2011: The Famine That Followed the Feast That Followed the Fiasco
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The truth is rarely pure and never simple, Oscar Wilde
After feasting on the US stock market’s 54% run-up from 2009 to 2010, we starved for performance in 2011, suffering a 1% loss. Some say the markets were due for a “breather” so this lull is healthy, but most say we’re lucky that results weren’t much worse, as they were outside the US.
Let’s take a close look at the details of what occurred in 2011 so we can assess the difficulties and prepare for the surprises 2012 may bring. The recent lessons we’ve learned about excesses and fraud, especially those of the fiasco in 2008, have not yet been entirely digested, and they should certainly not be forgotten. Despite popular opinion, we have not yet recovered 2008 losses. One might think that a 54% gain in 2009-2010 more than offset the 38% loss in 2008, but the realities of compounding reveal that we are still 5% underwater; the four-year return ending 12/31/2011 was an annualized loss of 1.4% per year.
So in this end-of-year commentary I review the lessons of 2011 around the globe and conclude with my traditional review of the longer-term history of U.S. markets over the past 86 years. As usual, these insights arm you for thoughtful investment manager due diligence.
The Year 2011 in Review
I’ll review the year by analyzing why popular indexes, namely the S&P500 and the EAFE, performed as they did. I provide attribution analyses set against a backdrop of the entire market.
US Stock Market
We begin with an analysis of the style composition and performance of the S&P500 as shown in the next exhibit.
The portfolio in the exhibit is the S&P500 index and the benchmark is the entire U.S. stock market, as provided by Compustat. Let’s begin with the style make-up of the S&P as shown in the bottom of the graph. Unsurprisingly, the S&P has a large-company orientation, especially tilted toward large-value companies. The total market is about 30% large-cap value, whereas the S&P is 40% large-cap value.
This large-value orientation benefitted the S&P because value companies, especially larger value companies, performed well in 2011, as shown by the middles of the floating bars in the center graph. These floating bars represent pure scientific peer groups described at Portfolio Opportunity Distributions (PODs). The median of each POD is the return for that style in aggregate and the ranges are the return opportunities for that style. As you can see, large- and mid-size value companies returned 7% and 4% respectively, with the S&P companies in these styles performing even better. By contrast, all other styles had negative returns in the year, with small growth declining most, with a painful 17% loss.
This concentration in large-value companies caused the S&P to outperform the broad market, earning 2.12% versus the market’s 0.93% loss, as shown in the far right table and floating bar. In other words, allocation to styles benefited the S&P relative to the total market in 2011. The other component of attribution is stock selection, which we can see as the location of the dots in the exhibit. For the most part, the stocks selected by the S&P committee performed near their respective medians within each style, with the exception of mid-cap core, where S&P stocks substantially outperformed.
You can use this exhibit to rank individual managers within styles, as well as rank their style components. Just plot your dots in the graph above. For example, locate your manager’s style in the exhibit (large value, small growth, etc.), and place his or her rate of return within the corresponding floating bar, using the scale on the left and the median from the table above as your guide. Voila, an accurate ranking.
Throughout this commentary, I use Surz Style Pure® (SSP) indexes defined at Style Definitions. Because SSP classifies many distressed financials with high price/earnings ratios as growth, SSP returns have departed materially in the past four years from those of the name-brand indexes, such as Russell. Name-brand indexes rely upon price/book ratios for their style classifications, which classify distressed financials as deep value. The problem with price/book in this current market is that the book values of many distressed banks are grossly overstated because bad debts and mortgages are not fully reflected. Consequently these companies are being misclassified. The disagreements between these indexes and SSP are shown in the next graph.