The Next Inflection Point? A Conservative Approach for U.S. Equity Investors

The U.S. equity market has benefited from a strong rally lasting nearly 9 years. During this time, U.S. equity valuations have inflated and decoupled from other developed markets. This insight presents a potential solution to help investors seeking U.S. equity exposure while managing the risk of a potential downturn.

  • February 2018

Recent History of the U.S. Equity Market

Current Bull Market - What a Run!

It has been more than eight years since the S&P 500® Index hit a low during the financial crisis. During this time, the S&P 500 Index has returned more than 370% (March 10, 2009 – March 31, 2018), and in the past year U.S. equity investors have benefited from twelve consecutive months of positive returns. The rally from March 2009 to March 2018 has lasted 109 months, significantly longer than the 81-month average for all rallies since 1970. The most recent rally has not only produced substantial returns, it has done so in a relatively consistent manner. The chart below plots the number of months with positive returns in each calendar year. The strong market performance has inflated U.S. equity valuations, potentially moving the risk/return ratio out of the investor's favor.

A Look Back: Duration of Bull Markets

bull markets since 1970

Time Period
Bull Run Duration (Months)
Subsequent Market Crash
May 1970 to Jan 1973 33 OPEC Price Shocks
Oct 1974 to Nov 1980 74 Volcker Crash
Aug 1982 to Aug 1987 61 Black Monday
Dec 1987 to Mar 2000 148 Dot Com Crash
Oct 2002 to Oct 2007 61 Financial Crisis
Mar 2009 to Mar 2018 109 ???
Average 81  

Analysis is as of March 31, 2018, and is based on S&P 500 Index monthly price return data. Past performance is no guarantee of future results.

Positively Skewed: Monthly Performance of the S&P 500 Index

NUMBER OF POSITIVE MONTHS BY CALENDAR YEAR

Source: FactSet, Standard & Poor's. As of December 31, 2017. Past performance is no guarantee of future results.


What About Risk?

Volatility Falls Below the Long-Term Average

CBOE VOLATILITY INDEX (VIX)

Source: Chicago Board of Exchange. As of March 31, 2018.
Past performance is no guarantee of future results.

Low Volatility, Low Risk?

According to the most common indicator of volatility, the VIX Index, volatility fell below the long-run average of 20.4 on June 28, 2016. The downward trend continued for nearly six months before spiking at the end of January 2018. The change in market trend was a reminder to all market participants investments contain risk and volatility can swiftly spike.

Strong market performance has inflated U.S. equity valuations, potentially moving the risk/return ratio out of the investor's favor. At the end of the year, the S&P 500 Index price-to-earnings ratio (P/E) was more than 50% higher than the MSCI EAFE Index (32.0 vs. 20.4).

How long can the divergence continue?

SHILLER P/E RATIO

Source: Bloomberg, Robert Shiller, Yale. S&P 500 Index and MSCI Emerging Markets (EM) Index as of March 31, 2018. MSCI EAFE Index as of February 28, 2018. The Shiller price-to-earnings (P/E) ratio is a cyclically adjusted valuation measure defined as price divided by average of the past 10 years of earnings adjusted for inflation. Past performance is no guarantee of future results.

Strong market performance combined with unusually low volatility may have investors feeling a false sense of security. As the equity market rallied since March 10, 2009, individual investors have steadily decreased their cash allocation to near 20-year lows.

Nearing 20-Year Lows

AVERAGE INVESTOR PORTFOLIO ALLOCATION TO CASH

Source: American Association of Individual Investors, FactSet. As of March 31, 2018.

A Plan of Action

For investors who still want—and require—U.S. equity exposure despite the current late cycle bull market and divergent valuations, consider a More Conservative Approach. Seek investments that may alter the nature of that exposure by combining:

  • Strong attention to risk and allocation to investments that may potentially provide greater downside protection relative to an index
  • A conservative approach focused on undervalued stocks


Over time, the challenges facing investors change. However, many of those challenges have arisen before, and recognizing that fact may provide an advantage in navigating uncertain markets. It may be the key to turning cyclical markets into consistent success.

AMG Yacktman Funds—A More Conservative Approach

During times of uncertainty, it is important to have a manager with a proven track record and experience in successfully investing through multiple market cycles. The AMG Yacktman Fund (YACKX) and the AMG Yacktman Focused Fund (YAFFX) have produced strong results relative to the S&P 500 benchmark over their respective histories. Although the Funds’ managers expect some performance lag late in a market rally due to their focus on managing risk, the Funds have provided significant outperformance during market declines and off market lows when bargain hunting is often best.

Yacktman maintains a long-term investment approach, attempting to identify companies with low purchase prices, good long-term businesses and shareholder-oriented management teams. They manage the Funds with a broad mandate, are benchmark agnostic and will utilize cash as an integral part of their portfolio construction process. Historically, the Yacktman Funds have performed especially well on a relative basis after equity market peaks. The Yacktman team does not attempt to prognosticate market direction as part of their investment process. The charts below demonstrate the Yacktman Funds results compared to the S&P 500 Index in the years following market peaks reached in 2000 and 2007:

Growth of a $1 Million Investment Following the Tech Bubble Peak

MARCH 10, 2000 - OCTOBER 31, 2007

03/10/2000-10/31/2007 YACKK YAFFX S&P 500 Index
Growth of $1M $3,153,199 $3,016,578 $1,253,768
Maximum Drawdown $984,925 $998,660 $573,641
Recovery (Months Below $1M) 1 1 68

Source: FactSet. Recovery based on months with value less than $1,000,000 at any point during the month. Past performance is no guarantee of future results.

Average Annual Returns and Expense Ratio
Average Annual Returns (%)1,2 (as of 03/31/18)

  QTD YTD 1 Yr 3 Yr 5 Yr 10 Yr Expense Ratio (Gross/Net)
AMG Yacktman Fund (YACKX) -0.96 -0.96 9.51 8.31 9.31 11.40 0.76%/0.76%
AMG Yacktman Focused Fund (YAFFX) -0.81 -0.81 9.76 9.01 9.54 11.95 1.27%/1.27%
AMG Yacktman Focused Fund (YAFIX)
-0.81 -0.81 9.89 9.18 9.72 - 1.10%/1.10%
S&P 500 Index
-0.76 -0.76 13.99 10.78 13.31 9.49 -

The performance data shown represents past performance. Past performance is not a guarantee of future results. Current performance may be lower or higher than the performance data quoted. The investment return and the principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. For performance information through the most recent month end, please call 800.835.3879 or visit our website at amgfunds.com.

Source: FactSet. Past performance is no guarantee of future results.

Growth of a $1 Million Investment Following the Housing Bubble Peak

NOVEMBER 1, 2007 - DECEMBER 31, 2017

11/01/2007-03/31/2018 YACKX YAFFX S&P 500 Index
Growth of $1M $2,714,480 $2,857,804 $2,134,449
Maximum Drawdown $539,542 $566,259 $451,810
Recovery (Months Below $1M) 10 9 59

Source: FactSet. Recovery based on months with value less than $1,000,000 at any point during the month. Past performance is no guarantee of future results.

Results: Growth of $1 Million Since the Tech Bubble

MARCH 10, 2000 - MARCH 31, 2018