490 / 708
8
When I was starting my career as a Morningstar
analyst in the late
1990
s, one of my closely held beliefs
was that value stocks were lower-risk than growth
stocks. I believed that funds that invested in value
stocks would always hold up better in a bear market
than those that owned growth stocks.
After reading books by Martin Zweig and David Dreman,
I believed that the low price multiples of value
stocks meant that they inherently had less price risk
than growth stocks. Expectations were low for
value stocks, and any bad news was already priced
into the shares. Meanwhile, I interpreted growth
stocks’ high relative price multiples to mean that they
were priced for perfection and any slip in company
fundamentals would ravage their share prices. I had
a lot to learn.
But, sure enough, value stocks did weather the storm
better during the next two bear markets. (See the
table.) The first came in
1998
’s third quarter when
Russia devalued the ruble and defaulted on its
debt. This occurred while the dot-com bubble in the
United States was still inflating. From mid-July
through early October
1998
, the Russell
3000
Index,
a proxy for the U.S. stock market, fell
21%
. Growth
stocks did a bit worse, with the Russell
3000
Growth
Index dropping
23
.
3%
while the Russell Value Index
fell a milder
18
.
6%
.
Value stocks outperformed by a wider margin
during the next bear market, but in much more dramat-
ic fashion. When the dot-com bubble finally burst
in March
2000
, growth-oriented technology stocks—
and Internet stocks in particular—were truly priced
for perfection. Of course, Internet stocks weren’t
the only shares trading at ridiculous price multiples.
Huge swaths of the equity market were overpriced.
Even mature companies like
GE
GE
and
Coca-Cola
KO
traded at trailing price/earnings ratios near
50
times
or higher.
Even so, growth stocks, and technology shares in par-
ticular, took the brunt of the bear market that
began in March
2000
. The pain lasted for nearly three
full years, and the Russell
3000
Growth Index fell
a brutal
61
.
5%
. The Russell
3000
Technology Index col-
lapsed by nearly
80%
. Value stocks, many of which
were ignored by investors during the late
1990
s
rally, dropped just under
20%
, as measured by the
Russell
3000
Value Index.
But anyone who bet on a value index would have
been worse off during the next three corrections. That’s
because not every bear market targets stocks
selling at high price multiples. Growth fared better in
2007
–
09
,
2011
, and during the recent
2015
–
16
correction because the sell-offs were focused on finan-
cials and later on energy. So, it’s very difficult to
know whether value or growth stocks will endure the
next bear market better than their counterparts.
No two bear markets are the same, and the catalysts
behind them tend to change. There is usually one
sector that gets hit particularly hard, but it is difficult
to anticipate which one it will be. The
1998
bear
market was, as mentioned above, sparked by the
Russian default. Given that it was a debt crisis, finan-
cials were hit the hardest with the Russell
3000
Finan-
cials Index dropping
33
.
2%
. Alternatively, utilities
provided a safe haven (as they did during the recent
2015
–
16
correction). But the roles of those two
sectors reversed during the
2000
–
03
bear market.
Financials dropped by just under
5%
, while utilities fell
an incredible
57%
, second-worst behind
technology stocks.
Reversion to the Mean
Whichever style or sector has been in favor tends
to get hit the hardest during the next bear market. This
is the idea behind reversion to the mean. While
reversion to the mean almost always happens eventu-
ally, it’s very difficult to know when it will happen.
Often, it can take far longer than one expects. Alterna-
tively, beaten-down sectors can come in for another
Like Snowflakes, No Two Bear Markets
Are Alike
Morningstar Research
|
Kevin McDevitt