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CLS: Weekly Market Review


Week in Review
After an extended upturn, markets gave investors a bumpy ride last week. The S&P 500 fell 1.1%. Small-cap stocks sank 1.8%. International markets increased 0.3%. Bonds rose 0.4%, and commodities rallied 1.4%. Given the strong rally since February 11, this is a relatively small step back.

This week starts the first quarter earnings season. Earnings for S&P 500 companies are expected to drop into the high single digits. Energy companies account for a large chunk of the decline, but other sectors are seeing declines too. The earnings fall is attributable to the dollar’s rally in recent years and declines in energy investment. Analysts have already cut estimates aggressively, which should mitigate the angst over declining earnings. Analysts also suggest the decline is temporary and earnings growth should resume in coming quarters.

Anatomy of a Rebound
In the first quarter of 2016, we witnessed a tremendous rally in the stock market. For instance, the S&P 500 rose nearly 13% from its lows for the quarter. It wasn’t as noticeable on quarterly statements because it followed a sharp downturn in the market that pushed most major stock markets down more than 10%. Expect volatility to make regular appearances in coming quarters.

When asset prices shoot rapidly higher, which asset classes do best? What does this tell us about how investors are looking at the market? The following analysis examines how various market indexes performed from the market bottom in mid-February through the end of the quarter.

Improved Attitude Toward Risk
The returns suggest investors became more positive about the prospects of risky assets, rather than rewarding particular segments for improved fundamentals. The rally produced tightly clustered sector returns in the recovery phase, which suggests low levels of discrimination by investors. Six of the 10 sectors rallied between 14.3% and 16.6% from the market lows. Those six sectors are classified as more aggressive and would be expected to do better in rallies. The defensive sectors – consumer staples, healthcare, telecommunications, and utilities – all posted returns of below 10% from market lows. For the quarter, telecommunications and utility stocks posted the best results because they rose in the early part of the quarter.

The major asset classes performed roughly in line with risk-based expectations. Investors welcomed the Federal Reserve (Fed) announcing lowered expectations for rate hikes, which flowed through to stocks and bonds. Small-caps did best, rising 17% and beating their risk-modified target return. International stocks beat domestic markets by a narrow margin. Even with the strong rally, bonds still generated a positive return.

Aggressive Interest Rate Sensitivity Performed Well
Most investors understand that bonds are particularly sensitive to changes in interest rates. And, some understand interest rates also affect the value of higher-dividend-paying sectors. During the decline stage, bonds and high-dividend sectors (telecommunications and utilities) held up better.

There are other sectors that benefit when rates are falling and the appetite for risk increases. Real Estate Investment Trusts (REITs) often pay high dividends but are viewed as sensitive to economic growth. During the rally stage, REITs rose more than 18%.

Emerging market currencies also fall into this camp. Investors believe emerging market currencies benefit from reduced expectations for interest rate hikes in the U.S. Lower rates in the U.S. provide less competition for investors looking to generate income. Emerging markets also issue bonds denominated in U.S. dollars. When the dollar falls, it makes it easier to make payments and refinance the loans.

While emerging market stocks lagged the U.S. in their home currencies, U.S. investors benefited from strong results when measured in its own currency. Emerging market stocks rallied 17.7% in U.S. dollars from the February lows.

This Pace Isn’t Sustainable
A key message for investors is not to expect the rally to continue at its current pace. While we expect future returns to be positive, markets will likely experience continued spikes lower and higher. Risk Budgeting is designed to help investors stay invested and benefit from long-term opportunities.

International Markets in the First Quarter
For the quarter, international markets fell and then rallied, just like the U.S. While the U.S. finished barely positive, international markets fell just short of neutral, falling 0.4%. Unlike the broad asset class returns, international markets experienced wide differentials between markets. Within the Asian, European, and resource (Americas, Middle East, Africa, and Russia) regions, excellent returns were tightly concentrated in a small number of generally smaller markets.

Wide dispersion created an opportunity for very strong returns in some international portfolios, while some international portfolios lagged behind. The graphic below shows how concentrated high returns were.

In Asia, Thailand, Indonesia, and Malaysia, markets all rose double digits, while the large markets of India, China, and Japan fell. In Europe, the top three performing markets – Turkey, Hungary, and Poland – all rallied by double digits. The Czech market, which performed fourth best, only rose 5%. Israel, Italy, and Greece were all down more than 10%. Major markets, like the United Kingdom and Germany (not pictured), fell just more than 2%.

The broadly defined resource region includes some big winners benefiting from the improved price of oil. Brazil, Colombia, and Peru all rose more than 20%. Russia rose more than 15%. Some of this increase can be attributed to political news. In Brazil, efforts to impeach the president contributed powerfully to the rally. Peru and Colombia benefited from healthy economies and renewed interest in Latin America.

One caveat: The rallies in these markets represent a bounce back from a period of underperformance. Only Hungary has posted a return above the average regional performance over the last three years. Fundamentals represent a challenge for some of these markets even as small international markets offer the potential for continued gains.

Six-Putts, Statistics, and Investing
On Thursday, Ernie Els, an accomplished golfer, six-putted the first green of the Masters Golf tournament in Augusta, Georgia. Of his six putts, five were within three feet of the hole. A Bloomberg article examined Els’ history-making putting performance and determined it should only happen once in 10,000,000 occurrences. When you see statistics like this one, you should be on your guard. Probabilities, whether applied to sports or investment performance, are fraught with the perils of improper assumptions that can lead to the wrong conclusions.

The author listed a number of events more probable than Els missing so many puts from close range, including:

  • “He would be over 1.4 million times more likely to hit a deer in Hawaii, the state where that is least likely to occur.
  • He would be 2,700 times more likely to get killed by a shark.
  • He would be 39 times more likely to win the Mega Millions jackpot.”

While being humorous, this analysis leads to the wrong conclusion that this event is highly improbable because it ignores key differences between the putting challenge and random statistical events. Specifically, it ignores the physical, non-random, and psychological conditions:

  • Physical Conditions: I am confident the greens at Augusta National are faster and the pin placements more difficult than the courses most of us play on. While golf and investing are always challenging, conditions can make them extra difficult.
  • Non-Random Conditions: The missed putts aren’t random events because too many of the variables are the same in each trial. They were all done within five minutes of each other, on the same green, by the same person. If Els had a headache or has trouble reading that particular green, then the odds of this happening increase. In investing, certain types of markets or a particular set of fundamentals may flummox an investor.
  • Psychological Conditions: Els has never won the Masters, but he has finished in second place twice. He is on the first hole. Every missed putt induces anger, creates embarrassment, exacts a financial loss, and destroys hopes. Each miss makes the next miss more likely as emotions, whether in golfing or investing, cloud judgement.

As investment fiduciaries, CLS structures its investment team to minimize these challenges. We evaluate the investment environment from multiple perspectives. We use an approach to risk management that encourages discipline and reduces emotion. We use a team approach so we can help each other reach better conclusions. These steps are designed to avoid a six-putt in your portfolio.


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 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. 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.

The views expressed herein are exclusively those of CLS Investments, LLC (CLS), and are not meant as investment advice and are subject to change. CLS is not affiliated with any companies listed above.  No part of this report may be reproduced in any manner without the express written permission of CLS.  Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such.  All opinions expressed herein are subject to change without notice. This material does not constitute any representation as to the suitability or appropriateness of any security, financial product or instrument.  CLS is not making any comment as to the suitability of any funds mentioned, or any investment product for use in any portfolio. There is no guarantee that investment in any program or strategy discussed herein will be profitable or will not incur loss.  This information is prepared for general information only.  It does not have regard to the specific investment objectives, financial situation, and the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized.  Investors should note that security values may fluctuate and that each security’s price or value may rise or fall.  Accordingly, investors may receive back less than originally invested.  Past performance is not a guide to future performance.  Individual client accounts may vary.  Investing in any security involves certain non-diversifiable risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk.  These risks are in addition to any specific, or diversifiable, risks associated with particular investment styles or strategies. The graphs and charts contained in this work are for informational purposes only.  No graph or chart should be regarded as a guide to investing.

Definitions and more information for the S&P 500 Sector indexes, MSCI Asia, Europe and Resource can be found at http://us.spindices.com/index-family/us-equity/sector-industry and https://www.msci.com. These sites contain information that has been created, published, maintained or otherwise posted by institutions or organizations independent of CLS. CLS does not endorse, approve, certify or control these websites and does not assume responsibility for the accuracy, completeness or timeliness of the information located there. Visitors to these websites should not use or rely on the information contained therein until consulting with their finance professional. CLS does not necessarily endorse or recommend any product or service described at these websites.



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