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Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: Stocks closed out 2016 with a fizzle, but have started 2017 strong. Are we seeing the market resume the uptrend we saw before the holiday pause?
Stovall: Yes, I think we are. With many people on vacation, there was very low volume. The market really just traded in a very narrow range during the final week of the year. But now that investors are back from the holidays, they are jumping back in with earnest in anticipation of tax cuts, infrastructure spending and repatriation efforts that should be successful by the new Trump administration.
EQ: There’s some speculation that the market could end its post-election rally when inauguration day arrives, perhaps in a buy the rumor, sell the news kind of way. How much credence do you give that?
Stovall: This widely distributed strategy concept sounds plausible, since the S&P 500 recorded a stronger-than-average advance following the surprise outcome of the Presidential election. However, history is not supportive of a pre-inauguration surge. Since 1945, the S&P 500 eked out an average gain of only 0.2% and rose in price only 50% of the time. In addition, the market will typically do what the majority does not expect. Besides, investors should focus on buying stocks that offer value, rather than attempting to divine short-term fluctuations in the equity markets.
EQ: Around this time of year, investors usually wrestle with either letting their winners ride or buying some of last year’s losers in hopes of them rebounding. In this week’s Sector Watch report, you discussed why they might want to do both using the Barbell Portfolio. How does this strategy work? How has it performed historically?
Stovall: Usually people want to know whether they should buy last year’s winners or last year’s losers. Usually it relates to sectors within the S&P 500. Historically, you’re better off buying last year’s three winning sectors and avoiding last year’s three losing sectors. However, you could take it one step further and look at this question on a sub-industry level. There are 134 sub-industry groups in the S&P 500, so what if you took the 10 best and 10 worst performing groups? Well, I found that instead of trying to decide which of the two strategies to buy, by buying both the 10 best and the 10 worst, you actually got a better return (13.8% CAGR) than if you owned just the 10 best strategy (12.4%) or the 10 worst (12.5%). Also, you ended up seeing a higher frequency of beating the market, rising to 77% of the time versus a maximum of 68% if you selected only the best or the worst groups.
EQ: What should investors be targeting this year if they want to use the Barbell Portfolio strategy?
Stovall: Well, probably not surprising, the areas that did the best in 2016 were Industrials and Materials companies related the expectation that they would do well when a Trump administration comes into office, and when the focus is on infrastructure spending. These areas include Agricultural & Farm Machinery, Construction Machinery & Heavy Trucks, Construction & Engineering, Construction Materials, Gold, as well as Steel were among the best performers.
In terms of worst performers, again, no surprise that a lot of them came from the Health Care area. Biotechnology, Health Care Distributors and Health Care Technology were areas in particular that had been beaten up pretty badly, and as a result, are likely to be turnaround candidates in the year ahead.
