risk?

This is the dilemma I know many people fear. But it doesn’t have to be that way. You can invest without taking on big risk. Let me show you how…

Cheers,

Greg Canavan,
Editor, The Rum Rebellion

Dead Men Don’t Spend
By Bill Bonner

The cheques went forth yesterday.

And all the peoples rejoiced. Bloomberg reports:

‘As the economy reopens, consumer spending over the next two quarters is likely to be the strongest such period in at least 70 years with a rebound in services leading the way, according to economists at Wells Fargo & Co.’

This is La Bubble Epoch…a gay time for all…full of farce and foolishness. Tesla is going to the Moon. Bitcoin is headed for Mars.

It makes us all giddy with excitement — 5G, 6G, 7G, 98G…million-dollar non-fungible tokens (NFTs) of cindered artworks and Michael Jackson ‘lactating’…negative real interest rates…Joe Biden…a free-range chicken in every pot and a stimmy cheque in every bank account…

All things are thought to be possible…even those that are physically, mathematically, and theoretically impossible.

And there is no longer any career risk or shame associated with saying or doing astonishingly stupid things.

Men can have babies, too — yes, we can! Farmers can plow backward to fool the crows.

But OMG…you’re using the third-person singular masculine pronoun rather than the all-purpose, politically correct (though grammatically idiotic) ‘they’.

Horrors!

But that’s just a feature of the era. Things that don’t matter do matter. And things that do matter…well, fuhgeddaboutem.

Cockamamie rip-off

Our problem with this glorious age is that many things that don’t seem to matter right away — like a whiff of smoke on a dry California hillside…or a $3.3 trillion federal deficit — may become big deals later.

Here’s one…the biggest heist in history.

We refer to the $200 billion stolen from the ‘bailout’ money. Here’s Yahoo! Money on the story…

‘More than $200 billion in unemployment aid may have gone to fraudsters in the pandemic

‘A significant chunk of the government support reserved for unemployed Americans went to fraudsters instead during the pandemic, according to new estimates.

‘More than $200 billion of unemployment benefits distributed in the pandemic may have been pocketed by thieves, according to ID.me, a computer security service that 19 states — accounting for 75% of the national population — use to verify worker identities. That's more than triple the official government estimate of $63 billion based on the 10% pre-pandemic fraud rate.’

Up to 30% of claims under the Pandemic Unemployment Assistance (PUA), the program that provides benefits to self-employed and contractors, are fraudulent, according to data by ID.me.

What’s $200 billion? Peanuts.

But people follow leaders. And when leaders impose a cockamamie rip-off as the law of the land…it doesn’t take the public long before getting in the spirit of dishonesty behind it.

Then, the whole society falls apart.

It’s complicated

But don’t worry, Dear Reader. The Biden administration is ready to fight corruption — overseas! Politico:

‘Going after the “Achilles’ heel”: Biden charges into global anti-corruption fight

‘Earlier this month, amid a blizzard of news both domestic and foreign, Secretary of State Antony Blinken took the time to ban a powerful Ukrainian oligarch from setting foot in the United States.’

That’s right. We won’t tolerate corruption — in the Ukraine. Here in the US? Well…it’s complicated.

We are not so much concerned by the facts…as by the theory. Sure, apparently many people — millions? — lied to get the stimmy money.

But when the money goes, everything goes.

Money is what determines our place in line. Those with the most money go to the head of the line and get the most stuff. Those at the end get what’s left.

And when the feds begin handing out money willy-nilly, the right and the wrong of it are hard to figure out. It’s not surprising that people begin cutting in line.

Raise the dead

First, the stimmy money itself…

Was it earned by House Speaker Nancy Pelosi? Did it belong to Joe Biden? Was it saved by Federal Reserve chief Jerome Powell? No.

Was it taken from any human being’s bank account? No again…

Then, how could it be stolen? From whom? Nobody.

Prosecutors would be at a loss. Because nobody is ever going to get standing in court to challenge the somebodies who made off with it.

Besides, who had a ‘right’ to the money? The young woman who fit the eligibility requirements, as determined by Congress?

But where in the US Constitution do the feds get the power to create money and give it to some people and not to others? You can check it yourself. Congress has no such right.

Maybe the thieves had as much of a right to the money as anyone else. It was up for grabs. They grabbed it.

And better they than some others.

According to the H&R Block website, even corpses are eligible for the stimmy money:

‘Q. I received a stimulus check for a deceased relative. What do I do?

‘A. It depends when your loved one passed. Individuals who died in 2020 are eligible for the second stimulus check while anyone who died before 2020 is not.’

This deepens our curiosity. Do the feds think they can raise the dead? If not, why give them money?

Federal spend-a-thon

Surely, a dead man needs the money less than a living one — no matter when he kicked the bucket. Even a fraudster would seem a better bag man than a corpse for the stimmy giveaways.

And maybe, it is ‘life-ist’…a kind of ‘live privilege’…to think that the shades are somehow unable to do their part in the great spend-a-thon that the feds are trying to incite.

Shame on us. We would be peddling a ‘negative stereotype’ if we were to observe that dead men are not big spenders, are not stimulated very easily, and that even $1,400 is unlikely to do the trick.

And perhaps, since the impossible is now possible, fake money is real money…and the frontier between right and wrong, true and false, ridiculous and sublime is no longer clearly marked…

…perhaps it is no longer permissible to make distinctions? Maybe the quick and the dead…sinners and saints…all have the same rights to the money that none of them earned?

So, in keeping with the Bubble Epoch zeitgeist, we will await the Dawn of the Dead… when the cadavers rise from their graves…shuffle into our malls…and, drawing on their stimmy cheques, leave with Hermès scarves…

…thus distracting the clerks so the crooks can make off with the big-screen TVs.

Yes…that ought to get the economy moving in the right direction!

Regards,

Bill Bonner,
For The Rum Rebellion