I’ve written this article for Institutional Investor Magazine. I feel very passionate about the topic and thus could not compress all my thoughts into 800 words. I expanded it and it was published in John Mauldin’s Outside the Box newsletter. “Expand” is an understatement as it is four times the original article. I suggest you skip John’s very kind intro (he is too kind) and go right into “Are We There Yet”? It is very long. Kill a small forest, print it. Also, leave me your comments, would love to hear your thoughts.
Vitaliy Katsenelson is a modern-day American success story, the kind we need more of. He grew up in Murmansk, in the extreme northwest corner of Russia, north of the Arctic Circle and close to the Finnish border. He says he barely escaped a career in the engine rooms of Russian Navy vessels when his family wrangled a visa to emigrate to the US in 1991.
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He finished high school here, knocked out a BA in finance at the University of Colorado at Denver, and followed up with an MS in finance and his CFA. At that point, a local Denver firm, Investment Management Associates, snapped him up; and before long he was one of the two principals in the company, alongside Michael Conn.
His first book, Active Value Investing: Making Money in Range-Bound Markets, appeared in 2007, and it proved Vitaliy had really been doing his homework: he had dug deep into the historical market data and emerged with insights that really broadened our understanding of range-bound or “sideways” markets (like the one we’ve been stuck in for more than a decade now). With the book, he also provided a very detailed strategic investment process for these very treacherous markets.
In today’s Outside the Box, Vitaliy brings those insights to bear on our present, tenuous situation, as we go on wondering what it is going to take to move the global economy off the (rapidly depreciating) dime and into a new, expansive phase. Vitaliy faces that question head-on, with a convincing combination of stock market analytics and global macro perspectives.
(This article is the core of a piece he just published in Institutional Investor. You can read the entire article here.)
Vitaliy and I corresponded on this piece for some time. I often publish something in Outside the Box I don’t agree with, as I like to listen to those who disagree with me. In this case, however, Vitaliy and I do in large part agree, although there are some minor points on which I will have to engage with him the next time we get together. We are still in the secular bear market whose imminent appearance I was writing about way back in 1999. The end of the bearish slant will come when valuations are low. That can happen with a decline in price or a sideways market for a longer period of time. It makes for a challenging equity market. But time is the healer for secular bears, and this one too shall pass. There is yet another secular bull in our future. Until then we get trading opportunities and have to look for value where we can find it.
John Mauldin, Editor
Outside the Box
Are We There Yet?
By Vitaliy Katsenelson
I started writing my first book, Active Value Investing: Making Money in Range-Bound Markets, in 2005; finished it in 2007; and published the second, an abridged version of the first (The Little Book of Sideways Markets), in 2010. In both books I made the case that there is a very high probability that we are in the midst of a secular sideways market – a market that goes up and down, with a lot of cyclical volatility, but ends up going nowhere for a long time.
Sideways markets happen not because stock market gods play an unkind joke on gullible humans but because of human emotions. Historically, sideways markets have always followed secular bull markets. At the end of secular bull markets stocks become very expensive – their valuations (P/Es) get very high. Sideways markets are just a payback for all the fun and returns stock investors received during secular bull markets.
In 1999, after 17 years of incredible returns, the mother of all secular bull markets ended at valuations we’d never seen before. For this reason, in my first book I argued that the present sideways market, which started then, might last longer than past ones. In the Little Book I want a step farther with the benefit of hindsight – it was written post-Great Recession. I argued that the economic growth rate going forward will be lower than it was in the past, and thus this sideways market may even last longer than I originally suspected.
Every so often I get an email from a reader with the question, “Are we there yet?” Are we still in the grip of a treacherous sideways market, or we are now entering into a secular bull market? I will try to answer that question as best I can in this writeup.
The Sideways View of The World
In early May I had the pleasure of attending and speaking at the Value Investing Congress in Las Vegas. The last time I spoke there it was May 2008 and the market was just coming off its top. (Here is a PDF of the ’08 presentation, and the new presentation is here.) The S&P was at 18x trailing earnings. Profit margins were at a modern-day high. They subsequently collapsed but came back to set an even higher high.
The market was not cheap in 2008. It is not cheap now, either.
Before I dive into my argument I need to introduce you to a very simple calculation that is at the core of my sideways argument:
E + Change in P/E + Dividends =