Even though the Barron’s 400 is still in its infancy when compared to long established indexes, such as the Dow Jones Industrial Average (first calculated in 1896), it has been around long enough to have seen quite a bit of cycles and market gyrations, if not outright turmoil. A traditional index, of course, designed to actually measure an entire market or segments of it, such as the Dow Jones U.S. Total Stock Market Index, is a good tool to measure how markets react to world events. The Barron’s 400, on the other hand, while not designed to measure any specific part of the market, nevertheless offers pretty unique insight into the economic development of—in this case—the U.S. and its financial markets. Since the index is designed to select and track what Barron’s has described as “America’s most promising stocks,” following it over time, particularly in contrast to market cap weighted benchmarks, provides a unique window into the areas of the economy that are growing the fastest; and in times of market turmoil, given the Value component in MarketGrader’s fundamental analysis methodology, the index is pretty adept at identifying areas of dislocation that usually prove to be quite profitable for investors willing to zig while others zag. This week’s column, the first one in a sporadic “time machine” series, will look back at some of the history of the Barron’s 400 through the two major market dislocations of the last 15 years. For the sake of full disclosure, we should note that any data referenced prior to August of 2007 is back-tested and anything since is actual published data. A quick reprise of its history for clarification: MarketGrader was founded in 1999 and our first index was published in 2003 (MG 40). We began discussing and planning the creation of B400 with both Barron’s and Dow Jones Indexes in 2006 and, as part of our agreement to develop B400, we agreed to perform a 10-year back-test, from 1997 through August 2007. Such data was reviewed and vetted by Dow Jones Indexes prior to the September launch of the index on the cover of Barron’s. In August 2007 Dow Jones Indexes became the official index calculation agent (in 2010 DJI became CME Indexes) until early 2013. Since the beginning of this year B400 has been calculated by the NYSE.
Our focus today will be on the period between 1997 and 2010, which covers the dot-com crash of 2000-2001, its subsequent semi-recovery, the 2007-2008 crash that resulted from the financial crisis and the subsequent recovery from March 2009 through 2010. Data on the performance of the index since then is available in the performance page in the B400 section of MarketGrader’s web site.
Between the end of 1997 and September of 2010, B400 went through 25 rebalance periods. During 18 of these the index posted a positive return, which averaged 11.7% per period; on the other hand, seven of the 25 periods were negative, with an average return of -12.3%. The top performing period, not surprisingly, came from March to September 2009, when the index gained 50.3%. The top-contributing sector was Industrials, responsible for 28% of that performance, or almost 14 percentage points. The second best performing sector in the period was Energy, which accounted for 16% of the index’s return in the period.
The worst performing rebalance period for B400 since 1997 came between September 2008 and March 2009, at the very depths of the financial crisis, when the index fell 41.8%. The top-contributing sector to such negative performance was also Industrials, responsible for 23% of the drop. The second worst performing sector was also Energy, responsible for 18% of the index’s negative return.
Interestingly enough, the two sectors that were hit the hardest among B400 components during the financial crisis sell-off, were also the two best performers during the subsequent rebound. While many market observers would have guessed that Financials were perhaps the worst performers during the crisis (and they were, only not the ones in B400), perhaps followed by Consumer Discretionary, what actually happened in fact makes a lot of sense. For starters, B400 did not own too many financials in September 2008. It owned only 31 of them, or 7.75% of the index on an equally weighted basis. In contrast to that the index was fully allocated to Industrials (80 companies, or 20%) and had a very healthy serving of Energy (68 companies, of 17%). These are both cyclically sensitive sectors and as investors anticipated a global recession, both were hard hit. In addition to that, as credit markets froze in the fall of 2008 and investors rushed to cash, the easiest positions to liquidate were high quality stocks, precisely what B400 owned (ask any hedge fund manager at the time how easy it was to sell a mortgage-backed security in the face of mark-to-market). Such rush to the exits, of course, created one of those dislocations that B400 is so good at exploiting. It therefore doubled down on Industrials and Energy in its March 2009 rebalance, selecting 80 and 67 companies, respectively, almost identical allocations to the previous period. The charts below illustrates the performance of the Barron’s 400 from September 2007 to date, capturing all of the financial crisis and from March of 2009 to date, capturing all of the rebound.
The story of B400 during the dot-com crash is a bit different, mainly because the market collapse was of an entirely different nature. The fact that B400 selected 79 technology companies during its August 2000 rebalance (B400 rebalances prior to 2007 were actually done in February and August) and yet gained 2.2% through March 2001 compared to a loss of 18% for the S&P 500 and 49% for the Nasdaq illustrate the benefits of fundamentals-based stock selection and an equally weighted portfolio. Yes, the technology stocks in B400 proved to be a major drag on performance during the aforementioned period, with a negative 110% contribution in this six-month period. This means that had it not been for the rest of the index and for equal weighting, B400 would have had a negative return for the period; or put another way, had it not been for technology, the index would have gained over 5% during this six-month period.
During the following period, from February 2001 to August 2001 B400 fell 5.2%. This time the biggest contributor to such negative performance was not Technology but Industrials, responsible for 60% of the drop. Technology was the second biggest contributor, responsible for 45% of the period’s performance. Yes, both of these add up to more than 100% but that’s because Materials, Health Care, Consumer Staples and Financials, all of which were positive contributors during the period, offset them. In other words, had it not been for this level of diversification, B400 would have had a much steeper drop. During that same period the S&P 500 fell 9% and the Nasdaq Composite lost 16%. The chart below shows the performance of B400 since March 2000 at the beginning of the technology bear market. To those who argue that buy-and-hold is dead, we would say: it depends on what you buy.
To conclude for now, it is worth highlighting the importance that we think diversification still plays today in any stock portfolio, something that is automatically embedded in B400. A review of all 25 rebalance periods between 1997 and 2010 shows that B400 gained, on average, 5% per period (coincidentally very close to the outperformance per year of the index against the total market benchmark). A look at the weighted contribution of all ten economic sectors for the entire time period reveals a very balanced portfolio, receiving contributions pretty much across the board. Technology and Financials, which many would consider the toxic sectors responsible for the last two stock market crashes in the last decade and a half, actually contributed 12% and 17% of the performance of B400 during this same period. The charts below shows how balanced B400’s returns were from a sector perspective as well as from a market cap perspective. So, next time anybody advises against buy-and-hold you may want to think twice about what they’re selling.
The latest B400 Diary entries by John Prestbo:
Sliding Average Grades Sting Some B400 Sectors
As the average financial-health grade of Barron’s 400 Index components has slid 7% over the past five months, some sectors were harder hit than others.
For 26% of B400 Companies, Rising Grades Buck the General Trend Downward
Although the average financial-health grade of Barron’s 400 Index components has dropped 7% since the index was reconstituted last March, more than one-quarter have seen their grades go up.
B400 Companies See Grade Erosion; For Some, Stock Rallies Are the Culprit
Barron’s 400 Index components are suffering from erosion in their average grade of financial health, and for some the reason is surprising.
