How My 'Strategies To Buy The Dip' Have Performed
Summary
- In April, I highlighted for readers early recovery strategies that tend to outperform in the year after stocks have bottomed.
- These strategies - equal-weighting, size, and value - have all outperformed record gains in the capitalization-weighted benchmark since in the market lows.
- These strategies generate structural alpha over a business cycle, but most of the alpha comes from the early phase of the economic recovery.
In a mini-series of articles beginning on April 17th, I highlighted for investors strategies to "buy the dip". I commented that timing the bottom is always a challenge, but that investors do know what strategies have worked the best from previous bottoms when the market has recovered. In this article, I want to highlight where those strategies currently stand, and use history to indicate where those trades could head in the future.
No sense burying the lede deep into the article on a topic on which I have already authored. The three strategies I highlighted in previous articles were equal weighting, small caps, and value-tilted funds. All three of these strategies have historically outperformed in early recovery periods. The three indices that I used to describe these strategies have all outperformed in the subsequent eleven weeks. The S&P 500 (SPY) has done tremendously over this period. Not since the 1930s has the broad market gauge risen so quickly over such a short time horizon. These three strategies have done even better.
Source: Bloomberg
Equal-Weighting
The first strategy I highlighted was how an equal-weight version of the S&P 500 (NYSEARCA:RSP) strongly bested the capitalization-weighted index in the year following stocks bottoming during 2008 and 2002. When the S&P 500 bottomed in March 2009, the index soared 72% over the next year, but the equal-weight version of those same constituents rallied 107%.
Like the Financial Crisis episode, the equal-weighted index sharply outperformed in the recovery from the deflation of the tech bubble in 2002. Over the next year from the 2002 bottom, the S&P 500 rallied 36%, but the equal-weight index rallied 58%.
Since the bottom on March 23, 2020, the equal-weighted index has outperformed the capitalization-weighted S&P 500 by more than 12% (57.7% vs. 45.1%). For those keeping score at home, roughly 9% of those relative gains have come since the article's publication on April 17th. For equal-weighting to continue to outperform, the contrarian rebalancing of equal-weighting and the bias towards smaller companies needs to continue to work for investors. As I highlighted in yesterday's article on the worst performing stocks since the market bottomed, some early downturn leaders are now lagging. This might suggest a transition in market leadership is underway.
Small Caps
The second strategy I highlighted was how small caps tend to lead large caps in the year after stocks bottom. The S&P 500 soared 72% from the bottom in stocks from the lows in March 2009, but the S&P 600 rallied 98%. Small cap stocks roughly doubled in value in one year.
Prior to the Global Financial Crisis, the previous stress period for stocks was the deflation of the Tech Bubble in the early 2000s. From the peak for stocks on March 24th, 2000 through the trough on October 9th, 2002, the S&P 500 had a total return of -47%. The small cap index did much better, shedding only 21%.
Given that the collapse in that episode was dominated in tech-heavy large caps, you might have expected the capitalization-weighted index to outperform in the recovery. Like the Financial Crisis episode, small caps still managed to outperform in the recovery despite also outperforming during the drawdown. Over the next year from the 2002 bottom, the S&P 500 rallied 36%, but the small cap index rallied 49%.
Small caps have been notably lagging in recent years, and trailed mightily during the 2020 stock sell-off as investors fled to large cap stocks, particularly in the tech sector. Since stocks bottomed on March 23rd, the S&P 600 (IJR) has bested the S&P 500 by about 10%. Since my article's publication on this relationship on April 20th, the small-cap index has bested the S&P 500 by 15%.
Value
The third strategy I highlighted was how Value-tilted strategies tend to outperform in the year after stocks bottom. In the year following the March 9th, 2009 cycle low, the S&P 500 soared 72% from the bottom in stocks over the next year, but the S&P 500 Pure Value Index rallied 200%. Value components of the S&P 500 roughly tripled in value in one year.
From the peak for stocks in the tech bubble on March 24th, 2000 through the trough on October 9th, 2002, the S&P 500 had a total return of -47%. While Value stocks tend to lag late in the business cycle, they actually outperformed over this period (-8%) as the broad market correction was more a function of over-valuation of Growth than an under-valuation of Value.
Given that the collapse was dominated in tech-heavy large caps, you might have expected the capitalization-weighted index to outperform in the recovery. Like the Financial Crisis episode, Value still managed to outperform in the recovery despite also outperforming during the drawdown. Over the next year from the 2002 bottom, the S&P 500 rallied 36%, but Value rallied 56%.
The Pure Value indices, which screen on book value, earnings, and sales to price ratios, are screening for stocks at lower valuations than the broader S&P 500 index. This strategy has underperformed meaningfully in recent years and lagged decidedly early in the the current crisis given tilts towards Energy and Financials and away from Tech and Healthcare. Value has offered long-run outperformance historically, driven by strong outperformance in previous early recovery phases. Since the market bottom on March 23rd, the strategy is up 66% versus a 45% gain for the broad market index. Most of those relative gains (27% for Value versus 12% for the S&P 500) have come since my article's publication on April 27th.
Summary
Equal-weighting, size, and value are three strategies that tend to outperform in early recovery periods. While the S&P 500 has posted historically rapid recent gains, these three strategies have still outperformed meaningfully since the market bottom. For investors wondering if there is still room to run, note that each of the three strategies is still down on the year, trailing the new modest gains for the S&P 500.
Source: Bloomberg
As discussed, these strategies are "early recovery" winners in a business cycle. Of course, it is always difficult to know where you are in a given business cycle. In the historically elongated expansion that ended early in 2020, many had been calling for the cycle's demise for several years. It had not been "early" for some time. I owned all of these strategies during the drawdown in 2020, but added meaningfully in March and April into weakness. Absent a virus-induced setback in the reopening of the economy, I would expect that these three strategies will continue to outperform on a relative basis as money rotates out of the megacaps and into "cheaper" stocks, investors look for pockets of value, and large cap companies buy smaller, higher growth adjacent businesses. From here, I am less likely to "buy into weakness" and more likely to "sell into strength" some of the higher cost tax lots owned in these strategies.
Disclaimer: My articles may contain statements and projections that are forward-looking in nature, and therefore inherently subject to numerous risks, uncertainties, and assumptions. While my articles focus on generating long-term risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly, and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon.
This article was written by
Analyst’s Disclosure: I am/we are long RPV, IJR, RSP, SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (5)
seekingalpha.com/...Combining your size and value factors has had some attractive returns as well, i.e. IJS. Not to mention more focused strategies of 20-30 stocks:
seekingalpha.com/...Looking forward to future articles.Thanks,
Ryan
Those strategies work as you describe only if you get the timing right. As your chart clearly shows, all 3 strategies have underperformed SPY YTD.
Had you rotated from SPY to any of the 3 strategies after a 20% drawdown, you would have probably underperformed SPY.
Beginning with 1974, and also 1987, 1990, 2002, 2008, and 2020 YTD, it's been thoroughly demonstrated and reinforced (to my satisfaction) that I should never exit equities. Corrections and recessions are inevitable, as is that I'll never know market tops and bottoms until after those events. If for nothing else the present bull market is an excellent example of a market being pushed higher by investors who didn't believe its initial advance, found themselves further and further behind, and now find themselves buying due to their FOMO. During declining periods I'll trim or exit declining positions, but also be nibbling (buying in small quantities) stocks I want to own when priced attractively. No one knows how long or deep a period of equity decline will extend--nor the propitious moment to buy. Beginning in January, I've exit positions in which I lack high-confidence (e.g., AMLP, BPR, MAC, RDS.B, SPG, VTR), and begin the building of new positions in higher-quality 'blue chips' (e.g., AVGO, DIS, HD, QQQ, RTX). I also took a position in WFC, based upon my confidence its new CEO Charles Scharf will the bank to its former blue chip standing.I never tell others to do as I do; I only post information on my process.Rich-untrack:12hrs
