As the Chief Investment Strategist, I am responsible for determining our firm’s stance with regard to the equity markets. This does not mean that I predict where the stock market is going. That is a fruitless task, despite what you might hear on TV or see on your Twitter feed. Instead, I try to think probabilistically about the markets. I weigh the evidence. I ask whether it makes sense that current drivers continue to dictate market outcomes. I am not dogmatic. Markets change. What works in one era may not work in the next.
I am pondering where we go from here. The stock market did very well since it bottomed eleven years ago. It was a great run. It was characterized by the fact that just three sectors carried the burden of the bull market on their backs. Two of the three were growth oriented, technology and consumer discretionary. Healthcare, the third, falls into the “Blend” category, neither fish nor fowl, not growth, nor value. Value as an investing strategy was left in the dust. So too were small stocks, international stocks and emerging markets. It was just the US and within the US it was growth.
Another way to look at market performance is through the lens of factors. Factors are qualities exhibited by certain stocks that seem to be associated with better performance over time. Quality is one factor. As implemented in the ETF QUAL, quality comprises stocks with low debt to equity, high return on equity and low variability of earnings.
Those sound like characteristics you would want in the companies you own. The market agrees. The companies that turn up in QUAL are well represented in the three sectors that drove performance since the GFC.
Momentum is the other factor that did well in the bull market. In momentum investing you select the stocks that have done the best among their peers over a short to medium time frame, typically three to fifteen months. You buy them and sell any laggards. You do that again a month or so later. Lather, rinse, repeat. It has worked extremely well post GFC.
The folks at Logica funds point out that not only has momentum worked, it has dominated value for the last twenty five years. They chalk it up to the surge in passive investing. Their idea is that as passive buying attained critical mass, it came to dominate investing and, through sheer weight of force, performance.
Perhaps Logica’s logic is right. That might not be the most important thing. Maybe the most important result is that the studies done by Fama and French that established value as a dominant factor in investing were conducted over the period most favorable to value.
So here I am, pondering what our policy should be for public equities. My experience over multiple market cycles has been that the future tends not to look like the past. The cycle that arises from the ashes tends to be different from the one before.
I have no answers, but I do have questions. Here are some:
Does momentum, the darling of this cycle, continue to prosper? It has done well in the bounce. Momentum adapts quickly; the portfolio turns over to those that perform well. Has-beens are shown the door. Still, there are momentum crashes, periods when momentum performs poorly. If we end up with a choppy market, uncertain of direction, momentum may lose…momentum.
Will value experience a resurgence? Value has had long droughts before. Perhaps you remember the tech bubble at the turn of the century? Value gasped for air during it, but dominated in its wake. Investors turned from buying castles in the air to buying solid businesses. Tech did not regain its footing until after the GFC. It’s different now. The internet companies with no profit have turned into internet companies with huge profits. They dominate the investing landscape. You can argue that they are overvalued, but betting against overvaluation is a poor strategy; you need a catalyst for change. It’s not clear that we have one yet. COVID-19 plays into the strengths of the tech sector.
Will emerging markets ever fulfill their promise? GMO, a money manager, is famous for featuring emerging markets as the best bet for the next seven years in their capital markets assumptions. There’s a saying in the emerging markets community: “Brazil is the country of the future…and always will be”. Many people feel that way about GMO’s emerging markets projection.
To be fair, I really cannot say exactly what I am doing. Compliance and my colleagues wouldn’t like that. I do hope that you find this exercise useful and, perhaps, thought provoking. I can say that, on balance, I’m playing it down the middle of the fairway. I don’t, at this time, see compelling reasons to stray into the rough.
If you would like to talk about this or anything else finance related, do get in touch.
Disclosures: We Are One Seven, LLC d/b/a: One Seven. This document may contain forward-looking statements relating to the future performance of the market generally. Forward-looking statements may be identified by the use of such words as; “believe,” “estimated,” “potential” and other similar terms. Forward looking statements are subject to various factors, including, but not limited to economic conditions, changing levels of competition and markets, changes in interest rates, that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, and uncertainties. Actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements. None of One Seven or any of its affiliates or principals nor any other individual or entity assumes any obligation to update forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.