The Resurgence of Small and Value
The year of 2016 had many interesting twists and turns. From the start of the year, which looked terrible (in fact the worst start to a calendar year in stock market history) to the unpredictable events scattered throughout the year, it would make you think 2016 was a rough one. But in fact, it was far from rough and in at least a couple ways, more of a return to normal. Why, you may ask?
- Stocks outpaced bonds: That may not be saying much, because long-term we all know this to be true. But it hasn’t felt true. Just look to 2015. That year global stocks (S&P BMI Global) lost -1.6% while bonds (Barclays US Aggregate Index) made 0.6%. Even taking a broader term perspective doesn’t overcome this feeling. Over the prior 15 years, an all-stock portfolio, with all the risk it assumes, returned about 5.3% per year. Compare this to a much less risky, much more boring all-bond portfolio and you would have made almost just as much, 5.0% per year. Over time, we want and need to be compensated for the risk we take on with stocks. The past year again turned that desire into reality with global stocks making 8.8% while bonds earned 2.7%.
- The return of factor premiums: The year of 2016 showed a strong resurgence of both the size and value factor premiums. Over time, but not all the time, stocks of smaller companies tend to do better than stocks of larger companies. Also, stocks that have cheaper prices relative to things like their earnings, cash flow, book value, or other metrics tend to do better than stocks with more expensive prices. You can see this depicted in the chart below:
Starting from the left, this chart shows the return of small companies minus the return of large companies. When the bar is negative, small companies did worse than large companies, like the 5 year stretch through 2015 (the blue bar). However, if you look over the long-term (the red bar), you can see that small caps indeed have done better than large caps. The green bar shows what happened in 2016. Both small cap and value showed tremendous resurgence power, particularly in the latter part of the year leading to the large outperformance in 2016.
Why is this important? The most obvious reason is that your stock portfolio has tilts towards small and value, so when years like 2016 happen, it’s a good thing.
But let’s dig a little deeper. The importance of this has to do with the one of the hardest things in investing, or in life for that matter: patience. Since your dollars are long-term, your strategy needs to be long-term. There are times, even prolonged times like the 5 years leading up through 2015, that can lead you to thinking that certain truisms of the past might be “different this time.” However, patience wedded with a sound strategy leads to the best results for your dollars over time. The year of 2016 was a friendly reminder of this very thing.