Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: With this being a holiday-shortened week, the markets have traded pretty calmly. Considering that the Trump administrations trade tariffs on China are set to begin at the end of the week, is this a surprise?
Stovall: Yes, actually because the volatility in the market seems to have been blamed upon the trade sanctions, and now that the sanctions are about ready to go into effect, the market decline has been either absent or muted. It makes me believe that either investors have already factored this eventuality into their decision making, or they feel that it won’t have that big of an effect on the growth of the US economy, and as a result, on corporate profit expectations. So, yes, it’s a bit of a surprise, but I’ll be happy to take it.
EQ: In this week’s Sector Watch, you reviewed the first-half performances of five portfolio strategies you’ve covered in your weekly articles, and of which we’ve discussed in our interviews. They are the Industry Momentum portfolio, Seasonal Rotation, Barbell, As Goes January and Nervous Nelly. To start, which of these portfolio strategies did the best against their benchmarks in the first half of 2018?
Stovall: Since 2018 thus far has definitely been a growth-tilting market, the Industry Momentum portfolio outperformed its benchmark by the widest margin. Also, the Barbell Portfolio did relatively well—which, if you recall, owns the 10 best and 10 worst sub-industries from the prior year.
The Seasonal Rotation portfolio, which rotates into defensive sectors during the sell in May period and cyclical sectors from November through April, saw the small-cap and global seasonal rotation outperform their respective benchmarks.
The As Goes January portfolio indicates that as goes January so goes the year, so you own either the three best performing sectors or the top 10 sub-industries based solely on their January performances alone and hold for the coming 12 months. In this case, the sector level outperformed the S&P 500.
Finally, we also have the Nervous Nelly portfolio, which consists of the low volatility subset of each of the large cap S&P 500, MidCap 400, SmallCap 600, International Developed as well as the Emerging Markets benchmarks. This approach has underperformed against its benchmark.
EQ: Looking at these performances, it does look like it did pay to be more aggressive, at least in terms of small caps and momentum plays. What were your thoughts on the environment in which these portfolios performed in?
Stovall: First off, I started preparing this article three days before the close of the quarter. At that time, all four seasonal rotation portfolios were outperforming their benchmarks, primarily because the market had been nervous. It was down on Monday, up on Tuesday, and down on Wednesday of that week—implying that investors had been pretty nervous thus far since the end of April as it relates to trade tensions, etc.
But I guess the market has since sort of shaken off that worry, and as a result, has done relatively well, allowing the large-cap and mid-cap and the equal weight components to outperform the seasonal rotation strategy. What I’ve also found is that people don’t feel the need just yet to become overly nervous, and therefore protect their portfolios by having low-volatility equities.
Another reason could be that low-volatility equities are traditionally your more defensive Consumer Staples, Health Care and Utilities type of stocks that also have higher dividend yields. In this rising interest rate environment, they have been held back as the Fed has continued to raise rates. We believe the Fed will raise rates two more times in 2018 and three times in 2019, so only if the market goes through some additional gut-wrenching gyrations will the Nervous Nelly portfolio outperform once again.
EQ: The market did seem to shift noticeably in sentiment during mid-June and into the start of the second half of 2018. Do you think that will have a meaningful impact on the trajectory and performance outlook of these strategies?
Stovall: I think it certainly alters the potential to affect the trajectory. On a year-to-date basis through the end of June, the S&P 500 is up almost 2%. In the second quarter, it was up more than 4%. However, in the month of June, it was up only 0.5%. So, investors are getting a bit nervous and they’re asking themselves what the catalysts are to push prices even further. If interest rates are going up, inflation is on the rise, trade tensions are increasing, and we also have the uncertainty associated with midterm elections, I think investors are wondering if they should lighten up on their risk exposure and sort of wait and see what catalyst emerges.
So, investors should remember that the third quarter of midterm election years tends to see a near-35% increase in average daily trading volatility.