2018 Strategies Review - A tough year for the gurus

After a solid 2017, most of the 60 guru-inspired investment strategies tracked by Stockopedia hit turbulence in 2018. Much of the trouble started in the second half of the year - and the worst of it unfolded in the final three months. After a decade of powering market returns, growth and momentum strategies pulled back sharply. Whether it’s the start of a new trend is unclear. Either way, stock market investors finished 2018 feeling pretty bruised.

About the Guru Strategies

2018 was the seventh full year of us tracking the Guru Strategies in the UK, with slightly less performance history for Europe and the United States. Over time, these models have been a handy gauge of what’s working in the market and how different styles react to different conditions.

Not only do they show what’s working, but they also show when trends start to change. Through the lens of of the gurus, we get to see how different styles of investing - spanning Quality, Growth, Value, Bargain, Income and Momentum - interchange with each other.

Over the past seven years, which covers a good chunk of the boom in equities since the financial crisis, it’s clear just how successful the growth and momentum trades have been (see the orange and red lines in the chart below). That performance actually accelerated in the after the EU referendum in June 2016. In fact, it’s fair to say that both styles were still strong right up until last summer.

But as the year wore on, the bull faded fast. In the US, the prospect of rising rates and trade disputes were just two of the reasons why the S&P 500 finished the year down 6 percent. In the UK, the same concerns mixed with a host of domestic economic and political uncertainties sent the market sliding. The FTSE All Share closed the year down 13.0 percent, while the more speculative AIM All Share finished with a fall of just over 18 percent.

In terms of the mechanics of Stockopedia’s Guru Strategies, each one has its own set of rules, and we constantly screen the market for companies that meet them. At the end of each quarter, those passing the rules are held in a portfolio for each strategy, which we track. It’s fair to say that the models aren’t always realistically investable, and sometimes there may not be many companies that meet their rules. In addition, we don’t account for the drag of trading costs or the bonus of dividend payments in the performance data.

A few highlights (and lowlights)

October saw the biggest falls for the previously strong growth and momentum strategies. Those models that posted positive gains - including the Jim Slater Zulu Principle screen (+8 percent) - either did it with strong results from a concentrated number of holdings or just managed to cling on to good returns from earlier in the year. Previous big 2018 winners for the Zulu strategy included stocks like dotDigital, Impax Asset Management and Iomart.

Moving into 2019, the number of stocks in the Zulu folio is stuck at six, which is the same as last quarter. Until the number of companies qualifying for that strategy rises, it’s going to be hard to get excited about growth. The Zulu screen is a neat balance between earnings growth, reasonable value and momentum. In the past it has been a good barometer of sentiment: when markets are under pressure the screen just dries up. Whereas in 2016, when markets were stable and just easing upwards, there were lots and lots of stocks passing the strategy rules and the folio did very well.

Meanwhile, in the momentum screens, the two that managed a positive return in FY 2018 were the Price Momentum and Jim O’Shaughnessy Tiny Titans strategies. That really masks what were two very solid performances though the bulk of 2018 and several years past. Tiny Titans, for instance, is a very simple two factor value and momentum screen focused on small-caps. But it just keeps on delivering consistent returns. To be fair, the stocks themselves can be illiquid, volatile and very unpredictable, but as a simple test of the power of small-cap value and momentum, it has been very robust over the past few years (see the chart below).

With stock prices tumbling and momentum dislocating, a lot of market commentary inevitably turned to whether value, as an investment style, would see a resurgence. It’s a bit early to say whether lower prices will lead to higher numbers of better quality of companies making it into value strategies. But there have been some promising signs. The leading value strategy in 2018 was the Ben Graham Enterprising Investor (+7 percent), and the number of companies passing that strategy does seem to have improved going into 2019.

Overall, the least worst style performance in 2018 was in the deep value bargain strategies. Here, the Trading Below Cash screen managed a 14 percent gain for the year. But it was propelled by a couple of big wins early in 2018, one of which was Webis Holding. So the true picture was that bargain strategies came under as much pressure as everything else in 2018.

Questions over quality

Over the past couple of years, the quality investing strategies - defined by gurus like Warren Buffett and Joel Greenblatt - have been fairly underwhelming. The Buffett strategies, for example, have underperformed and Greenblatt’s Magic Formula has been pretty flat too. Our take on Joseph Piotroski’s High F-Score model has perhaps been one of the most consistent.

Why the slow pace? It’s hard to say exactly but one argument is that the higher quality, large-caps the Buffett strategies look for have got pricey in recent years, which has held back returns. They had a terrible fourth quarter in 2018 but it’s worth remembering that the portfolios were refreshed just as the market started to slide. So those possibly expensive higher quality names quickly got cheaper. Refreshing into the new year, the new folios look fuller and perhaps better quality than we’ve seen in recent years. Certainly many of the holdings have rebounded with the market over the past week or so. So was it just that quality large caps were a bit toppy? We’ll have to see as the year unfolds.

Looking ahead to 2019

So what can we make of all this? Negative returns across the board for the gurus through 2018 were largely down to hostile market conditions in the last three months of the year. Before that, there had been some very strong performances. It’s a reminder, if anything, that it’s the longer term performance charts that really count. But from here, attention turns to how these strategies will react and recover.

While there’s never any certainty in the stock market, there’s perhaps just an extra twist of unpredictability about 2019. How that affects stocks is impossible to know. Hindsight bias says it’s pointless trying to map the past to the future in any kind of concrete way. But what we saw in the latter part of 2018 was a shift away from the go-go-growth and momentum trend that has been driving the market in recent years. Whether it’s a pause or a more solid change in direction… we’ll have to wait and see.