This week we are referencing our November 20, 2020 commentary where we focused on the market’s performance relative to the on-going positive vaccine news. Like now, the path of equity market performance leading up to year-end had produced tremendous upside and the general rhetoric was one of a potential short-term correction. Although conventional wisdom certainly supported such rhetoric, the objective nature of such a belief lacked decisive sentiment. It also lacked conviction. The commentary provides a glimpse of our assessment of the market three months ago and we are sharing it again because it still provides actionable information that relates to the current environment. The possibility for a short-term correction, alongside a maintained market-based dislocation, has not subsided. Attempting to gauge what this means from a risk management standpoint, however, presents its own risk. Rather than exiting equity market participation, which is the emotional based decision, the most prudent approach is to take advantage of active volatility alongside active portfolio management. We have decisively, and successfully, implemented such an approach over the past decade and stand ready to do it again.
Buy the rumor and sell the news?
There is no hiding the fact that near-term optimism tied to economic growth has surged in the current environment. One can simply reference the gains across global equity markets as an example. Or, better yet, spend a few minutes analyzing renewed forward earnings guidance from stocks in the discretionary sector of the U.S. economy and you will start to gain a sense of calm. For most contrarian warriors, however, it is that simple notion of calm that has them screaming from the rooftops for a potential resurgence of downside risk. Should we be worried? Is the fear warranted over the short-term? What about the long-term? Let us explore this from an objective and non-emotional perspective.
The idea of ‘buy the rumor and sell the news’ is a Wall Street saying that has been around for decades. In fact, some professional money managers use it as a direct investment strategy. Like all strategies though, it works some of the time but not every time (this is also one of Credent Wealth’s core beliefs!). The reason such an idea, or saying, has strongly re-emerged in today’s environment is because many market participants have associated the gains in the global equity markets to the rumor that a potential vaccine will soon be released. If the saying holds true, market participants should then consider selling when the actual vaccine comes out, which is a presumptuous way of saying that the gains in equity markets have priced-in the potential forthcoming economic growth. Here is where I would like to urge tremendous caution. Most investors tend to associate the equity “market” as simply that of the U.S. large capitalization S&P 500. Meaning, if the S&P 500 is up, say, 10%, we likely assume that a diversified equity portfolio should also be up 10%, or we also tend to assume that the average stock is performing somewhere around 10%. The reality could not be starker. In fact, in a year like 2020, the average large capitalization stock is underperforming the S&P 500 by a whopping -6% while most global small and midcap equity indices are underperforming the S&P 500 by over -10%. Why is this happening? It is simply a function of how market indices account for return attribution for each stock in the index. Without getting too granular, the current structure has built an inaccurate depiction of performance. Market indices have forced investors to either accept tremendous valuation risk (and sector concentration) or underperform the market. We would strongly argue that underperformance to the S&P 500 year-to-date is a function of appropriate risk management that stays away from runaway exuberance. It is such exuberance that has never historically benefited investors over the long-term. Bubbles pop all the time, and it is our job to help avoid holding a balloon full of water.
With that in mind, should we pay much attention to the “sell the vaccine news” adage? Perhaps we should in the short-term because we would agree that the upside has been phenomenal over the past six months. If we were to do that, however, we are also assuming that our crystal ball indicates a foreseen level of volatility that will allow us to take advantage of our market timing capabilities. Since no one can time market, and I mean absolutely no one on the face of the earth, then the short-term fear factor of volatility remains just that, short-term. What is critically important to understand in the current environment is that there is a notable dislocation in market returns. There is also a notable misunderstanding of why global diversification works and why it needs to remain embedded within core investment portfolios. As the news of an approved vaccine dominates the media headlines, we believe it may cause downside in global equity indices. Such indices, however, do not represent the average stock, nor do they represent the holdings of most sophisticated clients working with fiduciaries such as Credent Wealth. Risk within global equity indices should not be deciphered as an equal risk to most investment portfolios. The eventual re-opening of the global economy, which may occur sooner than anticipated, has the potential to provide one of the strongest catalysts in history tied to shifting and removing concentration in major global equity indices. We believe this to be an enormous positive for most investors.
Edison Byzyka, CFA – Chief Investment Officer – Credent Wealth Management
Investment advice offered through CX Institutional, a registered investment advisor.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted.
All return data sourced from Bloomberg.
All other data soured from Bloomberg, through the release of monthly figures from the Department of Labor, Bureau of Economic/Labor Statistics, U.S. Census Bureau, or from the Federal Reserve and any of its affiliated regional locations.
Small Business Optimism sourced through NFIB. Small business hiring plans sourced through NFIB. Consumer sentiment sourced through the University of Michigan.
Earnings data sourced through Bloomberg Intelligence and through Bloomberg’ earnings analysis composites. Interest rate cut/rise probabilities are sourced from Bloomberg’s tracking of futures contracts tied to the Federal Funds interest rate.
Manufacturing data – Markit PMI – Bloomberg
Economic Policy Uncertainty data sourced from Bloomberg via The Baker, Bloom, and Davis Index.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changed in the aggregate market value of 500 stocks representing all major industries.