One of the most observed facts about investing for retail investors is that their long-term investment goals are often clouded by short-term noise, or uncertainty. Such noise can often reflect our emotional bias to forego objectivity amidst a media news cycle embedded with uncertainty. We are clearly living in such an environment right now with COVID-19 and I hope that our commentaries over the recent past have helped investors remain educated and attentive. On the topic of noise, though, there is an added twist year-to-date that requires attention and education because the notion of sensible and risk centric decision making has been a penalty for investors. Such a penalty has come in the form of perceived weaker performance across investment portfolios. I use the term ‘perceived’ because the reality of the current environment is one that lacks clear information from broad media sources, or even market pundits. Many investors often seek to outpace the return profile of the Standard & Poor’s (S&P) 500 Index given its popularity and ease of access. Out of those same investors, however, only a handful are willing to accept the risk profile of the S&P 500 for the potential of achieving its return (we see this as a common and misunderstood concept for investors). The relationship between risk and return is often a critical component of how professional portfolio managers structure and maintain strategies. That is certainly our approach here at Credent Wealth Management. To effectively execute such an approach, the concept of appropriate diversification comes into play, which encompasses allocations to companies of different sizes, across numerous different sectors, and across varying countries. Here’s where things get interesting year-to-date. The benefits of diversification, which encompass a sensible approach to investing, have failed to provide measurable benefits. Such a penalty for actively avoiding concentrated risk has not been kind to investors.
As an example, let us look at the S&P 500. The index is comprised of 500 individual companies yet approximately seven (7) stocks are responsible for the nearly flat return of the index year-to-date. This means that an investor’s portfolio would have to be allocated to a concentrated set of just seven (7) stocks, within a concentrated sector, and within the domestic realm only, in an effort to attempt to outpace the S&P 500. Such a portfolio would be plagued with notable over-valuation alongside a risk profile that not even the most sophisticated investor should feel comfortable with. Yet that is the status of the stock market, at least as of right now. Any concerted effort to diversify assets across numerous strategies has been met with relative performance resistance. The most impactful shock factor for the year, in our view, has been the complete lack of diversification benefits associated with dividend paying stocks. When faced with historical short-term economic uncertainty, the concept of dividend exposure, alongside value-biased stocks (i.e. better valuation and stronger balance sheets), has generated better downside protection. None of that has materialized year-to-date as overall growth-biased stocks have dominated the cycle in a historical fashion. If your first thought is to switch to such an allocation, buyer beware. Historically, dislocations of such magnitude have not been consistent and the eventual winner (over the long-term) is a diversified and risk centric approach to investing. The abnormal market activity that has been initiated due to COVID-19 may not disappear overnight, but we urge investors to remain sensible and objective. Do not fall victim to chasing concentrated stock market exposure.
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