The farther backward you can look, the farther forward you are likely to see.”
Winston Churchill
Before the reader jumps ship thinking we are about to revisit the history of the 20th century, let’s make something clear: today we’re only going back to the semester just ended; that is, the rebalance semester ended last Friday for the Barron’s 400 index. We will, however, reference past newsletters, especially in the context of the market rotation that we are still convinced began last fall, but we promise we’ll keep those to a minimum and will limit historical market references to within the past couple of years only.
First, to the rebalance. As is customary, B400 reshuffled its constituent list after the market closed last Friday, March 17, replacing 165 of the companies that had been selected to it last September and in the process re-weighing all 400 components equally. The semester just concluded, by the way, proved to be a profitable one with the index gaining 15.8% from September 16, 2016 (the closing day of the prior rebalance) through last Friday’s close. This compared favorably to its benchmark, the Dow Jones US Total Stock Market Index, which gained 11.4% during the same period. Figure 1 illustrates both indexes’ performance along with three size benchmarks (small, mid, large) for the reader’s reference.
Figure 1. Barron’s 400 Index Price Return vs. Select Benchmarks, Sept. 16, 2016 – March 17, 2017
Source: Bloomberg
B400’s turnover of 41.25% was a hair’s breadth below its historical turnover average of 41.7% per reconstitution. The newly reconstituted B400 now sports an average overall grade of 67.0 (out of 100) vs. 62.6 for the September class. This score, of course, is based on MarketGrader’s fundamental analysis that measures the performance of all U.S. listed stocks according to metrics in growth, value, profitability and cash flow. It is, as our regular readers know, the means by which we seek to identify and track growth at a reasonable price (GARP) in U.S. equities. The new B400 class has, therefore, improved fundamental metrics both from a growth and value perspective, while maintaining a focus on quality. Worth highlighting, the average year-over-year growth in sales for the March class is 16% vs. 13% for the September class, while operating income growth has grown in the last year, on average, by 35% for the new index vs. 33% for the outgoing one. From a valuation perspective, when comparing companies’ market caps relative to each company’s trailing 12-month net income, our preferred metric of value across large company sets, the March class trades at a median 21.4 times trailing net compared to 21.7 for the September group.
Among the September class, 316 companies had a positive price return over the six-month period ended last week, gaining an average of 21%. The remaining 84 companies had an average price decline of 13%. This translates into a ratio of 3.76 advancers for every decliner, not too shabby a batting average. Among all companies in the newly reconstituted index, 78 (or 19.5%) have been members of B400 for at least two consecutive years. This goes to show that despite a historical turnover of almost 42% per rebalance, MarketGrader’s methodology rewards consistency. In our view, these companies are truly consistent creators of shareholder value. Remarkably, 19 current constituents have been members of the index for at least five consecutive years (or 10 rebalance selections). Their names can be seen in Figure 2.
Figure 2. Members of the Barron’s 400 Index for at Least Five Consecutive Years
| Ticker | Company Name | Overall Grade (out of 100 Max.) |
| BIIB | Biogen Inc. | 75.97 |
| EGOV | NIC Inc. | 75.93 |
| ULTA | Ulta Beauty Inc | 75.74 |
| TSCO | Tractor Supply Company | 74.06 |
| LOPE | Grand Canyon Education, Inc. | 73.57 |
| NKE | NIKE, Inc. Class B | 71.92 |
| USNA | USANA Health Sciences, Inc. | 69.91 |
| MANH | Manhattan Associates, Inc. | 69.35 |
| FFIV | F5 Networks, Inc. | 68.36 |
| ORLY | O’Reilly Automotive, Inc. | 67.70 |
| MKTX | MarketAxess Holdings Inc. | 67.51 |
| ROST | Ross Stores, Inc. | 66.30 |
| AAPL | Apple Inc. | 66.19 |
| TJX | TJX Companies Inc | 65.29 |
| CACC | Credit Acceptance Corporation | 64.39 |
| HD | Home Depot, Inc. | 63.40 |
| MA | Mastercard Incorporated Class A | 62.02 |
| PCLN | Priceline Group Inc | 61.94 |
| JBHT | J.B. Hunt Transport Services, Inc. | 61.55 |
Source: MarketGrader Research
Economic Reform and B400: It’s a Marathon, Not a Sprint
Investors running anxiously every 15 minutes to their monitor in search for the latest news coming out of Capitol Hill may be forgiven for paying closer attention to the ins and outs of the legislative process than to company earnings reports. Especially given our perpetually short-term focused punditry outdoing each other to predict the end of the “Trump” trade and with it the inevitable “correction’ that is sure to come. Maybe so; however, our view that the market entered a new cycle and began a significant rotation last fall remains intact (see Uncommon Wisdom – A Personal Reflection on the U.S. Election Through the Lens of B400). As we argued at the time, most of the policies the incoming president was proposing could have very positive effects on the U.S. economy overall, which went beyond the simplistic argument of more infrastructure spending. More specifically, we mentioned regulatory, health care and tax reform as potential drivers of economic growth that could potentially break us out of the sub-2% “normal” of the last decade.
So, what does this have to do with the latest B400 rebalance? The answer is: a lot. As we explained in our last newsletter (2016: Year in Review – B400 Gains 18.3%), B400 only gained significant separation over the market benchmarks in the fall, particularly after the presidential election. Yes, its exposure to mid and small cap names helped, especially given how difficult it had been in the prior two years for anything not mega cap to outperform the market. While this still holds true, in our view, the sustainability and duration of this rotation will come down to sector exposures and investors’ chances of doing well to good old fashioned security selection. Here’s where the latest rebalance strikes us as confirmation that significant changes are afoot in U.S. stocks as seen from the bottom up. To be specific, following last week’s rebalance, almost 80% of B400 is invested in just four sectors: Consumer Discretionary, Financials, Industrials and Technology. The biggest loser, in terms of net names lost last week, was Health Care, with a decline of 10 names, which brings it down to just 39, or 9.75% of the index, the lowest exposure to the sector in two years. Meanwhile Energy and Materials continue to be well underrepresented relative to the market, with less than 9% exposure between the two and Consumer Staples does no better, with just 14 names, or 3.5%. Figure 3 illustrates B400’s changes by sector during the rebalance.
Figure 3. Sector Changes for the Barron’s 400 – March 2017 vs. Sept. 2016
| March 2017 | September 2016 | Net Gain / Loss | |||
| Sector | Companies | % | Companies | % | |
| Consumer Discretionary | 80 | 20% | 72 | 18% | +8 |
| Consumer Staples | 14 | 3.5% | 16 | 4% | -2 |
| Energy | 16 | 4% | 14 | 3.5% | +2 |
| Financials | 80 | 20% | 80 | 20% | 0 |
| Health Care | 39 | 9.75% | 49 | 12.25% | -10 |
| Industrials | 77 | 19.25% | 80 | 20% | -3 |
| Materials | 17 | 4.25% | 16 | 4% | +1 |
| Technology | 75 | 18.75% | 67 | 16.75% | +8 |
| Telecommunications | 0 | 0% | 4 | 1% | -4 |
| Utilities | 2 | 0.5% | 2 | 0.5% | 0 |
Source: MarketGrader Research
Coupled with what is now hard to question evidence that the U.S. economy had entered a phase of better, and perhaps sustainable growth, it is no wonder investors are grasping at every opportunity available to divine how much, if any, of the new administration’s economic policies will actually be passed as new legislation and implemented. More so now that the Fed has unambiguously entered a more hawkish phase during which, we hope, monetary distortions and misallocation of capital will no longer favor just the large and politically connected names. Not that B400 doesn’t own any large names; in fact, during last week’s rebalance, companies with market caps greater than $10 billion had a net gain of 19 names and now represent 21.75% of the index; all of these, of course, came from small and mid caps, which naturally lost the same number of constituents. Here’s where it’s worth taking a closer look at how B400 zigs while the market zags, at least in terms of security selection. Using the S&P 500 index as a large cap benchmark (though not B400’s benchmark), we find an overlap of 98 names between both indexes. A comparison of both indexes on a sector-by-sector basis reveals, unsurprisingly, that B400 has a marginally larger exposure to Consumer Discretionary (by 2%), Financials (by 1.6%) and fairly significant over-allocations in Industrials (by 5.65%) and Technology (by 6.55%). The index is under-allocated, relative to the S&P, in all other sectors. When we remove from B400 the companies that overlap with S&P 500, the sector exposures change moderately, except for two sectors, in which the changes are considerable: Financials, where the over-allocation jumps to +5.4% and Industrials to +8.6. Both of these make perfect sense, as B400 only owns one of the mega banks in the S&P (JPMorgan Chase) while a large portion of its exposure to Industrials is in the mid cap space, which investors anticipate is better leveraged to a continued improvement in the domestic economic story currently playing out in the halls of Congress and the White House. Whether these bets materialize into superior returns is impossible to predict. What is certain, though, is that through its GARP approach, B400 has once again placed its bets.
Figure 4. Sector Exposure Differences Between the Barron’s 400 Index and the S&P 500 Index.
Source: MarketGrader Research
