It's only been the first business day of the new year, and already I am sick of reading forecasts for the upcoming year. Nonetheless, here are four big-picture issues that any serious investor should be chewing on. You are several steps ahead of me if you have them all figured out.
Growth vs. Value
Although the numbers are still being sorted out, it appears that in 1998, "growth" stocks in the
have outperformed "value" stocks by a mind-numbing 28 percentage points. As noted a number of times in the past, the analysis of what constitutes a "growth" stock vs. what is a "value" stock can border on the silly. But as a broad-brush stroke, this description fits 1998 rather well. I can also tell you it does not feel at all self-satisfying to have beaten the "value" index.
As a fervent believer in the theory that almost everything except
reverts to the mean over time, what change is occurring at the margin that will reverse or at least slow the dominance of growth over value?
I think Bill Fleckenstein had it right when he
pointed out that it won't end until it ends, and until then, we will look stupid. There is clearly a panic among professionals to "closet-index." This generally means that the pain of underperforming a loaded-deck index has overcome investment discipline. As a result, most managers are sneaking in a few large-cap stocks with P/E ratios of 60 to participate in this year's particular game of musical chairs.
I realize that many think the definition of a value manager is someone who has bought
every year since 1951-- with unhappy results. Despite this, a number of cyclicals and semicyclicals -- which are often confused with "value" stocks -- are looking awfully attractive as they have been beaten down to levels where anything but a disastrous recession in 1999 would produce a rally. There are also the stirrings of a consolidation theme in areas like paper and forest products, which are highlighting the degree of undervaluation. Lastly, the portfolio manager of the
is taking some very public heat for miserable performance in 1998, most of which was produced by large bets on cyclical stocks. Firing the PM for a wrong bet (or an early one) is usually a reliable turnaround signal for the group.
Large-Cap vs. Small-Cap
On a similar note, the
proxy for small-cap investing trailed the S&P by some 31 percentage points, and at some points in the year, it seemed even worse. Here again, "outperforming" in relative terms did not make us feel very good either.
Same question: What change is occurring at the margin that will reverse this trend?
The debate over large-cap vs. mid-cap vs. small-cap investing is endless, but recent performance results have been so lopsided that many are calling into question the entire theory of small-cap investing. Has the world changed so much that small-caps no longer warrant their historical performance pick-up? I doubt it, and the current overt neglect of the sector proves it.
Moreover, if the size of the organization was the crucial variable to performance, then the
U.S. Post Office
and the government of India would be on the cover of
as the world's most admired companies. It is clear that
have swung wildly in favor of the largest companies, but we question the concept that large necessarily equals good -- both intellectually and in our daily work. It's not that there aren't extraordinarily well-run large companies, it's just that being extraordinarily large has little to do with being well-run -- a thought we'd like to put the mergers-and-acquisition teams in corporate America.
Silicon vs. Stuff
I've said my piece about the Internet investment craze
before, so let me rephrase it as the following question:
Is the market correctly pricing "silicon" -- the chips, bandwidth, digitalization, Internet, etc. - vs. the "stuff" -- commodities like oil, paper, the metals, bricks and mortar and manufacturing capacity in general?
This is the $64 billion question. Is
really worth more than
together worth more than
Barnes and Noble
put together? Is
worth more than the entire market cap of the North American forest-products industry or 75% of the market cap of the U.S. radio industry? There is an enormous gulf today between the prices investors are willing to pay for what is clearly an exciting technology future vs. the prices they are willing to pay for boring old companies that make and sell things. We don't have the answer just yet, but we sure hope those people buying Internet stocks in the fourth quarter do.
clearly "saved" 1998 with a renewed determination to be the guarantor of the American nest egg. And that means the old rule -- "buy into a financial panic because the
will ease" -- has an unblemished track record in the postwar era. But it also raises a question:
Did Greenspan overdo it? Is there a decent chance of seeing a reversal of Fed policy in 1999?
The problem with 1998 was that, just as the Fed shifted from neutral to a "bias toward tightening," the world nearly fell apart thanks to the financial panics in Russia, Asia and Connecticut. So Greenspan and Co. moved on a dime and cut rates sharply to buoy confidence. In the short run, this worked, as the capital markets regained their footing, lending restarted and credit once again became available, albeit at a higher price. The flip side of the Fed's move though, is that it has fueled a Zeppelin-like surge in equity prices, particularly those in the U.S.
This policy is being echoed throughout the developed world: Japan's desire to flood the system with money has led, in final frustration, to the mailing of a check of $220 to every family to spend. Germany's new Finance Minister
, on the eve of a new pan-European central bank, was throwing out fiscal ideas that would have gotten him bounced out of a
Ben & Jerry's
board meeting. If the euro sucks some money out of the dollar and if the U.S. economy puts up some stronger-than-expected numbers early in 1999, the Fed may have to consider some policy options that might be considered hostile to investors.
Happy New Year and best of luck. You'll need it if you're not careful.