STA Weekly Report – Which Market Are You Trying to Outperform?
Written by Luke Patterson | Thursday, May 9th, 2019
INSIDE THIS EDITION: Which Market Are You Trying to Outperform? Unhealthy Looking Charts Staples, Utilities, and REITS Are Acting as Safe Havens Weekly Snapshot of Global Asset Class Performance Portfolio Stress Test 401k Plan Manager*Updated on 12/31/2018
It is not uncommon to hear that the goal of investing is to outperform the market. No doubt, being able to successfully predict the next market move is both fun (emotionally) and rewarding (financially). However, before you set such a goal for yourself or decide to trust someone who claims they have the ability to do so, it is wise to address a couple of questions.
First, what is the market? Second, what does outperformance
represent? Third, how important is it to outperform? We will focus on the first
For most U.S. investors, market is the S&P 500 index,
which a market-capitalization-weighted index of the 500 largest U.S. publicly
traded companies. Why S&P 500 happen to be the market? Probably because it
is a collection of liquid and large cap stocks that many investors have easy
access to. Alternatively, it just happens to be the market, simply because
everybody is familiar with the name that covered heavily by media. An
outperformance of S&P 500 can be satisfactory and enjoyable.
Defining the market is an important first step. Why? Because
it determines how you can outperform the “market”. Simply by investing in
smaller companies, investors might outperform S&P 500 stocks by a large
margin overtime. For example, if an investor put $100 into a S&P 500 Large
Cap index fund in 1996, he would have approximately $345, or $245 profits now.
But if he put $100 into the S&P 400 Mid Cap index and S&P 600 Small Cap
index, he would end up with $737 and $654, respectively, which are more than
double the return he would have earned from the S&P 500. However, smaller
companies are less established, have higher revenue concentration and less
stable cashflow. As a result, they are riskier than large companies and have
historically had higher bankruptcy rates in difficult times. Therefore, the
historical “outperformance” is simply an outcome of taking more risk.
If you take a global perspective, then the definition of the market goes beyond the U.S. borders. After all, the US stock market only accounts for 40% of the world’s stock market by market capitalization. Depending on the chosen periods, foreign stocks have either outperformed or underperformed because there is a cyclicality to market leadership. The return difference among individual countries is even more significant. A global stock portfolio, however, tends to have lower price volatility, or risk, than a US stock portfolio due to the benefit of diversification.
Stocks make up a massive part of American wealth. According to the 2017 SIFMA Fact Book, all domestic stocks listed on U.S. exchanges were worth as much as $27.4 trillion. However, the U.S. bond market is much bigger, valued at as much as $38.5 trillion. Therefore, excluding bonds from the “market” definition may not be reasonable, especially considering the fact that any given investment portfolio is typically a blend of stocks and bonds. Because bond prices are less volatile, it is often considered a safer investment. As a result, the long-term return of bonds is expected to be lower and a diversified portfolio composed of stocks and bonds is likely to underperform the stock market in most periods even though they can protect investors from significant losses during times of market stress.
With this in mind, we want to remind investors that the goal of outperforming the “market” is meaningless if the benchmark (i.e. the definition of the market) is poorly defined.
Unhealthy Looking Charts
Chart 1 shows the Health Care SPDR (XLV) falling further below its 200-day average today. It’s the day’s second weakest sector in a generally weak market. The dashed red line is a relative strength ratio of the XLV divided by the SPX.
The XLV held up better than the market during the fourth quarter selloff. But it doesn’t appear to be doing so this week. The biggest reason for today’s drop is heavy selling in biotech names. Chart 2 shows the Dow Jones US Biotechnology Index falling to the lowest level of the year. The red dashed line is a ratio of biotechs versus the healthcare sector. And it shows them leading the sector lower all year. Pharmaceuticals haven’t provided much support either. Chart 3 shows the Dow Jones US Pharmaceuticals Index trading below its 200-day average. The falling dashed line shows that group also underperforming the sector. Health care providers (not shown) have been the weakest part of the XLV this year . Biotechs and pharma are the next weakest. Healthcare may have provided some defensive protection during past market selloffs. It’s not acting like a safe haven today.
Staples, Utilities, and REITS Are Acting as Safe Havens
The traditional safe havens that should hold up
better during a market selloff are consumer staples, utilities, and REITs. And
they appear to be fulfilling that traditional role. Chart 4 shows the Consumer
Staples (XLP)/S&P 500 ratio bouncing this week. Chart 5
shows the Utilities SPDR (XLU)/SPX ratio doing the same. Chart 6 shows the Real
Estate (XLRE)/SPX ratio also rising. Those three
defensive groups are holding up better against a market drop today and over the
past week. At the same time, the weakest sectors this week have been
trade-sensitive sectors like technology, industrials, and materials. All three
are being hurt the most by this week’s jump in trade tensions. This week’s
sector rotations also reflect a more defensive market.
Andrei Costas, Senior
Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment
Analyst (Fixed Income Strategies)
STA Wealth Management – Portfolio Stress Test By Scott Bishop, MBA, CPA/PFS, CFP® Executive VP of Financial Planning
Although the markets have had a nice run since bottoming in March of 2009 (after the 2008 Global Crisis – see chart below), many are feeling that they are due for a correction based on time, valuations, “headline” risks, etc.
Important Disclosure: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC (“STA”), or any non-investment related content, made reference to directly or indirectly in this article / newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article / newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. STA is neither a law firm nor a certified public accounting firm and no portion of the article / newsletter content should be construed as legal or accounting advice. A copy of the STA’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a STA client, please remember to contact STA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. STA shall continue to rely on the accuracy of information that you have provided.
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