2021: The Year of Mean Reversion — Growth stocks Outlook

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.

HOODWINKED! Why Australia’s ‘miracle’ economy is a farce

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%.


ASX 200 Performers

Source: Sharesight

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


ASX 200 Performers

Source: Sharesight

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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.


S&P 500 Growth index

Source: Optuma

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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 Signature

Greg Canavan,
Editor, The Rum Rebellion

P.S: In a brand new report, market expert Vern Gowdie warns of the dangers waiting in a post-COVID-19 world. Plus, he outlines the steps you should take now to protect your wealth. Learn more.


Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts.

At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates.

Greg will help The Rum Rebellion readers block out all the nonsense and encourage personal responsibility…both in the financial and political world.

Learn more about Greg Canavan's Investment Advisory Service.


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