The Intelligent Investor
A bi-weekly publication from Consultiva Internacional, Inc. (Registered Investment Adviser) August 10, 2017
Myrna Rivera, CIMA®
July gave us yet another month of highs in the U.S. stock market, and a quick look at the Russell 1000 below, will show you how far we’ve come from the economic crisis. Last week, this paved the way for yet another instantly collectible tweet from Trump; “Business is looking better than ever with business enthusiasm at record levels. Stock Market at an all-time high. That doesn’t just happen!” Correct Mr. President, it doesn’t just happen. But, how much of the current streak can we reasonably attribute to the new administration’s policy efforts? According to the New York Times, not much. Recent interviews with CEOs and investors show that they continue to expect policy changes that will boost corporate profits, but admit that the legislative agenda has been seriously bogged down. Some feel that Trump can still come through on his pledge to lower regulatory burdens and costs through executive orders, but acknowledge that these have been slow to implement also. So, if we put aside the administration’s inability to successfully pass any meaningful piece of legislation, what then explains the stock market’s uphill trajectory? Part of the answer appears in the most recent corporate earnings calls, were executives have maintained their focus on the global economy, industry trends and investor concerns, without mentioning regulation related cost savings. Even the financial sector, which seems like one of the most likely to benefit from deregulation, is indicating that it is still too early to predict exactly how these changes are impacting their bottom-line. Nevertheless, the anticipation of change continues to influence markets, and it will for some time, but eventually, perceptions will be tested, and when they are, we will have a better idea of just how much deregulation or any of Trump’s policies will have boosted the economy. Don’t be surprised if deregulation doesn’t amount to much. In a recent article entitled “Regulatory Relief and Growth”, Douglas Holtz-Eakin argued that even if the President is able to “rollback” most of the previous administration regulations, the estimated savings (approximately $980 billion) would be gradually achieved over a 10 year period, which translates to an additional 0.1% point in growth per year. While not insignificant, it shows that long-term economic growth is not achieved “at one fell swoop”.
Graph I – U.S. Large Cap
Edmundo J. Garza
The Dow broke 22,000 early this month on the strength of Apple and its better-than-expected earnings. Not long ago we were at a record 21,000, so will Dow 23,000 soon be in our sight? Industry sector performance can provide some clues. Since the S&P 500 bottomed in 2009 five of its sectors have outperformed the index’s gain of 266% through June 30, 2017: Consumer Discretionary, up 476.1%, Financials (402.4%), Information Technology (395.7), Real Estate (352.7), and Industrials (343.0). The remaining six sectors have lagged behind the S&P 500’s return: Health Care (262.7), Materials (214.3), Consumer Staples (183.4), Utilities (139.9), Telecom Services (82.8), and Energy (55.5). As you might expect, S&P adjusts sector representation so that outperforming sectors maintain a greater weight on the index. The table below displays the sector weights for the S&P 500 Index from January 1990 through June 2017. Historically, sector exposure has been elevated in financials, information technology, health care and consumer discretionary stocks. If these sectors continue to gain ground at the current rate the Dow could achieve the 23,000 mark soon. However, active managers, and even indexed funds recognize that market capitalization is a function of a stock’s price, and that they may end up assuming unwanted sector risk by allocating more of their investment toward stocks rising in value, and less toward stocks that falling out of favor. When stocks revert to the mean, investors in passive funds can be overexposed to falling stocks and underexposed to rising ones. To cope with this risk, active managers regularly schedule rebalancing processes that decrease chasing sector performance. Hence, a rising stock market offers a good opportunity to gauge a manager’s assessment and rebalancing skills, and overall long-term performance.
Table I – S&P 500 Historical Sector Weights
(As of August 10, 2017)
CPI: 1.6% Chg. from yr. ago
CPI: 1.3% Chg. from yr. ago
CPI: 0.4% Chg. from yr. ago
CPI: 0.3% Chg. from yr. ago
Evangeline Dávila, CIMA®
Stocks: U.S. equities were mostly higher during the month (see returns table below). The S&P 500 gained +2.1%, pushing its YTD return to +11.6%, while larger gains were seen in the tech-heavy NASDAQ Composite, which advanced +3.4% and is now up +18.6% YTD. Non - U.S. equity markets mostly outperformed their domestic peers due to US dollar weakness and continued economic strength abroad. The MSCI World ex-U.S. Index increased by +3.0% and is now up +16.2% YTD.
Bonds: Fixed income markets posted modest gains during the month. The yield on the 10-Year Treasury note began July at 2.30% and traded in a fairly tight range before closing the month at roughly where it opened, at 2.29%. Meanwhile, non-U.S. fixed income continues to outperform U.S. The Bloomberg Global Aggregate ex-U.S. Index gained +2.7% and is now up +9.0% YTD. , with a weaker US dollar fueling much of the return.
Alternatives: Commodity prices rose, with the Bloomberg Commodity Index gaining +2.3%. Oil surged off prior month lows leading commodity gains. Nevertheless, coffee, copper, sugar and gold commodities also gained. Meanwhile, real estate investment trusts (REITs) were positive, at +1.2%, but trailed their peers. Hedge strategies posted their strongest performance since January as 2017's performance drivers – Equity Hedge, Technology, Healthcare and Emerging Markets – led the way.
Eileen Rivera, CFA
It’s no longer a secret; “Hedge funds are struggling to meet their promise of consistently producing high returns with low correlation to the markets”, remarked Matthew Granade, chief market intelligence officer for hedge fund legend Steve Cohen, on the CFA Blog recently. Still a significant number of investors continue to turn to hedge funds for an option somewhere between stocks and bonds. That proves difficult these days because US interest rates are far below average while US stock market valuations are far above average. The question then is: How many of the thousands of hedge funds out there are worth investing in? The correlation to the overall stock market was relatively low during the glory days of hedge funds between 1998 and 2003, but that relationship changed during the financial crisis, and they are more correlated to the stock market now than ever before, even though they have access to a much wider variety of investment strategies. Cambridge Associates, a consultant to large institutional investors, says that approximately 2% of the 11,000-plus hedge funds can successfully produce returns good enough to account for the high fees. Cambridge recommends paying high fees only for those funds producing consistent alpha. That can be a tall order when only 2% of funds fit this bill and when past performance is no guarantee of future results. Buyer beware…
The U.S. economy (GDP) grew about 2 percent in the first half of the year, and the second quarter was much stronger than the first. Consumer spending (60% of U.S. GDP) was a major contributor to growth. The stock market continues to post record high readings and inflation is still in a holding pattern. The Small Business Optimism Index (SBOI) published by the National Federation of Independent Business (NFIB) jumped 1.6 points in July. Analysts at NFIB commented that “Main Street was buoyed by stronger customer demand despite the dysfunction in Washington D.C.”. There are many signs like this of a strong U.S. economy, but we remain confounded by the dysfunctional government and the effects it may have during the second half of the year. Amid an uncertain scenario we continue to recommend prudent asset allocation and risk assessment, based on future capital needs, for plan sponsors, institutions and individual investors. Due diligence reviews and an adherence to a well-developed investment policy remain the most prudent course for long-term investors. Continued fiduciary education is paramount.
Consultiva Internacional Inc. (Consultiva) is a Registered Investment Adviser. The registration with the Securities and Exchange Commission does not imply a certain level of skill or training. Consultiva has compiled the information for this report from sources Consultiva believes to be reliable. Sources include: investment manager(s); mutual fund(s); exchange traded fund(s); third party data vendors and other outside sources. Consultiva assumes no responsibility for the accuracy, reliability, completeness or timeliness of the information provided, or methodologies employed, by any information providers external to Consultiva. Conclusions reflect the judgement of Consultiva Investment Strategy Committee at this time and is subject to change without prior notice. There also can be no guarantee that using this information will lead to any particular result. Past performance results are not necessarily indicative of future performance. Diversification does not guarantee a profit or protection against loss. This document is for informational purposes only and is not intended to be an offer, solicitation, recommendation with respect to the purchase or sale of any financial investment/ security or a recommendation of the services supplied by any money management organization neither an investment advice or legal opinion. Investment advice can be provided only after the delivery of Consultiva’s Brochure and Brochure Supplement (ADV Part 2A and 2B) once a properly executed investment advisory agreement has been entered into by a client and Consultiva. This is not a solicitation to become a client of Consultiva. There are risks involved with investing including the possible loss of principal. All investments are subject to risk. Investors should make investment decisions based on their specific investment objectives, risk tolerance and financial circumstances. Global and international investments may carry additional risks that are generally not associated with U.S. investments, such as currency fluctuations, political instability, economic conditions and varying accounting standards. Annual, cumulative, and annualized total returns are calculated assuming reinvestment of dividends and income plus capital appreciation.