(PUB) Investing 2016

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Like Snowflakes, No Two Bear Markets Are Alike Morningstar Research | Kevin McDevitt

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

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