Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
It's almost time to pop the champagne, toast the year that has been and look forward to what the new one will bring.
But, before pulling out the crystal ball, I have a confession to make.
I don't know where the markets will go in 2016. I wish I did. But trying to make firm predictions about the market's short-term moves has always seemed like a fool's errand.
It's one reason why I find value investing so appealing. Wise investors look for a substantial margin of safety to help offset the uncertainty of the market. That is, they refuse to pay up for a happy consensus and instead look for outstanding bargains that are unlikely to collapse at the first sign of trouble.
Unfortunately, 2015 proved to be a difficult year for Canadian investors. The broad Canadian stock market – as represented by the iShares S&P/TSX Composite ETF (XIC) – fell 6.7 per cent from the start of 2015 through Christmas. Matters were even worse for many energy and mining concerns, with the iShares Energy ETF (XEG) down 22.7 per cent and the iShares Materials ETF (XMA) down 18 per cent, according to Morningstar.ca.
Alas, the large-cap iShares Canadian Value ETF (XCV) lost 8.2 per cent over the same period. It also trailed the S&P/TSX Composite ETF by an average of 1.2 percentage points annually over the past three years.
On a more positive note, it bested the market ETF by 0.8 of a percentage point a year over the past five years.
The situation was better in the United States for the overall market, but much worse for large-cap value investors.
The S&P 500 – as represented by the SPDR S&P 500 ETF (SPY) – climbed 2.2 per cent from the start of 2015 to Christmas. On the other hand, the SPDR S&P 500 Value ETF (SPYV), which tracks value stocks in the S&P 500, fell 2.1 per cent.
The S&P 500 Value ETF has underperformed the S&P 500 ETF – prepare yourself for this – over the past one-, three-, five- and 10-year periods. It outperformed the market ETF by only 0.1 of a percentage point a year over the past 15 years.
It has been a trying time for value investors that feels a bit like an echo of the late 1990s. The go-go stocks of the day are ascendant and some people believe value investing has lost its mojo. It's open season on Warren Buffett, who is, once again, being portrayed as a quaint has-been.
Those who've been through similar cycles before will find such sentiments encouraging. After all, there have been – and will be – long periods when value stocks lag the market. But over the very long-term – as measured in decades – it's an approach that has fared very well indeed.
To get some long-term perspective, I turn to the Credit Suisse Global Investment Returns Yearbook.
The 2015 edition reveals that global stocks provided average real returns of 5.2 per cent annually from 1900 through 2014. That includes 23 countries and a couple of total losses from the Russian and Chinese markets in earlier years due to Communist revolutions. Other countries saw big gains from stocks despite more than a century's worth of wars and other calamities.
If past is prologue then investors should bet that stocks will move higher in 2016. After all, the S&P 500 climbed during 72 per cent of the calendar years from 1928 to 2014 in nominal terms. The odds are similar for the S&P/TSX composite, which saw gains 74 per cent of the time from 1958 to 2014. (Both figures include data from predecessor indexes in the early years.)
When it comes to value investing, I like to point to the long-term data complied by money manager James O'Shaughnessy in his book What Works on Wall Street. (If you don't own a copy, give yourself one as a New Year's present.)
He found that the tenth of large stocks with the lowest positive price-to-earnings ratios beat the market 67 per cent of the time over one-year periods from 1964 through 2009.
They topped the market in 95 per cent of the rolling 10-year periods. Over all, the low ratio stocks outperformed the market by an average of 3.4 percentage points annually.
While it might be easy to think that the end is nigh during a soft patch, odds are good that the markets – and value investing in particular – will fare well over the long term. After a dry spell, it's important for value investors to stick to their guns in the new year.
Norman Rothery