January Market Review
January made for a rough start to the year for the U.S. stock market, with the S&P 500 having its biggest decline in a year, and its first back-to-back monthly losses since 2012. Globally balanced portfolios performed relatively well though, given better performance in international equities (especially emerging markets) and in the bond market.
To put numbers to it, the overall U.S. stock market, as defined by the Russell 3000, lost 3% in January, as did the S&P 500 (large caps) and the Russell 2000 (small caps). International markets were unchanged (in dollar terms), though emerging markets had slight gains.
The bond market (Barclays Capital Aggregate Bond Index) gained 2% in January, and long Treasury bonds gained over 10%, with the 10-year U.S. Treasury bond closing at 1.68%. This compares to 2.17% at the end of 2014, and 3.03% at the end of 2013. The bull market in bonds lives on.
Commodities (Bloomberg Commodity Index) meanwhile, lost 3%, led lower again by oil prices (despite a sharp rally in crude oil on the last day of the month).
There were multiple drivers of market action last month, ranging from developments in Europe, to lower energy prices and the corporate earnings season. Let’s quickly review each of these “big Es” and how CLS is reacting to them.
Europe: Starting to Rebound?
Europe has had its share of negative news recently, with Greece’s latest woes getting most of the attention. Nonetheless, the European stock markets were sharply higher last month in local currency terms. Germany was up over 9% and France was up nearly 8%, although the strong U.S. dollar did whittle those returns considerably. It’s also interesting to note that European markets have had the same returns as the U.S. stock market since the beginning of last year (in local currency terms).
Where to next? In short, CLS is continuing to build positions in Europe. There are a variety of reasons why:
Energy: Hold it or Let it Go?
Energy stock prices continued to falter in January. Valuations were attractive at the end of the year, and now they’re even more attractive. As one Fidelity Investments portfolio manager recently noted, the valuation for energy stocks has reached a point that has historically indicated opportunity for investors. “Energy has rarely been this cheap relative to the S&P 500, and when the sector reached these relative valuations in the past, it has usually outperformed the market during the following 12 months,” said Fidelity’s John Dowd. “You want to buy energy when the outlook is dark and rainy – and recently it has been pouring.”1
CLS is continuing to hold energy stocks.
Earnings: Update and Expectations
As of January 30, about half of the companies had posted earnings reports. So far, earnings and sales growth hasn’t been very strong.
It has been good to see that technology – the sector in which CLS has the largest emphasis – has had the best beat rate in terms of besting earnings expectations at over 90%, led by the record-breaking quarter by Apple (though tech did have one high profile miss in Microsoft). Year-over-year sales growth for technology has also been at the top so far this quarter among the sectors.
The big issue with earnings, however, are the expectations for the rest of the year. In short, they are very optimistic. As we mentioned in the Quarterly Market Outlook a few weeks ago, expectations are nearly 20% for year-over-year growth. Sure, we’ve seen some good earnings growth numbers in recent quarters, but these expected returns are the highest yet in some time, and are well above the long-term average of 6%. In addition, it’s important to remember that half of that historical 6% growth rate comes from inflation, something that is still falling.
Bottom line, with expectations this high, we would expect some disappointment, which would cause some issues for the U.S. stock market. It’s also why we’re still favoring a mildly defensive stock market position while still being true to our risk budget promise. In addition, it’s why we favor high quality equities, which typically outperforms in choppy markets.
ETF.com’s Inside ETFs Conference Recap
A lot of us recently travelled to the leading ETF conference: Inside ETFs. This conference offers a chance to meet with many people in the industry and swap ideas and business cards. It also provides a great way to find out what other investors are thinking and doing.
Here are a few of my key takeaways and thoughts:
First, the ETF industry continues to grow dramatically. You can see it in how investors are allocating their money, and in the growth of this conference, which has essentially doubled in the last two years. The ETF tidal wave has a long way to go before hitting the beach.
Second, one of the reasons ETFs will continue to grow and take market share from mutual funds is the increasing popularity of “smart-beta” ETFs. A recent Investment News article notes, “Today, smart-beta assets make up nearly 20% of all exchange-traded products, up from 15% in 2013 and 12% in 2010.” Smart-beta ETFs essentially use quantitative rankings to determine what securities to own and how to weigh them. The reason why these ETFs will continue to grow is that they capture the essence of most actively managed mutual funds, but at a lower cost. CLS has embraced these ETFs from the beginning, and they dominate many of our top holdings.
Next, there is an area of significant growth for ETFs of late that I’m personally not that keen on for consistent long-term use: hedged ETFs (such as interest rate hedged and currency hedged ETFs). While these ETFs do hit some current investor concerns, and while I do agree that they can make sense for tactical, shorter-term use, I’m just not a fan of them for long-term strategic reasons.
There are two reasons why:
When it comes to bonds, having duration (in other words, exposure to interest rates) is an excellent diversifier for stocks and other asset classes. Hedge that duration exposure out and you also get less portfolio risk reduction. Add it all up, hedged-ETFs provide less portfolio risk reduction and higher costs.
Talking about bonds, this brings me to my last takeaway from the conference: the outlook on bonds. While the bond market, particularly Treasuries, has been despised in recent years, investor sentiment has notably improved in recent months. Isn’t it interesting that a year ago when yields were over 3% for 10-year Treasuries, investors didn’t want bonds? Now that bonds have 1% handles, the arguments are mostly for why yields can go lower. Sure there are indeed good reasons why they can go lower (a leading reason is that the U.S. still has higher yields than most developed countries), but there are also good reasons to be a bit cautious. One good reason? When investor sentiment is extremely bullish for bonds, as it is now, the bond market typically generates below average, if not negative, returns in the following year.
Thanks for reading. Stay balanced.
The S&P 500® Index is an unmanaged composite of 500-large capitalization companies. This index is widely used by professional investors as a performance benchmark for large cap stocks. The Russell 3000 Index is an unmanaged index considered representative of the U.S. stock market. The index is composed of the 3,000 largest U.S. stocks. The Russell 2000® is an index comprised of the 2,000 smallest companies on the Russell 3000 list and offers investors access to small-cap companies. It is a widely recognized indicator of small capitalization company performance. The iShares MSCI Emerging Markets ETF is an exchange traded fund which seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of publicly traded securities in emerging markets, as represented by the MSCI Emerging Markets Index. The MSCI EAFE International Index is a composite index which tracks performance of international equity securities in 21 developed countries in Europe, Australia, Asia, and the Far East. The MSCI All-Countries World Index, excluding U.S. (ACWI ex US) is an index considered representative of stock markets of developed and emerging markets, excluding those of the US. The Barclay’s Capital U.S. Aggregate Bond® Index measures the performance of the total United States investment-grade bond market. The Barclay’s Capital 1-3 Month U.S. Treasury Bill® Index includes all publicly issued zero-coupon U.S. Treasury Bills that have a remaining maturity of less than 3 months and more than 1 month, are rated investment grade, and have $250 million or more of outstanding face value. The Equity Baseline (EBP) is a blended index comprised of 60% domestic equity (represented by the Russell 3000 Index) and 40% international equity (represented by the MSCI ACWI ex US Index), rebalanced daily. The Bloomberg Commodity Index, formerly the Dow Jones-UBS Commodity Index, is made up of 22 exchange-traded futures on physical commodities. The index currently represents 20 commodities, which are weighted to account for economic significance and market liquidity.An index is an unmanaged group of stocks considered to be representative of different segments of the stock market in general. You cannot invest directly in an index.
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