Investing is never easy and there really is no such thing as low hanging fruit. But there are times when valuations are stretched to the downside in certain sectors, stocks, asset classes and countries making it easy(er) to make a case for new purchases. Buyer beware, some of the low hangers are rotten and will hang even lower in the weeks and months to come.
Quick Performance Peek
As I discussed in the last update regarding a potential turning point for the markets, I thought this would be a good time to take a look at our various strategy performance numbers, of course shown as net of all fees, as well as some drawdown numbers YTD through last Friday, compared to our benchmarks. Drawdowns are a measure of how far something fell at it’s worst over a given date range (YTD). It’s a good way of seeing what kind of volatility is in the system or our strategies on a relative basis. Regular readers might remember that we entered 2016 with a bold statement. We said, 2015 was terrible for risk managers and trend followers. We struggled with them but thankfully experienced no blowups. We also projected that after such years, we often outperform significantly. Well so far, that seems to be the case. Shown below is a simple table of our performance numbers by strategy as well as our respective benchmarks for each Investment category. These are unofficial numbers but a good check up with one month to go in the quarter.
YTD% Drawdown %
Income Strategies
ASFA Retirement Income +0.0% -0.60%
ASFA Freeway High Income +0.23% -0.00%
Benchmarks
Barclays Aggregate Bond (AGG) +1.68% -0.00%
High Yield Corporate Bond (HYG) +1.38% -5.72%
Blended Asset Strategies
ASFA All Season +0.03% -4.55%
ASFA Gain Keeper Annuity +0.87% -3.45%
ASFA Foundations +0.10% -4.22%
Benchmarks
Dow Jones World Stock Index -2.98% -11.60%
Barclays Aggregate Bond (AGG) +1.68% -0.00%
Tactical Equity Strategies
ASFA Worldwide Sectors -2.18% -6.28%
ASFA High Dividend -2.13% -7.20%
Benchmark
Dow Jones World Stock Index -2.98% -11.60%
ASFA New Power -10.05% -12.79%
Benchmark
Powershares Clean Energy ETF (PBW) -12.45% -24.68%
Scanning across our strategies and benchmarks, I see several things that show favorable performance relative to our benchmarks and in some cases in absolute terms. I also see one weak spot.
- 1.I see that all Income and Blended Asset strategies are positive YTD
- 2.I see that drawdowns numbers for our strategies relative to benchmarks are quite a bit lower meaning the inherent risk structure of our strategies is significantly less than our benchmarks especially in the case of our Tactical Equity and Blended Asset strategies
- 3.I see that New Power has not recovered from its January loss by much. However it is still outperforming (losing less than) the benchmark on both measures. See commentary below on Growth versus Value for an explanation.
Low Hanging Fruit
I chuckle when I read the shock and awe expressed by the financial media after seeing the value side of the stock market nearly explode to the upside in recent weeks. These are the low hanging fruit that we discussed several times including the very clear and lengthy commentary/ charts in our three part, Best Bets for 2016 series. This should not be a surprise to anyone as the market usually does a good job of allocating money to things that offer future growth and return opportunities. Meanwhile, the famous FANG (Facebook, Amazon, Netflix and Google) stocks can’t seem to stop losing money this year – also foretold and predictable. Neflix has already seen a drawdown of 27% this year. Amazon, 28%. Facebook and Google look relatively strong with drawdowns of only 10%. Only Facebook is positive YTD thus our maintenance of this position in our New Power strategy. The market is not looking for returns from the growth sector anymore as this style of investing has some of the worst optical valuations of any. I would throw biotech and consumer discretionary sectors into that statement as well. Now the low hanging fruit is in a different place. It’s in sectors like industrials, agriculture, materials, Emerging markets, high yield bonds, base metals and other things that have been slaughtered in the last 3-4 years on the back of waning global growth reports. Stocks in these sectors and countries are down 50,60 and 70% from their highs 2012. Many, including a majority of commodity ETFs, are actually trading solidly below the bear market lows of 2009! But as this fruit hangs lower and lower (in price) at some point, we need to say, that’s enough to factor in a total global financial depression. You can see why any indication that global demand is picking up would generate some enormous interest in these value plays. So investors are now aware that “Value” is back and a place to generate some real returns. Some piled on late to this trend with new investments in the last week or so. We did not, having made almost all “value” purchases between mid January and early February. Now, we could be seeing the first pullback following the initial thrust off the lows. It will tell us a lot about the sustainability of this new rally. We are watching closely to see which groups are holding up better than others during this much needed correction that really started yesterday.
Rotten Fruit
A sharp mind might have noticed that I didn’t list energy stocks in the list of low hanging fruit. Strangely, even after this generational wipe out in companies like Anadarko (APC), Devon (DVN), and Chesapeake Energy (CHK), the valuations here are still, at least optically, some of the highest out there. I see fast declining returns on capital, negative free cash flow, super high price to earnings ratios and a pile of debt. Coal companies are making Oil and Gas companies look fundamentally healthy. I see the gains in oil and oil related company shares. I hear the drop in rig counts and massive declines in cap ex spending. But I also see the supply of oil continue to rise month after month with no end in site. I see companies slashing dividends because they have no cash left. I see bankruptcies and mergers before I can believe that any of these will get up and go sustainably. I’ve been wrong on these things before but when there are so many other good values out there, why take the risk right? Not all O and G companies look the same and some may be worth your investment capital. Chevron (CVX) and Exxon (XOM) look fine, Phillips 66 (PSX) looks fine, as does Schlumberger LTD. (SLB) Full disclosure – we own PSX and SLB for our clients. Buyers beware.
2016, the Year of the Active Manager
On the other side of value based opportunity we find risk. On this limb, sticking far out, is the Growth sector, which was the darling of 2015 with a total of 6-10 stocks attracting Billions of investor capital. I spoke of this in regards to the FANG stocks above. But here’s the interesting thing about the impact of the growth sector on the US stock market indices. Over the last several years, a handful of stocks have taken over the performance of the S&P 500 as a cap weighted index. As these stocks became megatron, super nova stocks by market cap, they naturally became a larger and larger driver of index returns. Meanwhile, sectors like energy, industrials, telecom and materials are now only a fraction of the index by market cap. Effectively the biggest losers in 2016 are now dragging down the performance of the benchmark indices while the biggest winners by sector are barely having an effect. The insight should be obvious now. We might begin to recognize why “the market” is underperforming so many sectors and stocks now in 2016. In fact, in our Worldwide Sectors model, we just recently added a short position against “the market” (S&P 500) while buying and holding nearly 60% in value oriented individual stocks. It’s a really nice pairing strategy and one that should do quite well through this year both in generating returns with significantly reduced risk. We can adjust both sides of the portfolio as conditions warrant.
We could probably build the same type of paired strategy in the bond market although we haven’t done so yet. The pairing here would look like a short position against Treasury bonds, perhaps shorter term bonds like two or five year bonds. On the other side, we might own and accumulate high yield corporate bonds, preferred securities and emerging market debt all of which are now in uptrends in price and paying north of 5% interest. I would caution against taking a short position against anything in the Treasury bond market with a long maturity, like a 20 year bond. In fact, while I’m cautioning, I would NOT recommend you do any type of pairing trades with short positions on your own if you don’t know exactly what you’re doing. We’re comfortable with it but I wouldn’t try this at home frankly.
So far, 2016 is predictably shaping up to the year of the active manager (also one of our Best Bets for 2016). 2015 was clearly the opposite. Being able to shift assets into leadership groups on a timely basis is already paying off nicely. Being able to run a pairing strategy like those mentioned above is not the domain of the passive indexer. These are good days for our type of investment process and flexibility. I ran across a study from Hedge Fund Research that showed periods when active management has a history of outperforming more passive styles like indexing. The key variable turned out to be….. the Federal Reserve! During periods when the Fed is not easing, active managers like hedge funds (and us) are able to generate an annualized 3.5%- 9% in “alpha” which is a measure of excess returns over passive stock or bond indices. Today the Fed is raising rates aka tightening. I’m not smart enough to tell you why this happens, but we’re already seeing these results play out. Cheers to that!
Have a great week.
Sam Jones
