In April, markets surprised with their strong upswings and downswings. Stocks rallied all over the globe. The HCP Quant fund rose 11.43% in April and its benchmark index MSCI ACWI SMID Value Total Return gained 12.42% in euros. The US S&P 500 Total Return index in turn rose 13.17% in euros, whereas Europe’s S&P Europe 350 Total Return index returned a more modest +6.09%. Since the beginning of the year, HCP Quant is clearly ahead of its benchmark index, outperforming it by approximately 8 percentage points.
Quick rallies are a part of bear markets, after which the downswing continues. April’s recoil could be a so-called sucker rally, but we cannot know this for sure. Central banks’ stimulus efforts are stronger than in the financial crisis, which supports equities. Here too the United States seems to act more decisively and better than Europe.
The United States has this year too kept outpacing other countries. The story is the same old one I have told on many occasions. Big growth companies keep roaring ahead while smaller companies and value companies are having a more difficult time. The graph above shows the S&P 500 Growth Total Return index in euros year to date versus the small companies’ Russell 2000 Value Total Return index. These indices both represent American equity markets.
Where growth companies have returned +0.47%, small companies have lost 25.79% of their value. Quite a difference! We are still speaking of a market which considering the coronavirus situation is very strong. Considering this, HCP Quant has performed quite well this year. Especially considering that the fund does not have a single investment in the United States, but in markets where the trend has been more challenging.
The earnings yield spread (cheapest decile measured by the P/E ratio vs. the most expensive decile) is near an all-time high. The spread is already over 21%. Before in history, this has been followed by a 16.8% annualized outperformance period relative to growth companies over ten years. Typically the earnings yield spread is 6-9%. A good question for investors to ponder is how long this spread can keep widening.
In bear markets, small companies’ shares often drop in price faster than large companies’. Correspondingly after hitting the trough, they have rallied more quickly. The US Russell 2000 index lost 21.90% in March and lost 30.89% for the first quarter. One can get a perspective for this crash by looking at how such companies have performed over the next 1-10 years. Small companies’ 25 worst months’ drop has been on average 22.7% (21.90% in March 2020) and for the quarter -34.6% (2020 Q1 -30.9%). This year’s numbers are thus quite close to historical means.
With the market cycle turning from bear to bull, small companies have been one of the best-performing asset classes. After big drops, small companies have outperformed large companies over one, three, five, and ten years.
One of the most used pieces of investment advice is to buy low and sell high. Following this when you are shopping for milk is easy, but when it comes to investing it seems difficult. Investing in something that has had poor returns recently feels difficult. Still, markets have rewarded just such choices made by investors historically.
Are we experiencing a reversal or are we in the middle of a sucker’s rally?
HCP Quant portfolio manager
“Feel the fear and do it anyway.”
(This text is a translation of the Finnish-language HCP Quant investor letter.)