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bearish

Take a Step Back

For the month of April, stock prices measured by the S&P 500 nudged incrementally higher, up 0.27%, and are now in 1.74% above where they finished 2015. These modest numbers mask a lot of price movement, speculative news flow and investor angst during the first third of the year.

Recently, the market has been shape shifting. For example, after a long period when growth stocks outperformed value stocks, the tide has turned.  The S&P 500 growth ETF (IVW) is -0.74% for the year, while the S&P 500 value ETF (IVE) is 4.23%.  The spread in favor of value is even greater for the mid cap and the small cap segments.  And dividends are the thing, today, as the DJ Dividend ETF (DVY) is up an eye opening 10% year to date.  This is a sudden and complete reversal of the trend in 2015 when the growth IVW returned 5.37% while the value IVE returned a -3.29%.

There are multiple reasons for the u-turn in the return characteristics of the market. Core CPI is in the 2% range, and holding.  With the US 10-year Treasury currently in the 1.8% range, the real yield is negative, pushing investors to own higher yielding assets, including dividend paying stocks.  Dividends are generally taxed at a much lower rate than traditional fixed income, increasing the appeal.

Another reason is investors are generally bearish, marginally outnumbering bullish investors, as measured by the American Association of Individual Investors. This bearishness in conjunction with a declining Consumer Sentiment Index does not historically represent a lot of upside for stock prices.  The numbers are leading investors’ intent on staying in the market to lower their perceived risk, by owning dividends and stocks with lower valuation metrics.

Seasonality often comes up this time of year – the May through September window is historically not the most profitable.  In my opinion, the old wives tale to sell in May is not actionable.  While returns are generally lower, they are also generally positive.  In addition, it’s difficult to justify realizing capital gains (paying taxes on profits) to buffer some near term volatility, when in fact these are stocks with attractive long term growth potential. 

Q1 earnings reports are coming in and by and large the results have been slightly better than expected. One exception has been large cap technology stocks (Apple, Microsoft, Alphabet) have surprised with reports below expectations.  In my view, Q1 is the turning point, and I expect the trend in earnings to recover, aided by the stabilization in the US$, which had been a headwind, and from a recovery in oil prices by the end of 2016.

Some patience is key to successful investing. There have been roughly six pull-backs in stock prices since 2010.  These have trampled the unhealed nerves of investors still recovering from the financial crisis.  The Flash Crash in July ’10, Europe in October 2011, the Taper Tantrum in June 2013, Ebola in October 2014, China in August 2015 and Oil in February 2016.  Unnerving points in time such as these reveal the importance of a solid strategy and continued monitoring of factors effecting the markets. 

In that light, we have been shifting our portfolios into stocks with more value characteristics.  According to Empirical Research, growth and value stocks are traditionally non-correlating.  In today’s market, the focus is more on stability, and thus, the dividend as a key factor.  The value tilt we are enacting is in an attempt to capture the heart of the market.  According to Empirical Research, the value shift is one half complete based on historical trends.  We are not jumping in with both feet, as I believe the tilt will revert later in the year.

In response to the demand for yield, we have launched two new models (Dividend 5 and 10). The intent is for them to complement a traditional growth portfolio, and act as somewhat of a replacement to traditional fixed income.  We will be happy to discuss how these “sleeves” might complement your investment portfolio going forward.

Finally, with tax season behind us, we can all take a step back and assess. The shifting characteristics of the investment landscape will remain a challenge.  Further, with the market regime shifting, we have taken more capital gains than is typically the case.  I am happy to review these and other topics with you if we have not already done so.

 

Bruce Hotaling, CFA

Managing Partner