When Barron’s introduced the Barron’s 400 Index on the cover of its September 3, 2007 issue, it aptly described its new index as “a money-making tool for investors.” In doing so it cited back-tested performance going back 10 years, which, using data provided by MarketGrader and Dow Jones Indexes, co-creators of the index along with input from Barron’s editors, showed the new index “handily” beating “standard equity benchmarks.” Quite understandably this drew plenty of skepticism from investors that had seen plenty of shiny “back-tests” that failed to follow-through once their performance was calculated live and published daily1. So, today, as the index enters its 10th calendar year of live published performance, we thought it appropriate to take stock of the claim made by Barron’s almost a decade ago and see whether B400 has lived up to its expectations. We do so in the context of our 2016 annual review, as is customary every January.
Regular readers of this Newsletter have seen us write often about the market dynamics that affect B400, in good and bad times, and thus sway its performance (newcomers may access our complete Newsletter archive here) year after year. We have written numerous times about sector, size and style performance and how they have affected B400, particularly in the context of its growth-at-a-reasonable-price (GARP) strategy, based on MarketGrader’s fundamental rating system. So, while at times the index has outperformed and at others it has underperformed, overall, since it was first introduced in 2007, it has lived up to its goal to serve as a vehicle of capital appreciation and has thus delivered for investors. The total return version of the index (including dividends) outperformed mega cap stocks (as measured by the Russell Top 200 Index) by 27 percentage points; large cap stocks (as measured by the S&P 500) by 25 percentage points; small caps (as measured by the Russell 2000) by 16 percentage points; and micro caps (as measured by the Russell Microcap Index) by 36 percentage points. All of these figures, by the way, are measured from August 31, 2007 through December 30, 2016.
As many investors may be aware, Growth has outperformed Value in the last few years (although this may be changing with the market rotation that has followed the presidential election in November). In fact, during the same time period cited above, the Russell 3000 Growth Index has outperformed its Value counterpart by 34 percentage points. B400, with its GARP approach, has outperformed Russell 3000 Growth by 5 percentage points and Russell 3000 Value by 39 percentage points. Figure 1 summarizes the cumulative returns of the Barron’s 400 relative to all of these indexes.
Figure 1. Total Cumulative Return B400 and Select Benchmarks, August 2007 – December 2016.
Sources: Bloomberg, MarketGrader Research
2016: A Return to Fundamentals?
As we wrote a year ago, 2015 was a year thoroughly dominated by large caps, or, more specifically, mega caps. That year’s stock market performance marked the first time this century in which large caps had significantly outperformed small caps two years in a row. In 2016 this mini-trend was no more, especially following the performance of small caps following the election, which, in our opinion, ushered in a new market cycle during which a significant rotation got underway (see Uncommon Wisdom – A Personal Reflection on the U.S. Election Through the Lens of B400). With their performance in 2016, small caps once again reestablished their ability to deliver better capital appreciation potential than large caps (while this might be an overstatement of the obvious, plenty of investors seem to forget it from time to time). Case in point, in the 17 calendar years since the turn of the century, small caps have outperformed large caps in 10 calendar years. More importantly, perhaps, they have done so by an average of 2.8% per year across all 17 years. In other words, investors were paid 280 basis points annually since 2000 to own small caps rather than large caps.
The Barron’s 400, of course, fits in the middle, or the market’s sweet spot as we like to say. Although a multi-cap index, when measured by its median market cap (currently $3.16 billion) or by the number of mid caps among its constituents (currently 55%), the index tends to fall in the market’s middle. Its average annual return since 2000 has been 12.4%, besting small caps by 300 basis points annually. In this case the size premium is reversed as investors have been paid to own larger companies than those in the Russell 2000 (on average). Investors could be forgiven for assuming that B400 has simply outperformed because of its smaller cap profile; a closer look, however, suggests that its performance advantage can be attributed to more than size since, in fact, B400 has beaten both the S&P 500 and the Russell 1000 (both large cap benchmarks) in three of the seven years in which large caps have beaten small caps (2005, 2007 and 2009). Figure 2 illustrates the year-by-year performance across sizes since 2000 while Figure 3 illustrates the performance of all of the market’s size segments, with B400 in the middle, during 2016.
Figure 2. Calendar Year Total Returns Since 2000
| Calendar Year | Russell 1000 % | S&P 500 % | Barron’s 400 % | Russell 2000 % | Difference % | Outcome |
| 2016 | 12.1 | 12.0 | 18.3 | 21.3 | -9.26 | S |
| 2015 | 0.9 | 1.4 | -3.1 | -4.4 | 5.3 | L |
| 2014 | 13.2 | 13.7 | 7.1 | 4.9 | 8.3 | L |
| 2013 | 33.1 | 32.4 | 41.6 | 38.8 | -5.7 | S |
| 2012 | 16.4 | 16 | 15.1 | 16.3 | 0.1 | L |
| 2011 | 1.5 | 2.1 | 0.5 | -4.2 | 5.7 | L |
| 2010 | 16.1 | 15.1 | 24 | 26.9 | -10.8 | S |
| 2009 | 28.4 | 26.5 | 41.1 | 27.2 | 1.2 | L |
| 2008 | -37.6 | -37 | -39.2 | -33.8 | -3.8 | S |
| 2007 | 5.8 | 5.5 | 6.2 | -1.6 | 7.4 | L |
| 2006 | 15.5 | 15.8 | 12.7 | 18.4 | -2.9 | S |
| 2005 | 6.3 | 4.9 | 12 | 4.6 | 1.7 | L |
| 2004 | 11.4 | 10.9 | 23.5 | 18.3 | -6.9 | S |
| 2003 | 29.9 | 28.7 | 45.1 | 47.3 | -17.4 | S |
| 2002 | -21.7 | -22.1 | -9.8 | -20.5 | -1.2 | S |
| 2001 | -12.4 | -11.9 | -0.6 | 2.5 | -14.9 | S |
| 2000 | -7.8 | -9.1 | 15.9 | -3 | -4.8 | S |
| Average | 6.5 | 6.2 | 12.4 | 9.4 | -2.8 | S |
Sources: FactSet, MarketGrader Research. “Outcome” for the year is denoted by “L” for large cap, if the “Difference” between the Russell 1000 and the Russell 2000 is greater than 0%. Otherwise, the “Outcome” is “S” for small cap.
Figure 3. 2016 – Total Return Performance
Sources: Bloomberg, MarketGrader Research
From a style perspective, 2016 was also a very different year from 2015 as value roared back and outperformed growth by 11 percentage points. The prior year growth had done better by 9.2 percentage points. And while investors may think this rotation began also only after the election, the truth is that it was well under way before then. In fact, through November 8th, the Russell 3000 Value Index was beating its Growth counterpart 9.32% to 3.94% since the beginning of the year. Such outperformance, however, continued unabated through the end of the year as the value benchmark outperformed the growth benchmark 8.3% to 3.3% from Election Day until the last trading day of the year. Figure 4 illustrates the swing in fortunes between value and growth from 2015 to 2016.
Figure 4. Style Total Returns 2015 and 2016
Source: Bloomberg
As we have asserted plenty of times in the past, divining the performance of size and style segments is a fool’s errand and the volatility investors have experienced as a result of macro events in recent years is a testament to that. However, a simple understanding of the power of stocks to move upward along with economic growth and, overall, human progress, cannot be overstated. In investing, sticking to principles that have stood the test of time has always served patient investors well. We believe B400 embodies many of the characteristics that make successful investors better off, including diversification across size and sectors and a belief that owning quality companies at a reasonable price will, in the end, always pay off. We write this as investors reposition their portfolios for the momentous year ahead and would like to add a couple of points we think are worthwhile having in mind when looking ahead. First, and perhaps most importantly, the so-called “earnings recession” among public U.S. corporations came officially to an end last quarter. Regular readers of John Prestbo’s B400 Diary may recall how S&P 500 companies reported a better than 9% improvement in median earnings per share during the third quarter; and according to FactSet, the average earnings increase in third quarter earnings among that same set of companies was 3.1%. This marked the first time since the first quarter of 2015 in which corporate earnings for S&P companies rose from a year earlier. A report in Tuesday’s Wall Street Journal cited consensus analyst estimates of an overall 3.2% rise in S&P earnings during fourth quarter (with earnings reporting season beginning this week), turning recent gains into a positive trend. B400 companies, by the way, saw a median improvement in earnings per share during the third quarter of 12.4%, as this mostly smaller set of companies regularly reports earnings growth that’s higher than the S&P. Our point is that earnings growth might be making a comeback to the U.S. just in time when further multiple expansion seems, well, a stretch. If this is coupled with a continuation of the recent pick-up in nominal GDP growth that has been reported by the Commerce Department, the combination may be supportive of further equity gains in 2017. Look out for John’s preview of the upcoming earnings season in the latest edition of the B400 Diary, due out early next week.
Second, despite an improving picture in corporate earnings, stocks inevitably do get expensive and valuations do indeed matter. Thus it is worth reminding our readers that the Barron’s 400 index is due for its next semi-annual rebalance on March 17th, well after all U.S. public companies will have reported their most recent quarterly results. The index will hence rebalance toward a fresh new batch of companies growing profitably that can be bought at a reasonable price. Here’s to hoping that during such rebalance it may harvest many of the gains it accrued during a very successful 2016.
Happy New Year!
