Santa Claus rally -when will this end?

[RetireJapan]

... but the last time the market was like this - New Year 2000 - the market crashed and it took 13 years for the S&P-500 to come back,

Including dividend reinvestments (S&P500 Total Returns Index) this figure drops to 7 years though.

Converted into Japanese Yen and adjusted for Inflation at 2% P.A., the S&P500TR briefly came in to profit between Dec 2006 and Aug 2007, and then finally broke into profit again in Aug 2013.

Might be more useful to look at the total world stock market -i seem to remember EM and ex-US did quite well during that period. Particularly as most people have ESAC or VT as their main passive holding.

[Tkydon]

https://contrarianedge.com/value-growth-demagogues/

[EmaxisSlim Cultist]

https://contrarianedge.com/value-growth-demagogues/

This is paywalled, you can only read a few paragraphs.

Since you have a subscription, you can go to Print-> select PDF and save a copy. Then post a link to the PDF.

Otherwise, it might be better to summarize the article to prompt discussion.

[captainspoke]

This would appear to be it:

Value & Growth Demagogues - Vitaliy Katsenelson Contrarian Edge
One company that comes to mind as I write this is Qualcomm. That stock went from $4 in 1999 to $80 – that’s a 20x increase. Qualcomm is truly an incredible company (we own its shares, which we bought for the first time in 2015). It owns essential patents on wireless technology. Your mobile phone runs on Qualcomm’s intellectual property. Every time a mobile phone is sold on any part of this large planet, Qualcomm collects a few bucks. An incredible and very profitable business. From 1999 the mobile phone market went through an incredible growth spurt – it’s hard to find a market that grew faster globally. However, this did not stop Qualcomm stock from declining to $14 (an 83% drop) in the early 2000s. It took 15 years for Qualcomm to revisit its 1999 high, while its revenues went up 6x over that time.

The value demagogues also look at the high current statistical valuation of high-growth companies and ignore that this number is based on rear-view mirror earnings. They ignore that there is tremendous value in growth, and that value is unlocked when a growth company escapes its adolescence and enters maturity. Its costs start growing at a slower pace than its revenues, its margins expand, and its earnings skyrocket. This is why in our models we look at companies based on their earnings at least four years out. If we have a unique insight into the sustainability of a company’s future moat and exploding total addressable market, we are looking out farther than four years and then discounting back to today.

What makes the analysis of some of the growth darlings more difficult this time is that their income is distorted (depressed) by investments (in customer acquisition, for instance) that are made through their expense line on the income statement.

Let me give you this example. Walgreens, when it was opening several stores a day during its high growth stage, was doing so through its balance sheet. It would buy land, build a store, and stuff it with inventory – all these activities happened on Walgreens’ balance sheet. But a store is a long-term asset that will help Walgreens generate sales and profit for decades. Walgreens would depreciate the land and building over 30 years; thus, as an investor, you would only see 1/30 of the building’s cost going through the income statement in any given year. Inventory would show in the income statement as cost of goods sold when they were sold. Costs in the income statement matched revenues they helped to generate.

When software-as-a-service (SAAS) companies acquire customers, the costs are expensed through the income statement, depressing earnings (they never touch the balance sheet). Though the customer may stick around for 10 years, the cost of acquiring that customer hits the income statement on day one (e.g., in the salesperson’s commission). The faster you grow, the heavier the customer acquisition burden you carry.

Research and development (R&D) efforts also don’t flow through the balance sheet but are expensed through the income statement. R&D is building an asset that will have a long-term life (just like a Walgreens’ store), but almost all of R&D cost is expensed in the year it happens.

Modern accounting conventions were created for the industrial economy, which was heavy on physical, easy-to-identify, depreciable assets (stores, factories, etc.). Over the last two decades significant parts of the economy changed, but we are not going to wait for accounting conventions to change, so we need to change.

We don’t want to be either value or growth demagogues, though it is easy to turn into one or the other. Our goal is to produce good returns for our clients (and ourselves since we own the same stocks) while sleeping well at night. Or, in other words, we try to maximize returns per volatility of our clients’ blood pressure. We are constantly making a conscious and very deliberate effort to be neither type of demagogue. Our portfolio today looks a bit more eclectic than a traditional value portfolio. Over the years we’ve made gradual changes to our analytical process to capture value when it resides in growth, which allowed companies like Twilio, Uber, Twitter, and others to enter our portfolios.

Though I don’t want to be a demagogue, period, if I had to choose sides today, I’d rather err in being a value demagogue. Traditional value (defined as slower-growth companies) has been underperforming growth for too long. Also, the pandemic has widened this gap significantly. Today the stock market cannot get enough of high-growth stocks (even adjusting for nuances in their accounting). We believe many are tremendously, if not insanely, overvalued.

Today, we see value in the more traditional (slower-growth) names. At some point this will change.

The world around us is changing at an accelerating pace. We should strike a delicate balance of learning and adjusting to changes but at the same time remaining true to who we are as value investors (I highly recommend you read Six Commandments of Value Investing, (click here to receive them in your inbox).

[Jansen]

This is what I am struggling with. Even the gains from the last twelve months would give us 6-10 years of living expenses. And yet I am still mentally in accumulation mode (and we're going to continue working).

So I really don't know what to do. This is a new situation for me, one I have never been in before.

Well then, what were you planning to do during your non-accumulation phase?
Maybe now's a good time for a dress rehearsal?

[RetireJapan]

Well then, what were you planning to do during your non-accumulation phase?
Maybe now's a good time for a dress rehearsal?

It's a good idea.

I've seen people write about living off their portfolio and then using all their income to invest. Might give that a go in 2023 (too many variables in 2022 with my change in work, etc.).

As you say, it would give us a chance to test some of our assumptions before retiring properly

[TBS]

Might be more useful to look at the total world stock market -i seem to remember EM and ex-US did quite well during that period. Particularly as most people have ESAC or VT as their main passive holding.

Here is that data:

In terms of the drop sizes and the number of years to recover to previous peaks, there was not much in it between the S&P500 and ACWI.

Converted into Japanese Yen and adjusted for Inflation at 2% P.A., the S&P500TR briefly came in to profit between Dec 2006 and Aug 2007, and then finally broke into profit again in Aug 2013.

I'd question the need to adjust for inflation after converting to yen. Japan went through years of deflation in the naughties.

Anyway, to me this all isn't a good way of looking at things. Highlighting one period of low growth and using this as a basis to advocate for an active investment strategy, aiming to beat the market by holding equities in rising markets and cash in falling markets... well it is not a convincing argument.

Passive investing is all about making peace with the fact the markets will rise and fall, and understanding that steadfastly staying in the game will pay dividends in the long run.

But, as you say of course, active strategies will work out for some

[Tkydon]

another way to look at it

If you invested a lump sum (or had an existing lump sum invested) in the ^SP500TR, and you invested it

2 Jan 2000 = 1983
2 Aug 2007 = 2381

Then your annualized interest rate would have been

(2381 / 1983)^(1/7.5) = 2.46% Annualized

But if you had taken the money out of the market crazy over-priced market, waited 2.5 years...

1 Sept 2002 = 1140
2 Aug 2007 = 2381

(2381 / 1140)^(1/7.5) = 10.3% Annualized over the full 7.5 years (including the 0% return 2.5 years)

2 Jan 2000 = 1983
2 Jan 2022 = 9990

(9990 / 1983)^(1/22) = 7.62% Annualized

1 Sept 2002 = 1140
2 Jan 2022 = 9990

(9990 / 1140)^(1/22) = 10.37% Annualized over the full 22 years (including the 0% return 2.5 years)

You have to have dry powder when the opportunity comes along.

[TokyoWart]

You have to have dry powder when the opportunity comes along.

I don’t think this ever works well for investors. It’s market timing no matter how you look at it. The S&P 500 has felt very expensive to me for a long time but by P/E ratio it’s actually cheaper now (30) than it was last January (35) or in January 2009 (71) or January 2003 (31). I don’t think there is a reliable way to get the good of market returns without the bad of volatility and the occasional market crash.

[TBS]

...

This is a perfect example of hindsight bias. As others have already said in this thread, the problem is predicting the market tops and bottoms to make such investment moves.

Moreover, comparing portfolio values at two fixed time instances like this is completely divorced from the practical realities of investing in the accumulation phase, then drawing down in retirement. Nobody invests by making one large lump sum once, then withdraws everything in one go in retirement. Investments are made as income comes in, retirement income is drawn down slowly. It is inevitable that you'll be buying in times of both high and low markets, and likewise drawing down in high and low markets. Comparing two time points like this is no basis in which to devise an investment strategy.

You suggest keeping some dry powder aside - if so what percentage of total wealth is appropriate? All your calculate annualized return rates will change depending on this %. It would be easy then to pick another decade when markets were thought to be hot but kept on rising, then calculate how much you'd miss out on by holding this dry powder.

Age old adage, but time in the market is better investment advice than trying to time the market.