The markets remained quite volatile this week, with an early rally reversed by the end of the week. Here is how the models looked as of 9/2:
Top 20 struggled this week, declining 2.9%, while the S&P 500 lost just .2%. While part of the weakness was due to smaller stocks performing worse than larger ones generally, the poor performance can't be fully explained by this factor. 5 of our names declined by more than 5%, with four of them among our very smallest names in terms of market cap and each of those from the Industrial economic sector. The 2.7% relative decline against the S&P 500 more than offset the 1.9% relative gain from the prior week. In terms of overall positioning, we have vastly stronger balance sheets than the S&P 500 with more of a "value tilt", both of which should support the portfolio if the market remains under pressure. On the other hand, though, we have a bias towards smaller names as well as more cyclical economic exposure, which leave the portfolio somewhat exposed to further economic contraction.
Conservative Growth/Balanced also had a challenging week, declining 1.45% while the blend of stocks and bonds actually rose slightly due to the strength of bonds. We had four names decline by more than 4%, with three of them representing our smallest holdings in terms of market capitalization (all below $1 billion). Our positioning here (minimum on bonds, maximum on stocks) has hurt the performance over the past 5 or 6 weeks. I view bonds as in a bubble currently and offering extremely poor value. While I continue to believe that the risk-reward of stocks, especially the conservative ones that are included in this model, suggests maintaining high exposure, I will be looking to reduce if the market begins to trend lower again in order to preserve capital.
Sector Selector ETF lost just a little ground, declining .4% compared to the .2% decline in the S&P 500. Our large exposure to Emerging Markets (+2.9%) helped, but Financials detracted while exposure to Small-Cap and Micro-Cap also hurt. As with CG/B, we do have flexibility in this model to reduce overall exposure somewhat, and I will be considering that next week should the market appear to be breaking down again.
Market Outlook
Yesterday marked the end of the summer unofficially. Last year, the markets turned on a dime after Labor Day, having endured a similarly challenging summer. I don't expect that we will be as fortunate this time, but I remain constructive on stocks. My economic outlook has been based on sluggish growth, and I continue to expect that we have a less-than-typically robust recovery due to several headwinds. With that said, the recent data has been somewhat alarming and suggestive of the increased potential for another recession. My view on stocks has been more favorable, but the high level of volatility has certainly resulted in less demand for stocks from individuals despite very healthy corporate earnings.
It's very easy to get caught up in the manic-depressive nature of the stock market and to extrapolate bad times ahead. There's an old saying that the stock market has predicted 13 of the last 4 recessions. Stocks move more than the economy. There is some interplay, as a declining stock market can impact the confidence of consumers and businesses, but I don't expect that will be the case here. In 2008, the crash and collapse in real estate (and seizing up of the entire financial system) certainly impacted wealthier consumers who changed their spending habits for a few years. For most Americans, though, it's the price of gasoline and not the Dow Jones that matters most.
One very bright piece of news that was totally buried last week was the cut in rates by Brazil and the ensuing surge in its stock market (as well as other emerging countries). One of the few growth drivers in a world of headwinds is the development of middle classes in the BRIC countries, but their growth has been at risk due to anti-inflationary policies that were running the risk of going too far.
On the other hand, our employment situation remains atrocious. Earlier this year and late last year, we saw monthly trade-offs between hiring and wages/hours worked, but recently both have been downright scary. August saw no net hiring and a decline in the hours worked and average wages. I know that the President will be making some proposals this week, but it's not likely that we will see substantive change in the labor markets from whatever is announced. We have some real structural problems, with the unemployed constrained by a lack of skills as well as the inability to relocate due to their houses being underwater. I listen to a lot of companies, and most of them have unfilled open positions.
Taking everything into account, I continue to expect a muddle-along economy but am hopeful that historically cheap stocks can perform well over time and preferably sooner rather than later. This week marks the start of "conference season", with many companies participating in conferences sponsored by Wall Street. It will be very interesting to hear the marginal changes since most of the companies last reported (prior to the end of July in many cases).
Articles
- History says Stocks Should Rally - Seeking Alpha
Final Thoughts
I hosted our first conference call this week. While we had a technology glitch, I thought it went well. We had good attendance, and I know that many of you have listened to the replay. As I said on the call, Invest By Model is all about trying to provide above-average quality at below-average price. One of my pet peeves about the investment management industry is an inability or unwillingness to communciate with its clients. I am sure you are aware that not a Friday passes without me sharing comments, and I am willing to participate in this more interactive mode of communication as well. As always, if you ever have questions about the service or suggestions on how we can improve it, please feel free to email me.
Finally, while I am disappointed with the swing in performance over the past four months, particularly in Top 20, I want to share that I remain confident that we will get back on track. At the end of April, the Top 20 was up 14.49% YTD, which was 5.44% ahead of the S&P 500 at the time. The rapid erosion of our relative performance has been due in part to weakness in smaller stocks versus larger ones, which can happen, but it has also been due to several poor selections on my part. We have cleaned several of them up already. Another factor has been a failure to participate in the mergers and acquisition activities of late despite having several "shots on goal". I remain hopeful on this last point, as we have many smaller companies that I believe could be acquired. Investment performance varies over time. If you visit the website, you can review performance on a quarter-by-quarter basis since inception (performance tab - second section - click on quarterly) and see that even though the model can perform poorly in any given quarter, it tends to still do well over time. With 10 full quarters under our belt, absent some extremely good results this month, this will be our first back-to-back quarter of underperformance. While I don't expect that we will necessarily have the same kind of relative performance as we did last year in Q4, that's the nature of the beast. My goal for Top 20, as always, is to beat the S&P 500, and I am not going to give up. I am also not going to abandon the methods and processes that have allowed me to succeed over the years just because I am facing some recent challenges.
Have a great long weekend!
Regards,
Alan Brochstein
