Another Shining Moment

Cover Story, by Mark Robertson, Managing Partner

Posted on April 1st, 2014

If you’ve been around here as a subscriber for a while you may have heard or read about this before. For me, it was one of those etched moments during a few decades of investing. They don’t happen all that often but this one has been indelible.

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It was one of those moments. The setting was the 50th annual national convention of the National Association of Investors (NAIC) and the venue was Detroit’s Cobo Hall. The date was October 2001, mere weeks after the horrific events of 9/11/2001. One of our keynote speakers was renowned market technician Ralph Acampora, long-time friend to a long-term investing community embodied by a nation of investment clubs. Acampora is and was well-regarded and widely-regarded — perhaps most notably as one of Louis Rukeyer’s favorite “Elves.” It was moment because of something Ralph shared … a warning, and a beacon of encouragement for all of us in the audience. But the hairs on the back of my neck stood at attention as he described the situation and his concerns …

If you’ve been around here as a subscriber for a while you may have heard or read about this before. For me, it was one of those etched moments during a few decades of investing. They don’t happen all that often but this one has been indelible.

“I’m concerned. In fact, I’m a little worried. Why? Because there’s something in the world of investing that has become widely accepted. In fact, it’s become sexy and perhaps a little vogue.” [He may have struck a Madonna-inspired pose, but my memory may be a little hazy on that.]

“It’s this notion that buying an index fund is something of a panacea. Heals all wounds. Can’t go wrong over time…”

“And one of the most popular index funds is based on the S&P 500 …”

“Don’t get me wrong. Investing regularly is a fantastic idea and you all know that as Rule #1. I’m at risk of preaching to the choir here.”

“But mindlessly investing into the S&P 500 — a collection of large, very large, companies that have been on a TEAR for nearly ten years strikes me as vulnerable. In fact, I’d go so far to suggest that anyone investing in the S&P 500 index fund at this time is about to get killed.”

You could have heard a pin drop.

“But most of you are above all of this madness. You’re BETTER. You don’t invest in markets. You invest in leadership companies. In fact, your portfolios have been dominated by some of the S&P 500 blue chips for several years. But you’re going to excel over the next several years while others struggle.”

“Why? Because you’re stockpickers. You’re willing to hunt down promising smaller companies and — no matter what lies ahead — your quest for a blend of companies (based on growth and diligent about quality) will protect you from some of the carnage.”

He wasn’t patronizing us. He believed with all his heart that any long-term practitioner in the audience who could muster courage while channeling patience and discipline would realize better results on the road ahead. For many of you … for many of us, we know that he was right. Because as the next decade unfolded, it became known as the Lost Decade — particularly in the context of the S&P 500 market of stocks. The hairs on the back of my neck nailed it. So … what did Ralph know and when did he know it?

MANIFEST 40: Actual vs. Forecast P/E Ratios (1995-2013). This comparison of P/E ratio forecasts for the most widely-followed stocks by MANIFEST subscribers displays the exuberance from the early days of the last decade, a condition that has persisted for an extended period. P/E forecasts seem to have receded to normal levels by historical standards.

2001: The Thick Red Line?

What was on the mind of Ralph Acampora at the time? It might help to close your eyes and think back to those days of autumn 2001.

The 5-year trailing annualized total return for the S&P 500 was a staggering 16%.

Collective profitability had been bolstered for much of the last decade, a period we’ve referred to as the Renaissance of American Enterprise.

Growth rate expectations were … well … ambitious. Dot-com was a household word. Price-to-earnings ratios were clearly out-of-style. Many companies didn’t have an “E” … so P/E ratios were triple digits or NMF.

The accompanying chart shows the strong steady advance of the S&P 500-dominated Wilshire 5000 during the last half of the 1990s. It also displays the return forecasts back in 1991-1992 in the 16-20% range. Prescient.

Do you remember those days in 1998 and 1999 when the P/E ratio forecasts just kept meticulously ratcheting up? 20x last quarter … 25x during the next quarterly update … and 30x during the quarterly update after that?

Autumn 2001

Against this back drop, Ralph Acampora talked about things like The Nifty Fifty back in the mid 1970s. The average Value Line low total return forecast had dipped into mid-single digits during the early days of the new century but had continued even higher despite the market surge, when we’d typically expect a decline.

Market Forecasts During The Late 1990s. After several years of a surging (virtually unprecedented) market, the professional analyst community was forecast-challenged in the late 1990s and early years of the new century.

Ralph suggested that the S&P 500 forecasts seemed to be OK on the surface, but they were artificially inflated. As shown in the second figure, the astronomical P/E ratios of the late 1990s influenced analysts in 2000-2002 (and beyond) as the pendulum was now on steroids and immune from gravity or the lessons of history.

We’ve often wondered about these conditions back then, but never placed them in such stark relief. There are days lately when it seems like a throwback to 1999, but I’d forgotten P/E forecasts for companies like Walgreen (28x), Intel (35x), Stryker (28x) and Coca-Cola (30x).

Ralph most likely said something along the lines of … “We’ve Seen This Movie Before.” We know how it ends. But our audience who invests regularly in high-quality companies (not markets) when they’re on sale and makes absolutely certain to shop among smaller promising companies was gonna be OK. Ralph had a hunch that the S&P 500 indexers were vulnerable to a Lost Decade.

He was right. So were the hairs on the back of my neck. Thanks, Ralph.


Mark Robertson

Mark Robertson is founder and managing partner of Manifest Investing, a source for research and portfolio management focusing on strategic long term investors.

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