In my opinion there is no better example of the differences between Momentum and Value Investors than Bank of America ($BAC)-see the chart of the $BAC Daily Closing Price from June 2011 thru Feb 10, 2012 below.
(This note is not a recommendation for or against BAC but is simply meant to be an observation of the differences in investor thinking as they play out in the marketplace. I do recommend Bruce Berkowitz’s Fairholme Fund $FAIRX which has a position in BAC and hold Warren Buffet in high regard as one of the best value investors of all time who also holds a position in BAC)
The market and the media reflect a composite of investor styles and these include a hefty dose of the current trend of market psychology. My personal observations convince me that most investors (this includes professional portfolio managers) are driven by headline news and the belief that stock trends reflect “hidden fundamental information” that is not being revealed publically. This is often referred to as “The Invisible Hand” by many, but I think that it is more akin to the general belief in “Grand Conspiracies”. Most investors in my opinion do not believe that publically available information reveals the true nature of investment fundamentals and believe that “Smart Money” or individuals with inside knowledge have superior access to investment information and that the market reveals this in price trends. This is the basis for Technical Analysis and its use by Momentum Investors. Momentum and Technical investors are by definition short term investors! The market’s activity reflects this belief as it responds to news events as if each event casts a startling new light on the market or particular stock.
On the other hand, Value Investors believe that all one needs is information that is publically available to all investors. They routinely advise that to learn value investing and in particular to develop one’s own value investing style, one should read annual reports and the reams of information that is publically available. The market to Value Investors is in essence an “Open Book”.
The fundamental difference between Momentum vs. Value investors is the time perspective of each. Value investors view investments thru a lens of 50yrs+ of business and market cycles. If they turnover a portfolio more than 100% in 10yrs., it would be surprising. Momentum investors typically turnover portfolios more than 100% each year and there are many who turn portfolios 300%-500% in a single year (some managers have yet greater turnover). The term “Value Investor” is so overused about by the media that understanding the true differences between a true “Value Investor” and other investors is more than a little confusing. Buffett and Berkowitz fall into the Value Investor category.
Fundamental value (and the process which creates it) as defined as Earnings Growth, Book Value Growth and Dividend Growth does not occur in a series of public week to week or even month to month events. Value creation occurs by careful attention to business over the years. Value creation is especially accelerated during the upcycle portion of the business cycle. We are currently in the upcycle portion of the business cycle and by all appearances are witnessing accelerating employment. This can have a spectacular positive effect on financial stocks especially the banks. Of particular importance to improving bank earnings is the housing market which has shown recent strength especially in the HAHB HMI Index and the pace of New Single-Family Starts. The impact of higher employment which we have witnessed since Jan 2010 on diminishing the level of mortgage delinquencies can be enormous and prove a positive for financial stocks. Since June 2011, the positives in the financial stocks were overwhelmed by fears of default by several European Sovereign Debt issuers.
In the chart below I have added media headlines that reflect the change of market psychology concerning BAC since Jun 1, 2011. The financial news which was still negative in June 2011 became much more so as headlines became filled with European debt default fears and its impact on US financial institutions. Value Investors were buying BAC in the face of this extraordinarily negative news. The news continued negative till BAC reached its low point of $4.92 intraday on Dec 19th. The chart shows some of the headlines of the period in which some expressed fears that BAC could fail. Value Investors continued to buy! Both Berkowitz and Buffett were roundly criticized for their investment decisions to buy BAC. The media ignored their long term investing prowess. For the media and its many pundit commentaries, the short term decline in BAC June 2011 to Dec 2011 was vindication enough to declare that Buffett and other Value Investors had suddenly lost their investment abilities. Ignored in many analyses has been the fact that European regulators banned financial stock short selling. Short selling is the sale of stock in anticipation of it falling in price enough so that one can buy it back much lower for a significant gain. Banning short selling in Europe caused this activity to be visited on US stocks instead, i.e. BAC, AIG and the like. Meanwhile, the fundamental health of these issues continued to improve while Momentum Investors shorted these issues spurred on dire consequences that they believed were being telegraphed in lower stock prices.
Since Dec 2011, the European Debt fears have eased somewhat as has the short selling of US financial issues. Suddenly, US financials which were considered “Pariahs” of the stock market have become the “Darlings”-see the headline entries in the chart. Yesterday, CNBC analysts were praising BAC as the “hottest stock in the Dow” and likely to rise above its Tangible Book Value of $12-$13shr and even likely to exceed its Stated Book Value of ~$21. BAC was spoken of as having “tremendous value” and the ownership by those renowned investors Berkowitz and Buffett was touted. Suddenly, Buffett and Berkowitz had regained their respective caches. Such is the nature of market psychology!!!! Such is the power of a stock trend!!!
In less than 2mos BAC has gone from “Pariah” to “Darling”
If one takes the time to do the research, one can see that BAC has been improving since Brian Moynihan became CEO Jan 2010 as he restructured the Countrywide and Merrill Lynch investments of 2yrs before. It has been a steady process, but one that takes time. This information has been publically available in BAC’s multiple SEC filing
Market psychology is a powerful force and one that is unpredictable. What we can generally predict is our business cycle as there is a history on which to base one’s judgment. Since the 1940’s, the US has developed a considerable database comprising many aspects of the US economy and its cycles. The data which is available expands every month. For Value Investors whose perspectives are often 50yrs or more, this is grist for the mill. There is substantial information with which to make investment decisions if one’s time frame is the current business cycle, i.e. looking forward the next 4yrs-6yrs. But, developing expectations 6mos into the future is virtually impossible due to the nature of events which impact market psychology. The investment markets do not permit precision of the nature so often discussed on CNBC. There is no better recent example of this as BAC which many thought was headed for failure in Dec 2011 and which is now held in high esteem as a good value and viewed as a market top performer. Wow! What a flip-flop!! And, Momentum Investors call this ‘value investing”.
As investors in a period in which Hedge Funds dominate the day-to-day, week-to-week and month-to-month trading activity, trading on each news event and rumor with such rapidity and force that markets can gyrate ~5% in a single day, we need to know our investments, our portfolio managers and maintain patience. Very good portfolio managers like very good CEOs are a minority. Their skills are built over many years. They do not suddenly lose their investment judgment and go from geniuses one day to idiots the next.
There is an investment lesson to be learned in the market’s recent resurrection of BAC.
I hope this discussion of recent events in the context of various investment management styles which participate in the markets.