The “Holy Grail” of Stock Market Investing

David L. Debertin DLDebertin@aol.com

Professor of Agricultural Economics

University of Kentucky

 

            The “Holy Grail” of stock market investing has always been the development of a model that allows investors to identify when a boom in a certain kind of stocks is about to take place, move money into that boom in the early stages, and then quickly exit into something better performing when there are early signs that the boom has peaked and things have only started to fall apart. For many years I have been tracking the performance of the mutual fund Fidelity Low-Priced, a fund that focuses on small and mid-cap stocks that are purchased cheaply based on a price/earnings ratio. I have also watched a variety of large-cap growth funds. These are funds that concentrate on stocks of major corporations that are considered to be rapidly growing—generally companies whose stocks are expensive on a price/earnings basis because investors, especially in good times, believe that these stocks will grow earnings and appreciate in value faster than the market as a whole. For years I have noted that there are long periods in which Small- and Mid-Cap Value stocks (as measured here by the performance of FLPSX) outperform Large-Cap Growth stocks (measured here by the performance of FDGRX), but these long periods are often punctuated by shorter periods—often only a few months in length to possibly a year or even longer—in which Large Cap Growth significantly outperforms Small- and Mid –Cap Value

 

            For this experiment, I used about 15 years of monthly data on two funds, Fidelity Low Priced (FLPSX) a “classic” small- and mid-cap Value fund, and Fidelity Growth fund (FDGRX), a classic large-cap Growth fund. FDGRX is the type of fund that generally soared in the period from 1995 into early 2000, then tanked.  I normalized each share price at $1 a share at the start of the period, and calculated the difference between the normalized share prices. I then calculated a 3-month moving change in this difference vector. The resultant vector is labeled “Derivative 3” in the table below. Negative values for this vector in red indicate that the market is favoring small and mid-cap value stocks. Positive, black values indicate that the market is favoring large-cap growth stocks. When the number is near zero, perhaps between -0.05 and +0.05, the market is signaling that both Value and Growth are faring similarly, but also suggests that a rotation may be starting moving from Value to Growth or from Growth to Value.

 

I then color-coded these signals, and the color indicates where the investor should be for the current month—Green for (Large Cap) Growth and Red for Mid and Small-Cap Value.

 

In 1990 the model does a lot of shifting between Growth and Value, which suggests that either side would have been ok. The numbers in the Derivative 3 vector in that period are all very small, whether positive or negative. Then from November of 1991 on, the model starts to show a clear preference for Value, and suggests holding Value over Growth until March of 1995. After that, the model is signaling a shift into Growth, until December 1 of 1995. After that ,Value is held until  May 1 of 1998 and a switch is made into Growth that extends to March of 2000, with the exception of the three months  May, June and July, 1999, with a shift into Value. Whether this 3-month shift is actually made is of little consequence. The emphasis should be on Growth extending to  March 1, 2000. Then the model clearly suggests rotating back from Growth to Value.

 

Of course, what is of interest here for students of the stock market, is that March of 2000 roughly coincided with an important peak in the NASDAQ, and the model is clearly signaling this to be the point to rotate back into Value. Had an investor followed the model, this investor would have enjoyed the returns from riding up the Growth bubble of the late 1990s, but would have also received a clear signal as to the March, 2000 point for rotating back into Value. This is near perfect strategic timing based on the model calculations. Then the model suggests holding Value from May of 2000 all the way until August 2002 with one exception. Recall that there was a secondary peak in growth stock prices in 2000 that occurred in August of that year, and the model clearly spots it. Then from August 2002 through May of 2003 the model suggests holding Growth, then back into Value to current with one false signal in May-June 2004.

 

Currently the model is strongly favoring the Value (red) side.

 

I then took a one-time $1000 investment at the start of the period and calculated its value following three strategies 1. Buy and hold Value (FLPSX) with no switching, 2. Buy and hold Growth (FDGRX) with no Switching, and 3. Switch between the two funds at the points suggested by the model. The all Value (FLPSX) approach resulted in an ending value of $12,054.71. The all Growth (FDGRX) buy-and-hold resulted in an ending value of  $6,134.66. But the ending value for the switching model was $25,359.44, about twice the ending value for the buy-and-hold all Value strategy and four times the ending value for buy-and-hold all Growth strategy.

 

Of course, most of the gains from the switching model relative to the buy-and-hold Value model came because the switching model found the bubble in large-cap growth stocks early, rode it up and then also signaled a rotate back into Value almost exactly at the peak in March 2000.  This kind of Growth bubble might not happen again or if it does, another spurt like what we saw in that period might be a long ways off. In that scenario, the switching model may not outperform a Value buy-and-hold strategy for a long period of time.

 

Notes:

 

Fidelity Low Priced is currently closed to new investors, and will likely not reopen at least until the period of strong outperformance of Value over Growth ends. One of the problems is that there are fewer small- and mid-cap value funds to choose from than there are large-cap growth funds. Most people have too high a proportion of their long-term financial (i.e., retirement) assets in large cap, and even funds that do not have growth in their names frequently overweight Growth stocks. Simple S&P 500 index funds, by the way the index is calculated, favor large cap Growth over large cap Value.

 

I would suggest as a substitute for FLPSX on the value side one of the following: Royce Low Priced (RYLPX) has tracked Fidelity Low Priced for a long time, but effective October 29th, it closed to new investors as well. For University Employees in TIAA-CREF, their Mid Cap Value fund TRERX is available for most retirement accounts, and although the data are available for only a little over a year, it seems to be tracking FLPSX closely.  This fund is also available to anyone as a retail mutual fund as TCMVX. For fans of Vanguard, I would suggest their Small Cap Value index fund (VISVX) There are also exchange-traded funds (ETF's) that track S&P/Barra and Russell Small and Mid Cap Value Indices.

 

On the Growth side, there are any number of large-cap growth funds to choose from. TIAA-CREF participants have the CREF Growth account, which can also be purchased by anyone as shares of TIGEX. In Vanguard, there is the large-cap growth index fund sold as VIGRX .

 

 

 

Date

Derivative 3

  3-Month

All Value

All Growth

Switching

1-Dec-04

0.4925

V

$12,054.71

$6,134.66

$25,359.44

1-Nov-04

0.7760

V

$11,914.89

$5,938.19

$25,065.30

1-Oct-04

0.1942

V

$11,033.43

$5,668.87

$23,210.98

1-Sep-04

0.3731

V

$10,884.50

$5,456.95

$22,897.67

2-Aug-04

0.4080

V

$10,471.12

$5,270.42

$22,028.05

1-Jul-04

0.2406

G-V

$10,501.52

$5,331.13

$22,092.00

1-Jun-04

0.0009

G

$10,884.50

$5,830.02

$24,159.40

3-May-04

0.2475

V-G

$10,516.72

$5,724.06

$23,720.31

1-Apr-04

0.1869

V

$10,489.36

$5,559.60

$23,658.61

1-Mar-04

0.4269

V

$10,750.76

$5,695.36

$24,248.19

2-Feb-04

0.6599

V

$10,735.56

$5,695.36

$24,213.91

2-Jan-04

0.6530

V

$10,431.61

$5,688.74

$23,528.35

1-Dec-03

0.7558

V

$10,155.02

$5,526.49

$22,904.49

3-Nov-03

0.4970

V

$9,832.83

$5,452.54

$22,177.80

1-Oct-03

0.3315

V

$9,513.68

$5,423.84

$21,457.97

2-Sep-03

0.3039

V

$8,917.93

$5,045.25

$20,114.27

1-Aug-03

0.5107

V

$8,972.64

$5,089.40

$20,237.67

1-Jul-03

0.5781

V

$8,617.02

$4,858.72

$19,435.57

2-Jun-03

0.6910

V

$8,218.84

$4,650.11

$18,537.49

1-May-03

0.3855

G-V

$7,993.92

$4,621.41

$18,030.18

1-Apr-03

0.0599

G

$7,392.10

$4,211.92

$16,432.57

3-Mar-03

0.4225

G

$6,775.08

$3,897.35

$15,205.29

3-Feb-03

0.1886

G

$6,799.39

$3,812.36

$14,873.71

2-Jan-03

0.0759

 Hold ?

$7,042.55

$3,802.43

$14,834.96

2-Dec-02

0.0085

G

$7,209.73

$3,909.49

$15,252.66

1-Nov-02

0.3296

G

$7,528.88

$4,353.20

$16,983.76

1-Oct-02

0.3138

G

$7,063.83

$3,899.56

$15,213.90

3-Sep-02

0.4851

G

$6,805.47

$3,496.69

$13,642.13

1-Aug-02

0.0566

V-G

$7,422.49

$3,917.22

$15,282.80

1-Jul-02

0.0259

V

$7,480.24

$4,002.21

$15,401.71

3-Jun-02

1.0538

V

$8,194.53

$4,400.66

$16,872.42

1-May-02

1.0434

V

$8,431.61

$4,869.76

$17,360.56

1-Apr-02

1.2736

V

$8,486.32

$5,034.22

$17,473.21

1-Mar-02

0.9323

V

$8,215.81

$5,475.72

$16,916.22

1-Feb-02

1.0558

V

$7,756.84

$5,238.41

$15,971.22

2-Jan-02

0.5659

V

$7,805.47

$5,626.93

$16,071.35

3-Dec-01

0.0001

V

$7,680.85

$5,873.07

$15,814.76

1-Nov-01

0.1294

V

$7,294.83

$5,832.23

$15,019.95

1-Oct-01

0.7270

V

$6,863.22

$5,250.55

$14,131.27

4-Sep-01

1.1637

V

$6,595.74

$4,788.08

$13,580.54

1-Aug-01

0.8694

V

$7,112.46

$5,779.25

$14,644.46

2-Jul-01

0.6300

V

$7,142.86

$6,257.17

$14,707.04

1-Jun-01

0.1173

V

$7,118.54

$6,474.61

$14,656.97

1-May-01

0.4955

V

$6,948.33

$6,484.55

$14,306.51

2-Apr-01

1.4788

V

$6,720.36

$6,464.68

$13,837.13

1-Mar-01

2.3240

V

$6,306.99

$5,780.35

$12,986.00

1-Feb-01

1.7880

V

$6,428.57

$6,460.26

$13,236.33

2-Jan-01

1.8983

V

$6,471.12

$7,694.26

$13,323.95

1-Dec-00

1.8216

V

$6,066.87

$7,864.24

$12,491.60

1-Nov-00

2.1363

V

$5,674.77

$7,494.48

$11,684.27

2-Oct-00

0.1473

V

$5,765.96

$8,887.42

$11,872.02

1-Sep-00

0.1095

G-V

$5,738.60

$9,357.62

$11,815.70

1-Aug-00

1.0043

V-G

$5,717.33

$9,673.29

$12,214.29

3-Jul-00

0.3470

V

$5,401.22

$8,669.98

$11,538.97

1-Jun-00

0.8580

V

$5,382.98

$9,111.48

$11,500.01

1-May-00

2.8831

V

$5,224.92

$8,176.60

$11,162.34

3-Apr-00

0.0929

G-V

$5,270.52

$8,886.31

$11,259.75

1-Mar-00

1.3482

G

$5,337.39

$9,923.84

$12,574.39

1-Feb-00

3.8854

G

$5,176.29

$11,011.04

$13,951.96

3-Jan-00

2.3560

G

$4,963.53

$8,672.19

$10,988.43

1-Dec-99

2.2954

G

$5,109.42

$8,347.68

$10,577.25

1-Nov-99

1.0429

G

$4,902.74

$6,852.10

$8,682.21

1-Oct-99

0.9211

G

$4,784.19

$6,136.87

$7,775.95

1-Sep-99

0.6341

G

$4,829.79

$5,772.63

$7,314.43

2-Aug-99

0.8463

G

$4,978.72

$5,885.21

$7,457.08

1-Jul-99

0.1792

V-G

$5,185.41

$5,617.00

$7,117.23

1-Jun-99

0.2206

V

$5,243.16

$5,551.88

$7,196.50

3-May-99

0.0905

G-V

$5,006.08

$5,066.23

$6,871.09

1-Apr-99

0.1415

G

$4,872.34

$5,124.72

$6,950.43

1-Mar-99

0.7640

G

$4,537.99

$5,067.33

$6,872.59

1-Feb-99

0.5962

G

$4,610.94

$4,761.59

$6,457.93

4-Jan-99

0.6072

G

$4,832.83

$4,943.71

$6,704.93

1-Dec-98

0.2926

G

$4,881.46

$4,646.80

$6,302.24

2-Nov-98

0.2893

G

$4,720.36

$4,274.83

$5,797.77

1-Oct-98

0.3182

G

$4,534.95

$4,038.63

$5,477.41

1-Sep-98

0.5296

G

$4,361.70

$3,834.44

$5,200.47

3-Aug-98

0.5936

G

$4,212.77

$3,477.92

$4,716.95

1-Jul-98

0.4763

G

$5,000.00

$4,185.43

$5,676.51

1-Jun-98

0.1381

V-G

$5,240.12

$4,183.22

$5,673.52

1-May-98

0.1917

V

$5,264.44

$3,935.98

$5,699.84

1-Apr-98

0.1136

V

$5,389.06

$4,098.23

$5,834.77

2-Mar-98

0.0110

Hold

$5,313.07

$4,118.10

$5,752.50

2-Feb-98

0.0299

Hold

$5,124.62

$3,987.86

$5,548.46

2-Jan-98

0.0336

Hold

$4,857.14

$3,679.91

$5,258.86

1-Dec-97

0.1336

V

$4,857.14

$3,651.21

$5,258.86

3-Nov-97

0.2189

V

$4,802.43

$3,635.76

$5,199.63

1-Oct-97

0.4385

V

$4,778.12

$3,567.33

$5,173.30

2-Sep-97

0.2292

V

$4,857.14

$3,784.77

$5,258.86

1-Aug-97

0.1460

V

$4,559.27

$3,611.48

$4,936.35

1-Jul-97

0.0274

V

$4,522.80

$3,750.55

$4,896.86

2-Jun-97

0.0192

Hold

$4,297.87

$3,454.75

$4,653.34

1-May-97

0.0660

V

$4,130.70

$3,328.92

$4,472.34

1-Apr-97

0.1189

V

$3,841.95

$3,097.13

$4,159.70

3-Mar-97

0.1021

V

$3,848.02

$2,985.65

$4,166.28

3-Feb-97

0.1846

V

$3,917.93

$3,182.12

$4,241.97

2-Jan-97

0.0810

V

$3,875.38

$3,249.45

$4,195.90

2-Dec-96

0.2659

V

$3,829.79

$3,069.54

$4,146.54

1-Nov-96

0.0265

Hold

$3,723.40

$3,172.19

$4,031.36

1-Oct-96

0.0277

V

$3,534.95

$2,990.07

$3,827.32

3-Sep-96

0.0241

V

$3,471.12

$2,976.82

$3,758.21

1-Aug-96

0.0835

V

$3,364.74

$2,786.98

$3,643.03

1-Jul-96

0.0448

V

$3,240.12

$2,722.96

$3,508.10

3-Jun-96

0.0455

V

$3,370.82

$2,900.66

$3,649.61

1-May-96

0.1003

V

$3,434.65

$2,940.40

$3,718.72

1-Apr-96

0.1127

V

$3,334.35

$2,862.03

$3,610.12

1-Mar-96

0.0345

V

$3,200.61

$2,775.94

$3,465.32

1-Feb-96

0.0698

V

$3,148.94

$2,754.97

$3,409.38

2-Jan-96

0.0584

G-V

$3,051.67

$2,692.05

$3,304.07

1-Dec-95

0.0183

Hold

$3,018.24

$2,628.04

$3,267.87

1-Nov-95

0.0648

G

$2,978.72

$2,654.53

$3,300.81

2-Oct-95

0.0913

G

$2,902.74

$2,601.55

$3,234.93

1-Sep-95

0.0278

G

$2,987.84

$2,615.89

$3,252.77

1-Aug-95

0.0686

G

$2,933.13

$2,544.15

$3,163.56

3-Jul-95

0.0884

G

$2,905.78

$2,513.25

$3,125.13

1-Jun-95

0.0863

G

$2,738.60

$2,338.85

$2,908.28

1-May-95

0.0853

G

$2,635.26

$2,177.70

$2,707.90

3-Apr-95

0.0704

G

$2,583.59

$2,102.65

$2,614.57

1-Mar-95

0.0473

V-G

$2,501.52

$2,015.45

$2,506.14

1-Feb-95

0.0214

V

$2,483.28

$1,940.40

$2,412.81

3-Jan-95

0.0333

v

$2,413.37

$1,862.03

$2,315.37

1-Dec-94

0.0271

Hold

$2,416.41

$1,883.00

$2,341.44

1-Nov-94

0.0118

V

$2,401.22

$1,879.69

$2,326.72

3-Oct-94

0.0026

V

$2,465.05

$1,947.02

$2,388.57

1-Sep-94

0.0559

V

$2,446.81

$1,886.31

$2,370.90

1-Aug-94

0.0578

V

$2,434.65

$1,924.94

$2,359.12

1-Jul-94

0.0654

V

$2,346.50

$1,831.13

$2,273.71

1-Jun-94

0.0538

V

$2,294.83

$1,790.29

$2,223.64

2-May-94

0.0137

Hold

$2,328.27

$1,876.38

$2,256.03

4-Apr-94

0.0134

V

$2,337.39

$1,887.42

$2,264.87

1-Mar-94

0.0729

V

$2,316.11

$1,865.34

$2,244.25

1-Feb-94

0.1234

V

$2,422.49

$1,956.95

$2,347.34

3-Jan-94

0.1142

V

$2,425.53

$1,988.96

$2,350.28

1-Dec-93

0.1092

V

$2,303.95

$1,926.05

$2,232.47

1-Nov-93

0.0398

V

$2,197.57

$1,855.41

$2,129.39

1-Oct-93

0.0212

V

$2,234.04

$1,911.70

$2,164.73

1-Sep-93

0.0236

V

$2,155.02

$1,886.31

$2,088.16

2-Aug-93

0.0567

V

$2,136.78

$1,834.44

$2,030.73

1-Jul-93

0.0031

V

$2,063.83

$1,762.69

$1,951.31

1-Jun-93

0.0554

Hold

$2,036.47

$1,791.39

$1,983.08

3-May-93

0.0537

Hold

$2,030.40

$1,784.77

$1,975.75

1-Apr-93

0.0279

V

$1,987.84

$1,689.85

$1,934.34

1-Mar-93

0.0393

V

$2,009.12

$1,708.61

$1,955.04

1-Feb-93

0.0548

V

$1,948.33

$1,649.01

$1,895.89

4-Jan-93

0.0436

V

$1,966.57

$1,696.47

$1,913.63

1-Dec-92

0.0152

Hold

$1,917.93

$1,656.73

$1,866.31

2-Nov-92

0.0398

Hold

$1,857.14

$1,612.58

$1,807.16

1-Oct-92

0.0242

Hold

$1,738.60

$1,512.14

$1,691.81

1-Sep-92

0.0307

V

$1,711.25

$1,434.88

$1,665.19

3-Aug-92

0.0480

V

$1,696.05

$1,411.70

$1,650.40

1-Jul-92

0.0276

V

$1,702.13

$1,451.43

$1,656.31

1-Jun-92

0.0665

V

$1,647.42

$1,401.77

$1,603.07

1-May-92

0.0830

V

$1,689.97

$1,453.64

$1,644.48

1-Apr-92

0.1599

V

$1,677.81

$1,454.75

$1,632.65

2-Mar-92

0.2271

V

$1,662.61

$1,483.44

$1,617.86

3-Feb-92

0.1152

V

$1,717.33

$1,564.02

$1,671.10

2-Jan-92

0.0204

V

$1,613.98

$1,550.77

$1,570.54

2-Dec-91

0.0388

Hold

$1,486.32

$1,534.22

$1,446.32

1-Nov-91

0.0610

V

$1,389.06

$1,350.99

$1,351.67

1-Oct-91

0.0437

G-V

$1,446.81

$1,403.97

$1,407.87

3-Sep-91

0.0285

G

$1,398.18

$1,407.28

$1,411.19

1-Aug-91

0.0339

G

$1,392.10

$1,415.01

$1,418.93

1-Jul-91

0.0590

V-G

$1,355.62

$1,356.51

$1,360.27

3-Jun-91

0.0221

V

$1,276.60

$1,257.17

 $1,280.98

1-May-91

0.0295

V

$1,358.66

$1,347.68

$1,363.32

1-Apr-91

0.0988

V

$1,337.39

$1,279.25

$1,341.97

1-Mar-91

0.0164

G-V

$1,288.75

$1,291.39

$1,293.17

1-Feb-91

0.0198

G

$1,206.69

$1,225.17

$1,226.86

2-Jan-91

0.0853

G

$1,109.42

$1,150.11

$1,151.70

3-Dec-90

0.0863

G

$1,015.20

$1,034.22

$1,035.65

1-Nov-90

0.0224

V-G

$984.80

$983.44

$984.80

1-Oct-90

0.0240

V

$933.13

$888.52

$933.13

4-Sep-90

0.0748

V

$951.37

$884.11

$951.37

1-Aug-90

0.0465

V

$993.92

$970.20

$993.92

2-Jul-90

0.0206

V

$1,103.34

$1,082.78

$1,103.34

1-Jun-90

0.0748

?

$1,109.42

$1,117.00

$1,109.42

1-May-90

0.0465

?

$1,082.07

$1,104.86

$1,082.07

6-Apr-90

0.0206

?

$1,000.00

$1,000.00

$1,000

 

 

1