Macro Value Investing What to Expect in Sideways Markets Presented Presented by: by: Kim Shannon, CFA, MBA President & Co-CIO Sionna Investment Managers Economic Growth Only Explains 17% of Stock Market Returns No Clear Correlation Between Long-Term GDP Growth and Equity Returns (1900-2012) We continue to ignore political and economic forecasts which are an expensive distraction. Warren Buffett Source: The Bank Credit Analyst as at November 2012. Provided for illustrative purposes only. Past performance is not indicative of future results PAGE 2 Short-Term vs. Long-Term Historical Perspective Dow Jones Industrial Average Source: http://www.macrotrends.net/1319/dow-jones-100-year-historical-chart. Provided for illustrative purposes only. Past performance is not indicative of future results
PAGE 3 Additional Value Tool Micro Value Investing Macro Value Investing Traditional New tool Stock level analysis Market level analysis Capital gains primary Dividend yield primary Valuation level Bull or range bound phase Stocks have life cycle
Markets increase over long run Takes advantage of emotional mispricing Examines trend behaviours PAGE 4 First Financial Buddhist Invisible Hand Benefits of Trade Reconciles Fundamentals with Emotions By pursuing his own interest, he frequently promotes that of the society more effectually than when he really intends to promote it. Adam Smith, The Wealth of Nations (1776) PAGE 5 Range-Bound Markets are Frequent U.S. Stock Market 16 Years 10 9 As of 2016:
Returns (log normal scale) 8 15 Years 7 Markets have been range-bound 107 of the last 143 years Secular bull runs are a rarity, not the norm After major bull markets, markets have historically trended sideways for a minimum of 15 years
6 5 20 Years 4 3 2 1 25 Years 30 Years Source: Wells Capital Management. For illustrative purposes only. The above returns do not represent the performance of any product or security managed by Sionna or Bridgehouse and are provided for illustrative purposes only. The performance presented represents historical performance of an unmanaged index. Returns would have been lower if they were subject to management fees and trading expenses. Past performance is not an indicator of future results. The indices are unmanaged and have no fees. One cannot invest directly in an Index. PAGE 6 Market Returns Tend to be Bi-Modal Frequency of US Returns Since 1872 (64 of 144 observations are between 0% to 20%) Number of Observations
12 10 8 6 4 2 0 0 to 2 2 to 4 4 to 6 6 to 8 8 to 10 Percent Source: Robert J. Shiller, S&P 500 Price Returns, average annual returns since 1872 is 5.9%. PAGE 7 10 to 12
12 to 14 14 to 16 16 to 18 18 to 20 Last Full Sideways Market (1965-1982) 4 100 CRB Spot Index Dow Jones Industrial Index Dow Jones Industrial Index PE Ratio 90 80 70 3.5 60 3
50 40 2.5 30 20 2 10 1.5 1950 Dow Jones Industrial Index (PE) CRB Spot Index & Dow Jones Industrial Index (Log Index) 4.5 Sideways markets typically end with single digit P/Es
0 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Source: Rathbones Investment Strategy, February 2008. CRB: Commodity Research Bureau. P/E: Price/Earnings ratio *As at December 31, 2016. The above returns do not represent the performance of any product or security managed by Sionna and are provided for illustrative purposes only. The performance
presented represents historical performance of an unmanaged index. Returns would have been lower if they were subject to management fees and trading expenses. Past performance is not an indicator of future results. The indices are unmanaged and have no fees. One cannot invest directly in an Index. PAGE 8 Learn to Love 6% Expected Return of Sideways Market Earnings Growth + Change in P/E Multiple + Dividend Yield Bear Market 19291932 Range-Bound Markets* Average Bull Markets Average Earnings Growth -28.1 5.6 5.6 +/- P/E Growth
Inflation/Deflation -8.4 4.9 2.5 Total Real Return -26.4 1.0 14.2 + Dividend Total Return Jan. 2000 Dec. 2016 S&P/TSX Composite 6.1% S&P 500
4.1% MSCI World 3.2% MSCI Canada 6.1% MSCI Global (US) 3.8% Top Table *Range-Bound Markets: 19061924, 19371950, 19661982 Bull Markets: 19501966, 19822000 Dividends are 90% of total returns in range-bound markets. Values in chart shown in percent Source: Vitaliy N. Katsenelson Active Value Investing Making Money in Range Bound Markets, 2007. PAGE 9 Annualized Return (CAD)** Bottom Table
**Gross Total Returns Source: Bloomberg For illustrative purposes only. Indices are unmanaged and cannot be directly invested into. The Price of Entry Contributes to Returns Subsequent 10-Year Returns Based on S&P 500 P/E Ratios from 1871 - 2012 S&P Forward Earnings Cheapest valuations S&P 500 Trailing Earnings Most expensive valuations Buy low, increase chances of good returns. Buy high, increase chances of low returns. Source: Plexus Asset Management (based on data from Prof Robert Shiller and I-Net Bridge). As at September 30, 2012. The above returns do not represent the performance of any product or security managed by Sionna and are provided for illustrative purposes only. The performance presented represents historical performance of an unmanaged index. Returns would have been lower if they were subject to management fees and trading expenses. Past performance is not an indicator of future results. The indices are unmanaged and have no fees. One cannot invest directly in an Index. PAGE 10 Are We There Yet?
If earnings growth continues at same pace as history, P/E will fall to 9x sometime between 2020 and 2022 Price and Earnings levels of the S&P TSX Composite Index Average earnings growth of 6.1% since bull peak suggests 2020 Historical range-bound markets earnings growth of 5.6% suggests 2022 (Katsenelsons Active Value Investing) Source: Bloomberg PAGE 11 Bond Yield Trends Tend to Last Approximately 20 Years and Symmetrical 10-Year Treasury Rate (percent) Max. 15.32% (Sep 1981) Min. 1.95% (Jan 1941) Suggests rates may bottom 2021 Source: US Treasury, January 20, 2017
PAGE 12 Recent Min. 1.36% (July 2016) Interest Rate Changes Will Historically Signal Equity Bull Market Asset Classes & Secular Trends Monthly Data 1900-01-31 to 2013-11-30 (Log Scale); Source: Ned Davis Research Group, December 2013. Indices are unmanaged and cannot be directly invested into. PAGE 13 U.S. Weak Recovery Follows Path of Big 5 Modern Financial Crises The Slow Pace of the U.S. Recovery Suggests that economy and bond yields can stay subdued for some time Source: C.D. Howe Institute, Commentary No. 413, July 2014; U.S. Bureau of Economic Analysis, Organisation for Economic Co-operation and Development, and Bank of Canada. This chart updates one which originally appeared as Chart 7 in Bank of Canada, Money Policy Report, July 2012. PAGE 14
Excessive Debt Historically Leads to Extended Periods of Low Interest Rates Average number of years to lowest level of interest rate after panic: 18.6 After excessive debt panic years: Reduces GDP Growth, slows inflation and lowers long term interest rates Suggests low in bond yield could be 2026 (2021-2026) Source: Federal Reserve Board, Homer & Sylla. Bank of Japan. U.S. line through 2012 PAGE 15 Macro Value Investing Suggests Yields Bottom and Equities Enter Bull Around 2018-2021 Current earnings growth trend suggests single digit P/E of 9 by 2022 Two standard deviation event symmetry suggests after an 18-year bull market, will get an 18-year sideways market; thus sideways should end 2018 Bond market symmetry suggests 40 years: 1981 + 40 = 2021
Reinhart and Rogoff after major financial crises it takes 10 or more years for economy to recover and return to normal On average, rates bottom 13-26 years after major financial crisis with an average of 18.6 years, suggesting 2026 Expect modest returns in next decade in both equities and bonds, but equities with better yields should do better PAGE 16 Lessons From Sideways Markets Lows in rates probably not seen yet Equity returns volatile and below long-term averages in sideways (disappointment in equities is cyclical, not secular) After rates bottom, equities will historically enter a long-term secular bull Expect modest returns in next decade in both equities and bonds, but equity returns will exceed bond returns Time to begin bringing equity allocations back to more normal levels PAGE 17 Benefits From Adding Macro Value Investing
Deeper understanding of markets Clearer indications of expected returns Long-term market return ~ 9.5% Sideways return ~ 6.0% Bull return ~ 17% Sense of when and how paradigm pricing shifts may occur Supportive of asset mix decisions PAGE 18 For More Information Sionnas communications offer subscribers additional insight from the managers. Subscribers can choose to receive: Quarterly Emails Soundbites Daily Value Quotes To subscribe to email updates, please visit: www.sionna.ca/sign-up/. eBook and Hardcover available: http://www.sionna.ca/commentary/book Or follow us:
Sionna Investment Managers @SionnaValue Links to other internet sites should not be construed as an endorsement of any kind or of the views contained therein. PAGE 19 Disclaimers Any information contained in this presentation is provided as a general source of information and should not be considered personal investment advice. Every effort has been made to ensure that the material contained herein is accurate at the time of publication. However, Sionna Investment Managers cannot guarantee its accuracy or completeness and accepts no responsibility for any loss arising from any use of or reliance on the information contained herein. Certain statements in this presentation are forward-looking. Forward-looking statements are statements that are predictive in nature, depend upon or refer to future events or conditions, or that include words such as may, will, should, could, expect, anticipate, intend, plan, believe, or estimate or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the forward-looking statements. The forward-looking statements are by their nature based on numerous assumptions. Although the forward looking statements contained herein are based upon what Sionna Investment Managers believe to be reasonable assumptions, Sionna Investment Managers cannot assure that actual results will be consistent with these forward-looking statements. Forward-looking statements are not guarantees of future performance. Any number of factors could contribute to differing results including, among other things, general economic, political and market factors, interest and foreign exchange rates, global equity and capital markets, business competition, technological change, changes in government regulations, unexpected judicial or regulatory proceedings and catastrophic events. This list of factors is not exhaustive. Investors should not place undue reliance on forward-looking information. PAGE 20
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