Seeing the Future from the Past

Imagine an investor equipped with a crystal ball in 1963—we will call her Cassandra. She would have looked forward five decades and seen some bizarre outcomes. She’d have seen that the best performing stocks would be mundane, boring food & beverage companies, cigarette makers, and insurers. The worst performing (and most volatile) would be stocks from the technology sector, even though that sector would produce the most innovative and exciting companies.

Cassandra would have also seen a remarkable shift in the landscape of global business.

She’d have seen enormous equity share (the percent of total market common equity) transfer from Utilities, Telecom and Industrials (the “lame three”) to Financials, Technology, and Health Care (the “exciting three”). In 1963, the exciting three sectors represented a combined 11% of the markets total common equity. Today, they combine to represent 46%. During the same time, the lame three would fall from 39% total share to 17%.

Ditto for earnings. The exciting three earned just 10% of the overall earnings pie in 1963, but today earn 47% of the pie. Meanwhile, Energy, Material, and Utility companies would see their earning share fall from 46% to 18%.

Now imagine what will happen in the next 50 years. Our goal is to find active strategies which can be among the few that outperform, so it’s helpful to review some broad historical features of the stock market. As we shall see, the past doesn’t tell us which stocks will do best in the future, but it does give a good indication that future results will be rather spread out (widely dispersed), which makes outperformance possible. What follows is a brief survey of history’s most & least successful sectors and industries.

The Best and Worst Performers

So over our 5-decade sample (1962-2015), who have been the winners and losers in the stock market? Let’s answer the question at increasing levels of specificity, starting with sector (see the end of this piece for calculation methodologies).

Across the board, consumer staples stocks have dominated. They’ve delivered the highest return, and the second lowest overall AND downside volatility. Technology has been the polar opposite, delivering lackluster and volatile returns to investors. I’ve included both equal and market-cap weighted returns, and they disagree in spots. I prefer equal weighted, because it is the best representation of the opportunity set for active investors. Still, market cap weighted returns are more commonly quoted and match the style of indexes like the S&P 500.

Notice that the spread between the best- and worst- performing sectors is roughly 4% annualized. That may not seem like much in any given year, but over a 30-year period, that could result in an almost 3,000% difference in total return.

Next we dive into industry group (24 classifications instead of 10 sectors). This is my personal favorite way of categorizing stocks. The groups are still broad, but much better defined (for example, both media stocks and automobile stocks fall into the Consumer Discretionary sector—but they are very different types of business).

Here we gain new insight. It turns out that the fantastic results from Consumer Staples are driven by its Food, Beverage & Tobacco subcomponents. Sure enough the best performing stock across the entire sample–Phillip Morris, with a return of more than 20% per year–falls in this category.

Within technology, semiconductors have been weak, but so has technology and hardware.

Financials have the widest dispersion of industry group returns, with real estate stocks lagging and insurance stocks soaring. Note that within insurance, the equally-weighted return set did much better than the market-cap weighted return set. For diversified financials, it was the opposite because of the influence of Berkshire Hathaway’s outstanding returns.

We can dive deeper to the industry level (~70 classifications), but things start getting hairy. There are often just a few names in an industry, and there are interruptions in several of the monthly returns due to lack of data. We should therefore not read TOO much into these results. Here are the top 10 industries, sorted by their market-cap weighted returns.

Among the best we find familiar groups: beverages, tobacco, food, and insurance. Pharmaceuticals jump near the top now that they are decoupled from biotechnology stocks. If I had to sum up the businesses in these top 10 with one word, I’d choose “steady.” With the exception of Road & Rail, they pretty much all meet bottom-of-Maslow’s-pyramid human needs. We eat, we drink, we smoke, and we tend to our health. Demographics may have played a significant role in these results, as baby boomers were growing up throughout this sample period. Lots more people doing all of these things daily was a boon for these industries. The fact that the products haven’t changed that much has probably helped as well. Semiconductors change constantly. A can of Coca-Cola today is similar to a bottle in 1962.

The Past and the Future

So what, if anything, does this all mean? For one, we can expect that the future will look different than the past. We should not expect consumer staples to continue to dominate, nor should we expect technology to lag. What is important in this data is the wide dispersion of results. We tend to think of the market as this amalgamated juggernaut (say the S&P 500), growing at a nominal long term rate of 10% per year or so, but beneath that juggernaut lay businesses of many types that deliver very different results around that 10% average.

There is evidence that things are speeding up fast, with the average lifespan of major companies falling. This chart from the great book The Nature of Value shows how.

Were there a modern day Cassandra looking forward today, she might not be able to see as far, as change is increasingly the only constant.

It will be hard to identify the companies that will be the beverage & tobacco stocks of the future. I believe the most reliable way to try is to use models. Making decades-long predictions is impossible. It is far easier (or at least, has been historically) to use stock selection factors (value, momentum, quality, yield) to find stocks that have higher odds of doing well in the next 1-5 years. In the coming months we will continue to explore those concepts.

I’ll leave you with five ideas/questions for the day.

1. Will we reach a point where indexing (or other strategies) are free (or even have negative management fees)? If so when?
2. What is the fairest way to charge for active management? Buffett partnership style (0% management fee, 25% of gains above 6%)? Flat low management fee? 0% management fee and 20% of gains above a major benchmark?) I would love to hear your thoughts.
3. Explore the impact of consuming only one type of enjoyable art over four months. In the first month, spend every night reading. In the second month, spend every night listening to music. In the third month, watch shows/movies/documentaries. Finally, in the fourth month, stick to conversation. Which leaves you happiest?
4. What is the best way of identifying out-of-favor stocks OTHER than traditional valuation measures? Low share turnover? Poor 5-year returns and earnings drops? Leave some ideas in the comments below.
5. What is the worst mistake an asset manager can make?

P.S. to drive the direction and content of this site in the future, please leave comments below, submit ideas, and/or rate this post 1-5 stars below.

Note for returns calculations: for each sector/industry group/industry listed above, groups are determined using standard GICS classification codes. The stocks included in each return series are only those with an inflation adjusted market cap larger than $200MM. These returns also include non-U.S. companies that trade here in the U.S. (think Ali Baba, BP, China Mobile, and other ADRs). All other data in this story relies on the same universe of U.S. listed stocks.