Learn why the stock market dramatically shifted starting in 1975, why this recent bear market was so severe, and why we see the next bull market on the horizon.
Welcome to our Eye on Market Trends segment featuring macroeconomic and stock market commentary grounded on facts, not opinions. Robert Zuccaro, Founder & CIO of Golden Eagle Strategies, shares his 2022 market outlook along with some untold facts and stories about the economy, stock market and the aggressive growth investment style. Robert is a quant pioneer driven by a never-ending pursuit to identify the common threads of top-performing stocks in pursuit of superior performance. He is also a prolific writer and author of the book How Wall Street Reshaped America’s Destiny.
A long time ago, my wife and I got out of college and we started saving money. Intuitively, I knew savings should go into the stock market, which is the best place for it. I read a book before I came into the investment business. The book is still topical today. It's called How To Buy Stocks by Louis Engel. And he made a case for investing in growth stocks, which made imminent sense to me. So immediately, the first thing I did was to adopt a growth stock philosophy. The first stock that I bought in 1968 was a manufacturer of handbags that traded on the New York stock exchange. The company was growing its earnings at a rate of maybe35% per year and I doubled my money in 90 days. So I was off to the races.
Ever since, I've continued to work and research the relationship between earnings growth and stock prices and every study that I've ever done over my 40 year plus career shows that there is a very high correlation between the two. In the early years, I used to buy fast growing companies, but subsequent research led me to the direction of investing in 25 of the world's fastest growing companies, based on two studies that we've done (1985 - 2000 and 2010 – 2019), which demonstrates that those companies that produce the fastest rate of earnings growth generate the highest market returns. And that's where we are today. And that's what our Golden Eagle Strategy embodies. We invest in 25 of the world's fastest growing companies.
The stock market is very different. One of the things that we do at Golden Eagle, we do a lot of data mining, and we have a lot of untold stories. And this is an untold story: historically the stock market returns 10% per year going all the way back to the University of Chicago studies, which started with the year 1926. But, the world changed for everybody in 1975. From 1926through 1975, corporate profits grew at a rate of 3.7%per year. And the stock market during that period, returned 9% annualized. We hit an inflection point in 1975, and that inflection point can be called technology.
What technology means is companies have rapid scalability. They have high productivity. And by that, I mean, Google and Facebook generate sales per employee of $1.5 to $1.6 million a year. Whereas Coca-Cola, which is a traditional company has annual sales per employee of $500,000. Technology means that companies can get to higher profitability than ever before. At the end of the first quarter, Corporate America hit record profitability in terms of net profit margins of 14.8%. If we look at Apple, it's net margins at the end of last year were 26%, Google 30%,Facebook 33%, and Microsoft at 36%. Now the federal government's concerned about the oil industry. They're picking on Exxon, because Exxon reported profits last year of $23 billion. What's not mentioned in the flogging of the oil industry is that they lost $22 billion the year before. As good as their profits were in 2021, they showed a net margin of 5%, which is less than half of corporate America so why in the world are we beating these people up? I don't think it's very appropriate and I don't think it's constructive from the standpoint of the economy and also from the standpoint of society.
So, let's look at1975 on. Corporate profits over this period accelerated to a 10% rate. And the market returns since 1975 have been the highest in history at an annualized rate of 12.1%. We have just gone through the wringer in the first six months of this year, the major market averages have gone down more than they have in any year since 1950. But as we speak today, I am every bit as excited about the outlook with the stock market and going forward and about the outlook for aggressive growth stocks, which have led the market in the past and will continue to lead the market in the future.
The entire stock market has just gone through its worst first half ever. In 2008, the aggressive growth category went down more than the S&P. And in that calendar year, our index showed a decline of 44.8%. In just six months, our index for aggressive growth companies has gone down 47%. If we go back to the 2000-2002 bear market where aggressive growth funds lost 64% of its value - from the market bottom they went up 67% over the next five years, from the market bottom, they showed a return of 188%. So off the bottom, they in effect, tripled in price. In terms of 2007-2008, it was a 13-month bear market. The index declined 54%. Coming off that market bottom, the aggressive growth fund index shot up 62% over one year and 208% over the next five years. So the outlook for these companies and these stocks is very bright.
Now there's acritical fundamental difference between now and yesteryear. In 2001 corporate profits dropped 31%. In 2008 corporate profits dropped 40%. Despite the shellacking that this investment style has taken in the first half of this year, corporate profits, aggressive growth earnings are actually up over the past six months. Now this is important. This is an untold story.
Most people attribute the market decline to a potential recession. In going back in history, this is the most advertised recession. If you go back to 1973-74, the economy entered into recession in November of 1973. It was only a year later, that the National Bureau of Economic Research figured out that the economy had been in recession for a full year. We are not in recession now, despite the first quarter GDP showing a decline of 1.6% by the department of commerce. It's a really silly number because here's what took place in the first quarter. We added 1.7million new jobs. We had one of the lowest unemployment rates in history at3.6%. We set a record in corporate profit margins. Net margins got as high as12.8%. And at the same time, we had a record 11.7 million jobs that were unfilled. How in the world, can you expect GDP to be negative in that type of economic environment?
The authority on business cycles was handed to the National Bureau of Economic Research in 1995.And they use more broad categories than the standard definition of two quarters of negative GDP, which can possibly take place because of 2 of the12 federal reserve banks, two of them calculate that we had negative GDP growth in the second quarter, which would mean two negative quarters of GDP growth, which according to the broad definition would mean recession in the first half of this year. But NBER, I think when they get around six to 12 months from now in looking and concluding on the second half, I think they will come to the conclusion that the economy has yet to go into recession.
Now, the untold story about why the market went down so much in the first half has more to do with regression to the mean than anything else. For the five years ending 2021, the annualized return for Aggressive Growth stocks was well above trend at 31.3% on an annualized basis and 18.5% for the S&P. So if you look at the trendline for these two types of return, we are well above trend. Here's what happens when we update these numbers through June 30th of this year:
For 2017, we drop a positive return of 44% in the aggressive growth stock universe. We drop a return of 22% for the S&P 500. We incorporate a first half return of -47%for aggressive growth funds, of -20% for the S&P 500. So the five year annualized return for aggressive growth drops from 31.3% to 8% annualized, well under its historic average of 17.6%. The S&P drops based on an introduction of a 20% decline, on a total return basis, to 9%.
So one of the very few times in stock market history, over a five year period, the S&P 500 has returned more than the aggressive growth stock universe. In terms of looking the trend line, both aggressive growth and the S&P are under their trendlines so I think without a doubt that we could expect by the end of next year for the stock market to be higher, and for the aggressive growth fund stock universe to be very much higher than it is today.
Let's go back and look at this from the industry standpoint. One of the most commonly used classifications to compartmentalize investment strategies is Morningstar’s nine-box grid. In that grid at the top, you have growth, you have blend, you have value. Then you have it broken down into market caps: large-cap, mid-cap, and small-cap. There is no compartment for aggressive growth. It is just lumped into the growth category.
We have identified aggressive growth as a legitimate investment style. We have built what we believe is the only data bank on aggressive growth stocks that goes all the way back to 1958. Now before I go on further, I'd like to touch upon what aggressive growth stocks are: aggressive growth stocks tend to grow much faster than the growth stock universe. Aggressive growth stocks, because of their high growth characteristics, tend to be more volatile in the stock market.
In the aggressive growth category, you will find more IPOs, and you'll find more money-losing companies than you will in the growth style. In part, the style is not really defined. But if you look at the aggressive growth style going all the way back to 1958,based upon our data, this genre of stocks have generated an annualized return far and away better than any other style with an annualized rate of 17.6% per year whereas the S&P has annualized at around 10.2%.
First of all, we've done more work on this than any other advisory service, than any other advisory manager. We have searched far and wide on coming up with data on the aggressive growth style. If you go to the internet and you type in aggressive growth, you're not going to get much help. We believe we have built the only aggressive growth stock index in the investment business. And our index goes all the way back through 1958, so we have a very good handle on the behavior of this style.
In addition to that, we have defined the style as being one of very rapid earnings growth of being very volatile, but also as a style that incorporates more IPOs (that are regarded as being risky because less is known about IPOs and publicly traded companies) and also, money losing companies which we have found to be a very fertile source of top performing stocks.
We have studied the stock market and we've looked at the best stocks over 10-year periods from 2015 through 2019. The earnings of these companies grew at meteoric rates and most of these top stocks, return more than a thousand percent. But 53% of the top performing stocks started out losing money. In 1980, Apple came public in December of that year at a very small IPO, about a $102 million dollars. They lost money for 26 consecutive years before turning a profit in 2006. Now it is the largest, capitalized stock in the world exceeding a market cap over $2 trillion. Another example is Amazon, which lost money in its first years of operation. It started in 1995. Today, that is the third most valuable stock based on market capital in the S&P 500. So we know a lot about the style. We know how it behaves, and we also know how to generate superior returns over time by investing in 25 of the world's fastest growing companies.
Well, most aggressive growth managers invest based upon historic growth rates. For example, they’ll look at three-year growth rates of the company's growing rapidly and they mayor may not get involved. The same thing would apply to companies with strong five years of earnings growth.
We define the style a little bit differently because unlike others, we seek performance now, not later. And what we do is we track the fastest growth rates. A year ago, two years ago, three years ago... the fastest profits growth rates we could find were rooted in technology companies. With the acceleration inflation starting from early 2021, commodity companies have started to produce gargantuan rates of earnings growth. The obvious one is the energy sector, and our style pursues the fastest rate of earnings growth. And right now, some of the companies in our portfolio are energy companies because they are exhibiting the fastest rate of earnings growth.
The typical aggressive growth fund manager will stick with the same investments. In most cases they have a heavy influence of technology stocks. They have a heavy influence of biotech stocks and other healthcare companies. So we are a little bit different. Again, we seek performance now. Not later.
My outlook for the market is very constructive, more constructive than opinions and investment stances held by the vast majority of investors. In 2020, we had a pandemic and the shortest bear market in history over a five-year, five-week period. The market dropped 34%, and that's based on the S&P 500 index. A lot of investors panicked and they sold their stocks and by June 30th, the market had embarked on a recovery. It was up 38% off the lows and Barron’s reported that in a typical equity account or a typical investment account (60% stocks/40%bonds) that investors were only 12% invested in stocks. Two months later, the stock market's trading at a record high again, and fewer than half of the investors were invested fully in the stock market. Specifically, 47% were full in their equity positions.
Bank of America is just released a statistic today. Stating that, going back to 2008, 300 major funds have the highest cash position that they've had in 13 years. Well, the fact is the majority of damage is done in the stock market. It's conceivable that we touched bottom on June 16th which is a little bit more than a month ago. And the averages and many funds have rebounded and are holding above the lows of June 16th.
But my point is this, the next major move in the stock market is going to be up. I think at the very most, there's no more than 5% downside potential, but every bull market on average goes up 156% over nearly a five-year period. In the aggressive growth category, we can expect a gain that is triple to five times that of the upward market movement. And I think most portfolios are not really positioned well today because all we talk about in the media is the negative things. People are fearful of recession. If we have a recession, so what it's already priced into the stock market. So I think the downside is limited and people are giving up an opportunity to recoup their losses by carrying very heavy cash positions. At Golden Eagle, we have no idea if the market's going up or going down near term and we hold to the philosophy that bear markets are temporary, but the bull market is permanent.
The bull market has been going up for more than 200 years. It was only, seven months ago that the stock market was at an all-time high. And typically, what you find, when we go into a bear market that it takes two or three short years for the market to recover and go on into record-high territory once again. This has been ongoingfor more than 200 years. Nothing's different. And it will be the same. At some point in the near future, we will be at record highs in the stock market. Andyou really don't want to miss that move.
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This transcript was generated by software and may notaccurately reflect exactly what was said.
Please note, that the thoughts expressed in this podcastare those of the presenter. This is not, nor should it be considered an offeror a solicitation of an offer for investment.