Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: Up until Tuesday, the market seemed to be enjoying a fairly smooth ride higher in 2019. However, a slew of headlines involving a snag in trade talks between the US and China, reduced global growth projections from the IMF, and other lingering concerns, gave the major indices their first whack of the new year. Is this a good example that the market is not quite out of the woods just yet?
Stovall: Yes, I think that the market has to go through a bit of a retest of the Dec. 24 low, and it has to undergo what technicians call a “backing and filling” process before it can move meaningfully higher. I think the prospect of a slowdown in both global economic growth and US economic growth, which was also confirmed Tuesday by a much weaker-than-expected existing home sales report, is causing investors to say, “Gee, maybe the market can still rise this year but let’s not get overly enthusiastic about a reversion to a very sharp upward trend.”
It’s probably going to be two steps forward and one step backward between now and the end of the year.
EQ: Interestingly, before Tuesday’s dip, the S&P 500 actually touched the top-end of the key resistance range between 2,629-2,674 that you indicated in last week’s CFRA IPC Notes. You also noted the rally and breadth average readings looked a bit stretched. From a technical perspective, where do things stand?
Stovall: Well, where things stand right now is that we think it’ll be a retest, not a resumption of a downward move that will throw us officially into a bear market. The S&P 500 just missed slipping into an official bear market when it fell 19.8% on a closing basis from Sept. 20 through Dec. 24. Because of valuations being where they are and the trajectory of earnings growth and global GDP is still upward—albeit with a reduced angle of ascent—we think this will be a retest and not a resumption of the overall bear trend.
i10Research reminds us that there is support at 2,474 and 2,400 on a pullback or retest of the previous decline. I would tend to say that any bounce above this area would be an encouraging sign.
EQ: In this week’s Sector Watch report, you looked at three rebalancing strategies that investors may be considering early in the new year, such as letting their winners ride by buying and holding the 10 best-performing sub-industry groups within the S&P 500, finding value plays in the 10 worst-performing groups, or doing both via the Barbell Portfolio. How have these strategies stacked up against the S&P 500 and each other historically?
Stovall: Well, all of them have beaten the market on a compound annual growth basis, but two out of three beat the market more than 50% of the time while a similar percentage recorded an improved return-for-risk ratio, which essentially measures how much return you get for every $1 worth of risk.
In general, I find that the best-performing one has been the “let your winners ride” strategy, where you just focus on the 10 best-performing sub-industries from the prior year, buying and holding them for the coming year, based on return, risk and frequency of beating the market. While the best return came from the Barbell Portfolio, where you own the 10 best and the 10 worst from the prior year, it outpaced the market less than 50% of the time. Owning last year’s losers—sort of similar to buying the dogs of the S&P 500—also beat the market, but exposed the investor to increased volatility, thus resulting in a reduced return-for-risk ratio.
So, I find that simplicity tends to work best. If your stock has hit a 52-week high, chances are you’re going to be bragging about it and you’re going to be less upset than if it recently hit a 52-week low.
EQ: You also applied a new twist to the strategies, looking at returns based on a monthly rebalancing method. How did that impact the performance?
Stovall: A monthly rebalance means that at the end of each month, you look back at the 12 months to see which of the 125 sub-industries in the S&P 500 had the best price performances. You then own the 10 best performers in equal amounts for the month. Then at the end of each month, you review the portfolio again, selling those that are no longer in the top 10 and buying those that are to complete the top 10. You also have to make sure they are all equally balanced.
I found this strategy actually improved the compound annual growth rate. It also increased the batting average, and at the same time, provided the best risk-for-return ratio and it was highest using a let your winners ride strategy that also engages in monthly identification and rebalance.
EQ: How does this strategy compare with your Industry Momentum Portfolio strategy?
Stovall: Let your winners ride, which simply looks at the 10 best-performing sub-industries on a rolling 12-month basis is the root for my Industry Momentum Portfolio. However, in an attempt to increase the number of industries as well as reduce the overall turnover of the holdings, for the Industry Momentum Portfolio, I select the top 10% of industries in the S&P 500 and hold them until they fall out of the top 30%. So, I’m still picking the winners to be entered into the portfolio, but I cut them a break in a sense that if they happen to slide a little. Only if they fall out of the top 30% do I then jettison them from the portfolio.