What's the Equal-value weighted( RSP ) vs Market-cap weighted, top heavy( SPY ) ratio useful for?
- Simply for discussing how two of the most well known investment strategies have performed in the recent years.
There's many books written on this topic, but I will try to keep this post as short as possible.
1. First things first, here's the whole chart.
As expected, in downturns, large caps should perform outperform small caps, simply because of the lower risk. People tend to park their money in safe well-diversified stocks, when the systematic risks become too high. Vice-versa, in normal cycles and economic expansions, due to the higher betas, small caps outperform large caps. This was understandable for the short liquidity cycles in 2011-2012, and 2015-2016, which I discuss in my previous idea on liquidity cycles,
But what about post 2016? There was a few rate hikes, but at the same time both fiscal and monetary expansion, that gave an above average GDP growth. Interestingly enough, the RSP/SPY ratio, almost has perfect correlation with the treasuries spread(yield curve, US10Y-US03M). Nonetheless, momentum strategy kept outperforming value investing. The question is why?
2. One of the answers is of course, the rise in the gig-economy and automation. Small business, even listed small caps, simply can't compete anymore. Whenever a company has a competitive edge(i.e instagram) it gets acquired by the time it becomes too threatening. Unfortunately, the end product of this trend, I would argue has been overall lower market competitiveness. The second answer to the same question, is because of the rise of ETF's and investing. In simple terms, ETF's magnify momentum outcomes. Buy high, sell higher. Greater up-trends, but at the same time greater down-trends!
3. Will the momentum outperforming trend continue in the future? As this trend has been going on for few years, it's very hard to tell how far the gig-economy will expand. Lately, there's been support for the idea to break up big-tech, but this will just takeaway the competitive edge that the U.S economy has over the world. Nevertheless, history has shown consistently, that trends typically revert to their mean, and as we head into the next decade there's a high probability that value investing will once again perform well.
To sum up this idea, with all said, I am taking the contrarian view. I think that we are entering into a speculative bubble. Obviously, things are looking quite well right now. Every-time, there's a minor chance of a market sell-off, the FED steps in with more liquidity. At last, the market will wake up at some point after the 2020 election(perhaps 2021-2022), and finally realize that there's no growth and no fundamentals supporting these high valuations(P/E consistently above historical average).
This is my view on value and momentum investing. If you are interested in a discussion, simply write a comment or send me a private message. Thanks for the continuous support!
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For reference, fundamental investing is doing even worse than value investing.
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