NEW YORK (Reuters) - Investors counting on sustained double-digit percentage gains in U.S. stock prices should lower their expectations, according to Joel Greenblatt, a hedge fund and mutual fund manager who also teaches value investing at Columbia Business School.
Speaking on Thursday at the Reuters Global Investment 2018 Outlook Summit, Greenblatt, who blends buying stocks he likes with "shorting" overvalued stocks, said the Standard & Poor's 500 .SPX has appeared cheaper only 16 percent of the time over the last 27 years.
He said that could herald annual 3 to 5 percent gains over the next few years, with negative returns possible from the Russell 2000 index of smaller stocks, because it has been cheaper only 4 percent of the time.
“The only thing that could hurt us going forward is if the market continues up 15 to 20 percent a year for the next three to four years,” he said. “That’s unreasonable to think, given current valuations. I think there will be normal to subnormal returns, and that’s fine for us.”
Greenblatt and his longtime business partner Robert Goldstein oversee about $5.2 billion of hedge fund and mutual fund assets at Gotham Asset Management in New York.
Greenblatt described his favorite strategy as “index plus,” followed in his 2-1/2-year-old Gotham Index Plus Fund (GINDX.O).
That fund owns the S&P 500 stocks and then uses offsetting leverage, plowing 90 percent in the index’s best stocks in that index and putting a 90 percent short on the worst.
Last year, the fund returned 18 percent, outpacing 98 percent of its “long-short” peers, though it has trailed two-thirds of them this year, according to Morningstar Inc.
Greenblatt said he likes businesses that do not need much capital to grow, as well as businesses that can earn money efficiently and can reinvest it at high rates of return.
He called an example of the latter the BNSF railway unit of Berkshire Hathaway Inc (BRKa.N), whose chairman Warren Buffett studied under value investor Benjamin Graham at Columbia.
Another long bet has been iPhone maker Apple Inc (AAPL.O), also a big Berkshire investment.
“Companies that are gushing cash, with high returns on capital, with nice niches and trading at low multiples to cash flow, if I buy a bucket of those, I’m going to do very well,” Greenblatt said.
One problem with index investing is that passive managers must buy stocks that investors are bidding up, even in bubbles such as the late 1990s when technology stocks were the rage.
Greenblatt sees parallels to the current environment, with some of investors’ current emotions being of the “frothy” rather than “fearful variety,” a situation he said may not persist.
The tech bubble “was one of the craziest things I’ve ever seen,” he said. “Very good, cash-generating companies with nice business niches – no one was interested in them. They were interested in money-losing businesses that had the word Internet or dot com attached to them.”
Greenblatt called that period an “extreme version of how stocks can be emotional and why we have opportunities, discipline. And also why it’s so hard in the face of the market doing and rewarding totally different things, how important it is to stick to your guns.”
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Reporting by Jonathan Stempel and Jennifer Ablan in New York; Editing by Susan Thomas