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Time Machine 3: Five Years Later

Barron's 400 Newsletter. Powered by: MarketGrader.com

Lehman Brothers: The End Of the World Live On CNBC

  Despite all the summer turmoil and palpable market nervousness, B400 had managed to close on Friday, September 12 down ‘only’ 11.6% for the year, still ahead of the overall market, which was down 13.9% as measured by the Dow Jones U.S. Total Stock Market Index. Furthermore, it was readying a rebalance the following week, which turned out to be, of course, one of the most frantic weeks in the history of financial markets. From September 12 on, B400 became one more proxy for the overall stock market. At that point it wouldn’t matter which index an investor used as their benchmark, as the entire market would move in almost perfect synchronicity through the end of the year.

A research note published by MarketGrader for its clients the following week focused on the B400 rebalance and the market dislocations that were beginning to emerge as a result of the crisis, which would lead eventually to one of the biggest buying opportunities in history. An excerpt:

“In order to arrive at the equivalent of current bond yields, an interesting comparison in this dislocated market, we calculated the earnings yield of all B400 components in order to arrive at the index’s average yield (the inverse of the P/E ratio, the earnings yield theoretically shows the percentage earned by each dollar invested in each company). We have calculated it based in every company’s trailing 12-month earnings. The table below illustrates the index’s yield relative to a few current bond index yields.

IndexYield (%)
Barron’s 4008.36
Barron’s 400 financial companies11.76
S&P 5006.69
S&P 15006.45
High Yield 100 Index (Merrill Lynch)*10.62
DJ Corporate*6.71
Emerging Markets**7.77

*Bond total return indexes **EMBI Global Index
Sources: The Wall Street Journal, Baseline, MarketGrader

Current stock prices therefore put the earnings yield of the B400 above that of an index of investment grade corporate bonds and even 59 bps above the yield on an emerging market bond index. Based on current balance sheets only 23% of total capital of all B400 components, on average, is made up of long-term debt. This is below the S&P 500 average of 32%.”

–MarketGrader Research, September 19, 2008

The chart below illustrates how little B400 changed during the September 2008 rebalance relative to the March 2008 selection. Notably, it reduced its exposure to financial stocks from 11.75% to 7.75%. The chart also shows what B400 picked up in March 2009, which turned out to be the market bottom and what it owns now, based on the March 2013 rebalance.

Five Years Later

Five years after what we now know was the climax of the financial crisis of 2008, the story for B400 has been a mostly happy one. The index is up, on a cumulative basis, 64.3% exactly to that Friday before Lehman Brothers famously filed for bankruptcy. That compares very favorably to the 39.0% cumulative return for the stock market, as measured by the Dow Jones U.S. Total Stock Market Index and to the 34.5% gain clocked by the S&P 500 Index. On an annualized basis, B400 has gained 10.4% per year, through friday’s close, in each of the last five years, besting DJUSTSM and the S&P 500 by 360 and 430 basis points per year, respectively. And despite a very strong market run this year and valuations that are definitely nowhere near where they were five years ago, much less at the March 2009 bottom, stocks could have plenty of room to run, especially if the economy continues to improve, as evidenced by an updated earnings yield analysis, a handy comparison to our analysis five years ago, as seen below.

Index2008 Yields (%)2013 Yields (%)
Barron’s 4008.365.59
Barron’s 400 financial companies11.767.54
S&P 5006.695.61
High Yield 100 Index (Merrill Lynch)*10.625.59
DJ Corporate*6.713.34
Emerging Markets**7.776.33

                               *Bond total return indexes **EMBI Global Index
                              Sources: The Wall Street Journal, Baseline, MarketGrader

Also worth noting, a remarkable 91 companies selected by B400 during the September 2008 rebalance are currently members of B400. This doesn’t mean all of them have been in it without interruption but it does show that while B400 is always picking the cream of the crop, well managed, growing companies at reasonable valuations tend to stick around B400 for long periods of time. Of these 91 companies, all but seven are trading at higher prices than they were during that fateful week of 2008. In fact, all 91 have gained, on average, 112% during the past five years. When comparing today’s selection to the March 2009 mother-of-all-buying-opportunities selection, we find that 107 companies picked back then are in today’s index. Their average five-year gain: 254%. The table below shows the top five gainers since September 2008 and March 2009 currently in B400.

Company Sept. 2008Chg.Company Mar. 2009Chg.
Priceline.com1,028%Questcor Pharmaceuticals1,351%
Tractor Supply481%Priceline.com1,159%
NewMarket Corp.393%Herbalife887%
Biogen373%Nu Skin Enterprises882%
Fossil Inc.319%Green Mountain Coffee Roasters745%

The latest B400 Diary entries by John Prestbo:

Five Sectors Lead B400 in Market’s Rebound Over Past Five Years
Five years ago, the financial industry imploded. Lehman Brothers and Bear Stearns went out of business; Bank of America absorbed Merrill Lynch, at the government’s behest; Citigroup and AIG were put on taxpayer-funded life support.

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