Welcome to our inaugural market update, The Helm. These quarterly posts are designed to provide a quick-hit look at general portfolio changes, our read of the markets and what we see ahead. We’re happy to provide our clients more detail — and we also welcome hearing from people who want to secure financial services.
We’re in the midst of one of the longest bull markets in American history — nine consecutive years — and anticipate a strong finish for 2018. Though we see a continually growing economy, we also see on the horizon geopolitics that could contribute to stock volatility and rising interest rates on inflation fears.
Here’s an overview of how Cardan Capital is adjusting course accordingly:
At the start of 2018, Cardan Capital adjusted our portfolios to increase stock exposure in general (growth stocks in particular), hold steady on Treasury bonds, and reduce exposure to high-yield bonds.
Our allocation of stocks and bonds is driven by our assessment of the valuation disparity between the two asset classes. We “tilt” portfolios to have greater allocation to overweight the asset class we deem to be a better relative value. Right now, we’re tilting toward stocks — and specifically growth stocks.
Growth stocks have had a much stronger performance than value stocks for many years now — and that run looks set to continue. However, we also believe that superior performance in growth over value is running thin and that value stocks soon will have their day in the sun. We’re watching carefully — but until the instruments tell us to make a change back to value, we will stay the course.
A few bright spots for some Cardan clients along the way: Investors in our Core Equity and Core Moderate portfolios saw the sale of three companies in the fourth quarter of 2017. Scripps Network (SNI), Dr. Pepper (DPS) and Bioverativ (BIVV) were acquired by AMC Networks, Keurig Green Mountain and Sanofi, respectively. We are now looking for one or more targets to add to the portfolios to invest the cash that was generated from these sales.
On this side of the equation, we reduced credit exposure (high-yield, corporate bonds) and increased our U.S. Treasury exposure. We made this adjustment because of the strong returns of high-yield bonds in relation to U.S. Treasury bonds. The strong returns in high-yield versus treasuries narrowed the credit spread to some of the lowest levels in years. When the spread is wide, corporate bonds are thought to be cheap — and when the spread is narrow, corporate bonds are often considered expensive. When determining the cheapness or expensiveness of the spread, we assess the state of the economy. Like stocks, high-yield bonds prefer economic expansion. Because most indicators continue to project a growing economy, we continue to have some exposure to this asset class — just less than we did last year.
2018 started with a bang — and make that BANG! The S&P 500 was up 5.7 percent through January, and all indications were that the smooth sailing of 2017 was set to continue unabated.
Then came a sea change in February. At the low of February 9 — a short 10 days after the market high on January 26 — the market fell more than 11 percent. The remainder of the first quarter left equity investors in need of Dramamine to endure the choppy waters.
The volatility of the markets in 2018 is a distinct departure from the calm of 2017. Consider that throughout the entirety of 2017, the S&P 500 saw only eight days that closed above or below 1 percent — while the first half of 2018 already has seen 36 such days.
But wait. Does that make the volatility seen in 2018 unusual? Good question — because when a stark contrast such as the difference between 2017 and what we’ve seen so far in 2018 presents itself, it is helpful to examine the change in a historical context.
So, here you go: Since 1950, the average number of days with a +/- 1% move in a calendar year for the S&P 500 Price Index has been 49.7 days. That means 2018 so far has actually been more in line with standard market volatility! It was actually the calm of 2017 that was outside the standard.
Volatility is a constant companion of stock market investors. The following chart shows the S&P 500 Price Index Calendar Year Returns and the largest intra-year declines — meaning the largest percentage decline the market experienced during the respective calendar year. As an example, in 2010, the largest decline during the year was -10 percent but the year finished up 13 percent. The average intra-year decline since 1980 has been -14 percent, and the average calendar year return 10 percent.
Data Source: Bloomberg L.P.
Yes, in the first half of 2018, most asset classes lost ground, and diversification was left wanting. Even the fashionable Bitcoin currency lost more than 50 percent. But if there is any solace to be taken from these events, it’s that there have been only two calendar years in which the 10-year Treasury bond and S&P 500 have been down in the same calendar year. That demonstrates that, on average, balanced portfolios work. By the end of 2018, we believe diversification once again will have proved its mettle.
The economy is still growing. However, we can see some clouds gathering on the horizon (think compressing yield curve and maximum employment). Whether these clouds turn into anything meaningful is yet to be seen. The U.S. economy is now almost nine years from the end of its last recession, and in theory, it is overdue for a contraction. But it is worth remembering that the economy is more like a baseball game than a football game – there is no set time it must end. When we feel the first rumblings of recession, we will adjust our portfolios to reflect the new economic reality and to adopt a more defensive posture.
Cardan’s view is that while fundamentals are still relatively sound, and recessionary headwinds are currently not an issue, the geopolitical risks remain, and volatility will be with investors for the foreseeable future. For the time being, our portfolios will remain positioned for economic growth until the recession rumblings are detected by the Cardan seismometer. In the meantime, we will continue to work with you to ensure your portfolio matches your personal needs and risk tolerance.
|Good earnings growth||Geopolitics||Yield Curve|
|Strong Employment||Brewing Trade War|
|Low Inflation||Fed Rate Hikes|
|Leading Economic Indicators|
Data Source: Bloomberg L.P.