Posts Tagged ‘Vitaliy Katsenelson’

I’m back from the Value Investing Congress in Las Vegas. There were a number of outstanding presentations, but, for mine, the best was Vitaliy Katsenelson’s epic presentation based on his Little Book of Sideways Markets.

12 years into this sideways market, valuations are still 30% above the historical average, while in 1982 they were about 30% percent below average! Also, historically, stocks spent a good amount of time at below-average valuations before sideways market turned into a secular bull market.

Vitaliy shows that genuine 1930s-style bear markets are rare. Most of the time the market trades sideways or up.


Since 2000, the market has traded sideways. Vitaliy expects this to continue for another decade:


Read GDP growth has been consistent. There’s little relationship between earnings growth and stock returns.


Real GDP growth is very similar in both sideways and bull markets…


…the difference in returns is the change in valuation.


Don’t chase stocks. In the absence of good stocks, hold cash.


Sideways markets contain many cyclical bull and bear markets.

slide-321During a sideways market, asset allocation is not as important as stock selection.



See the full presentation:

Order Quantitative Value from Wiley FinanceAmazon, or Barnes and Noble.

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I have recently read Vitaliy Katsenelson‘s excellent The Little Book of Sideways Markets. Vitaliy’s thesis is that equity markets are characterised by periods of valuation expansion (“bull market”) and contraction (“bear market” or “sideways market”). I think it’s a compelling thesis, but I am well and truly in the choir. I’m open to counterarguments. Here’s the Cliff Notes version of Vitaliy’s thesis:

Sideways Markets

A sideways market is the result of earnings increasing while valuation drops. Historically, they are common (this is one of many charts Vitaliy provides in support of his thesis):

Equity markets are going sideways

Equity markets are presently experiencing an extended period of valuation contraction, manifesting as increasing earnings, falling cyclically adjusted price-to-earning ratios (“CAPE”) and a sideways market.

While the S&P500 TR is approximately flat for the period from December 1999 to the present, valuations have fallen 52 percent, from a CAPE of 44 in December 1999 to a CAPE of 20.56 presently (via Multpl).

Shiller PE Ratio Chart

20.56 is not cheap.

Despite over a decade of dropping valuations, a CAPE of 20.56 is presently still well-above long-term averages (the long-run mean is 16.43 and the long-run median is 15.84), indicating that the market is still 25 percent to 30 percent above those averages.

The market probably wont stop at the averages. CAPE has in the past typically fallen to a single-digit low following a cyclical peak

Sideways markets can continue for some time. The last time a sideways market traded on a CAPE of ~21 (1969) it took ~13 years to bottom (1982). The all-time peak US CAPE of 44.2 occurred in December 1999, all-time low US CAPE of 4.78 occurred in December 1920. The most recent CAPE low of 6.6 occurred in August 1982.

What Would Vitaliy Do? Buy and Sell

Vitaliy advocates a systematic approach, buying stocks that meet his “QVG” or “Quality, Value, Growth,” framework, and selling, rather than holding. He deals with this in some detail in the book.

The book is excellent. I highly recommend it. You can purchase a copy here.

Full Disclosure: I received from the publisher a copy of Vitaliy’s book gratis. I would have bought it if I had not.

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Vitaliy Katsenelson’s Contrarian Edge has a great post on Medtronic Inc. (NYSE:MDT) (Barron’s is wrong on Medtronic). Katsenelson’s post is a rebuttal to a Barron’s article, Should Medtronic Investors Lose Heart?, in which the author argues that MDT is a sick man. His post is a superb line-by-line refutation of Barron’s thesis:

“The stock looks cheap, trading at about 8.2 times expected forward earnings, but the company’s 10% long-term-earnings growth rate is below the industry average…

At 8.2 times earnings, the market prices in zero growth. If any growth is produced, even half of its “below-industry-average” growth, the stock will not be trading at 8.2 times earnings, but at a much higher valuation. Ironically, today’s low valuation gives MDT earnings a yield of 12%. If MDT remains at this valuation for a long time, it can buy back 12% of the company year after year, and this in itself would result in 12% earnings growth.

“… and it carries a fair amount of debt….

The amount of debt seems high at first, at $10.5 billion; but the company has $3.9 billion in cash and short-term investments, thus net debt is closer to $6.6 billion. MDT generates $3.4 billion of free cash flows – it can pay off ALL of its net debt in less than two years. Also, don’t confuse MDT with low-quality, highly cyclical stocks that were in vogue in the first half of 2010. This is a company that maintained a return on capital of over 20% for decades – an indication of a significant moat. Its revenues are extremely predictable, cash flows are very stable, and thus debt levels are very reasonable. Medtronic’s stock was punished with a 10% decline for lowering its guidance by an astonishingly minor 2%.

“The stock is also a historical underperformer, turning in losses year-to-date, as well as in the last one-, two-, and five-year periods that are greater than its peers in the Dow Jones U.S. Medical Equipment Index and the overall market….

This argument fails to draw a distinction between fundamental performance and stock performance. Over the last ten years, MDT grew both sales and earnings per share at 14% a year. It increased dividends 17% a year. These are not the vital signs of an “underperformer.” As the article pointed out, MDT’s stock has gone nowhere over the past decade – that is true, but not because MDT was mismanaged or failed to grow, but rather because at the turn of the last century MDT was trading at almost 50 times earnings. Medtronic is a typical sideways-market stock: it was severely overvalued at the end of the secular bull market, thus its earnings and cash flows grew while P/Es contracted. This happened to a battalion of stocks, from Wal-Mart to J&J to Pepsico. In fact when I hear the statement that a stock has “not gone anywhere,” I immediately start looking at the stock to see if it is a buy.

Read the article.

No position.

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