The valuations of most stocks stretched a long way down in 2008, getting to a level where the disappointments driving them down became irrelevant. From 2009 to 2012 the valuation of almost everything rebounded, first in the face of apparently awful general news, and then as the news turned out to be less terrible than feared.
Individual stocks and industries tended to move in response to general surprises – and until 2012 surprises were unusually prevalent. 2012 marked a transition only in the sense that general surprise turned to general disappointment, but it did sow the seeds for a more interesting and eclectic 2013.
Last year saw stocks start to move towards extremes; there was a big spread between winners and losers and some big divergences in sector performances. The stocks starting to move in 2012 kept on going; stocks that had been left behind in 2009-2011 headed towards the middle, and stocks that had rallied unusually hard since 2008 started to roll over. Mid-2012 set the direction, 2013 carried them past the middle line.
This meant news flow orientated strategies – buying stocks where things were getting better and selling stocks where things were getting worse – worked well in 2013. So house builders and retailers did especially well, having past the nadir in 2012. Mining, energy, tobacco and food retailing performed poorly. The former stocks delivered generally surprising results, and were rewarded and this helped lift lingering anxiety. The latter generally disappointed as growth became more difficult, while management remained in denial.
Management lacked discipline
Valuation was slippery. Valuation based on cash flow, or earnings, was a poor indicator of relative direction. A lot of ‘cheap’ looking stocks stayed cheap or got cheaper, while a lot of ‘expensive’ stocks stayed expensive, or got more expensive. A more helpful way of spotting winners from losers was to watch management behaviour.
Industries where management behaviour lacked discipline did badly. For all the talk of ‘capital discipline’ in the mining sector, companies still expanded aggressively, and couched all the ‘capital discipline’ language in terms of expanding more slowly than before. Real capital discipline is about not expanding at all. Struggling businesses, like Tesco, still persisted in chasing growth overseas, while realising it also had to spend more at home, just to stand still.
But in general, the scars of 2008/2009 still exerted a restraining influence on management behaviour. M&A activity remained low, capital expenditure was only marginally expansive, and a reasonable number of companies remained unusually open to returning money to shareholders through stock buybacks and special dividends.
Despite the heady stock price moves of 2013, the conditions for an equity investor remain relatively benign.
The trauma of 2008 still keeps investor anxiety at sensible levels. Widespread capital discipline keeps risk in check. We suspect the same stocks that moved last year will move in the same direction in 2014, and generally most stocks will move up.
