Joel Greenblatt’s Market Observations

Investing

US Equity Markets Remain Very Expensive (based on our 28-year valuation history)

  • S&P 500 and Russell 1000 are both in the 15th percentile towards expensive
  • When markets have been at these levels in the past, one-year forward returns have averaged 2-4% and two-year forward returns have averaged 7-9%, which is well below normal returns historically
  • Russell 2000 is in the 3rd percentile towards expensive. When the Russell 2000 has been this expensive in the past, one-year forward returns have averaged between -3% to -5%

Large Disparity Between Growth and Value has Continued

  • Outperformance of growth and momentum-driven indexes over value has continued through the YTD period (as of 8/31)
  • Morgan Stanley Momentum Index has outperformed Morgan Stanley Value Index by 31.8% (11% vs. -20.8%)
  • Russell 1000 Pure Growth Index has surpassed the Russell 1000 Pure Value Index by 25.7% (28.6% vs. 2.9%)
  • Russell 1000 Growth Index has outperformed the Russell 1000 Value Index by 12.7% (16.4% vs. 3.7%)
  • From 1980 to 2006, value outperformed growth by an average of 2% to 5% per year. Since the GFC, value-oriented strategies have underperformed growth strategies by an average of 5% per year. Over this period, the only year where value substantially outperformed growth was 2016

There Has Been Outperformance by Money Losers

  • Over the YTD period, money-losing names have outperformed the overall indexes. We do not believe this trend can persist and are confident that markets will revert back to reflect underlying company fundamentals
  • YTD average return of all companies with negative cash flow in the Russell 1000: 15.7%
  • YTD average return of all companies with negative earnings yield in the Russell 1000: 31.5%
  • We are generally short “hope stocks”, many of which burn cash and/or trade at 50 to 100 times FCF

The Opportunity Set is Significant

  • Expensive valuation levels and the disparity between stock returns and fundamentals both point to very attractive expected spreads for us going forward
  • The valuation gap between value and growth has become very stretched. Although we can’t predict exactly when, we believe it will inevitably snap back in a big way

Gotham Funds Market Observations, September 13, 2018

Image Source: Forbes

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