Risk markets performed well across the board in the first quarter of 2017 as the Trump rally trade continued virtually unabated. The global risk-on rally showed few cracks developing, with trends pushing higher even though there were a number of obstacles to overcome. The markets faced uncertainty on numerous fronts in the first quarter, including the change of power in the White House with President Trump taking office in January, a flurry of executive orders, Congress’ failure to repeal and replace Obamacare, the Federal Reserve’s third interest rate hike of the cycle, and growing geopolitical tensions with North Korea firing missiles, just to name a few.
Even so, the markets remained very calm with volatility seeming to hibernate. For example, the S&P 500 enjoyed a 109-day streak without a 1% decline, its longest stretch in nearly 22 years. The benchmark went 55 trading days without a 1% daily move in either direction, the longest such streak since 2014. In fixed income, credit dominated with the Barclays High Yield Index gaining 2.70%, the Barclays Intermediate Term Credit Index gaining 1.14%, and the Barclays 7-10 Year Treasury Index positive by 0.94%.
The Federal Reserve did hike rates for only the third time in the cycle and suggested more hikes. Possibly two to three more are in the offing this year. The market doesn’t seem to believe the Fed will hike that much, evidenced by the fact that the 10-year Treasury Note yield has peaked concurrently with each of the three Fed rate hikes. If the market put any trust in the Fed’s willingness or ability to hike more rapidly, we believe the 10-Year Treasury Note yield would remain firmer after each rate hike.
First Quarter Attribution
The Fixed Income Total Return (FITR) portfolio remained fully invested in high yield bonds during the first quarter, as has been the case since the allocation to the high yield bond sector over one year ago on February 29, 2016. For the quarter, the Fixed Income Total Return portfolio rose 2.57% gross of fees (1.81% net), marginally trailing the Barclays High Yield Bond benchmark which gained 2.70% and outperforming the Barclays Aggregate Bond benchmark, which gained 0.82%. The portfolio’s performance was again driven by its allocation to credit risk, which performed well in the quarter given a supportive economic environment and continued spread compression.
Credit spreads have steadily contracted since peaking at 840 bps on February 2016. Spreads ended the quarter at 345 bps, which is below the mean spread of 544 bps since 2000, arguing that high yield bonds are expensive. While valuations are a concern and may be a headwind to future high yield bond returns, we would caution against turning negative on the sector purely based on valuations as we have witnessed spreads much lower than current levels as recently as 2014 when they fell to 221 bps.
The strong gains in high yield bonds and sharp contraction in spreads over the past 13-months can be attributed to fundamental support on several fronts. First, the risk of corporate bonds defaulting is low. Default risk is reduced when the economy grows and expectations are for continued, and accelerating, economic growth. Second, there has been a huge recovery in energy and other commodity prices, which had driven spreads wider into early 2016. In addition, the lack of any source of stress has also kept volatility low, which has allowed the high yield bond market to remain buoyed despite being fully valued.
As we mentioned in our last Commentary, we continue to favor credit and thus are fully exposed to high yield in the Fixed Income Total Return portfolio. We do not expect to see the same surge in credit as we saw in 2016, but history shows spreads can remain tight for long periods of time without an economic downturn. We do not see any evidence of potential trouble for the economy as indicators we look at are in solid growth territory, including the Conference Board’s Index of Leading Economic Indicators (LEI), which recently surged to a new high, suggesting continued economic growth through the remainder of the year.
The below investment grade credit space still has a nice yield advantage over other fixed income sectors, and we are comfortable remaining allocated to credit, enjoying the yield advantage. We have dialed back our return expectations for the portfolio given the large gains over the past year. Given the run up in high yield bonds, tighter credit spreads, and lack of volatility in the market, we think low to mid-single digit return expectations are appropriate at this stage of the credit cycle.
The opinions expressed are those of the Clark Capital Management Group Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. There is no guarantee of the future performance of any Clark Capital investment portfolio. Material presented has been derived from sources considered to be reliable, but the investment singular accuracy and completeness cannot be guaranteed. Nothing herein should be construed as a solicitation, recommendation or an offer to buy, sell or hold any securities, other investments or to adopt any investment strategy or strategies. For educational use only. This information is not intended to serve as investment advice. This material is not intended to be relied upon as a forecast or research. The investment or strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. Past performance does not guarantee future results. All investments involve risk, including loss of principal and there is no guarantee that investment objectives will be met.
This document may contain certain information that constitutes forward-looking statements which can be identified by the use of forward-looking terminology such as “may,” “expect,” “will,” “hope,” “forecast,” “intend,” “target,” “believe,” and/or comparable terminology (or the negative thereof). No assurance, representation, or warranty is made by any person that any of Clark Capital’s assumptions, expectations, objectives, and/or goals will be achieved. Nothing contained in this document may be relied upon as a guarantee, promise, assurance, or representation as to the future.
The S&P 500 measures the performance of the 500 leading companies in leading industries of the U.S. economy, capturing 75% of U.S. equities.
The Dow Jones Industrial Average is a stock market index that shows how 30 large publicly owned companies based in the U.S. have traded during a standard trading session in the stock market.
The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performers of developed markets outside the U.S. and Canada.
The MSCI Emerging Markets Index is a free float adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The Russell 3000® Index measures the performance of the 3,000 largest U.S. companies based on total market capitalization, which represents approximately 98% of the investable U.S. equity market.
The CBOE Volatility Index (VIX) is a forward looking index of market risk which shows expectation of volatility over the coming 30 days.
The volatility (beta) of a client’s portfolio may be greater or less than its respective benchmark. It is not possible to invest in these indices.
Barclays U.S. Government and Credit Bond Index measures the performance of U.S. dollar denominated U.S. Treasuries, government-related and investment grade U.S. corporate securities that have a remaining maturity of greater than one year.
The Barclays U.S. Aggregate Bond Index covers the U.S. investment-grade fixed-rate bond market, including government and credit securities, agency mortgage pass-through securities, asset-backed securities and commercial mortgage-based securities. To qualify for inclusion, a bond or security must have at least one year to final maturity and be rated investment grade Baa3 or better, dollar denominated, non-convertible, fixed rate and publicly issued.
The B of A Merrill Lynch U.S. High Yield Index tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.
The Barclays 7-10 Year Treasury Index tracks the investment results of an index comprised of the U.S. Treasury bonds with remaining maturities between seven and ten years.
The Barclays 20+ Year Treasury Index tracks the investment results of an index comprised of the U.S. Treasury bonds with remaining maturities greater than twenty years.
The Barclays Long-Term Treasury Index tracks the performance of the long-term U.S. government bond market.
The Barclays U.S. Corporate High-Yield Index covers the U.S. dollar-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.
The Barclays U.S. Treasury Bond Index is an issuances-weighted index measuring the performance of the U.S. Treasury bond market, one of the largest and most liquid government bond markets in the world.
Barclays U.S. Aggregate Bond Index: The index is unmanaged and measures the performance of the investment grade, U.S. dollar denominated, fixed-rate taxable bond market, including Treasuries and government-related and corporate securities that have a remaining maturity of at least one year.
MSCI All Country World Index is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world. The MSCI ACWI is maintained by Morgan Stanley and is comprised of stocks from both developed and emerging markets.
Index returns include the reinvestment of income and dividends. The returns for these unmanaged indexes do not include any transaction costs, management fees or other costs. It is not possible to make an investment directly in any index.
Gross performance shown is presented gross of investment advisory fees and includes the reinvestment of all income. Gross returns will be reduced by investment advisory fees and other expenses that may be incurred in the management of the account. Net performance includes the deduction of a 3.0% annual wrap fee, which is the highest anticipated wrap fee charged by any sponsor. Management and performance of individual accounts will vary due to differences such as the availability of securities, trading implementation or client objectives, and market conditions. For a fee schedule, please contact your advisor or refer to AssetMark’s Form ADV Part 2A. If you enter into an agreement directly with Clark Capital, refer to Clark Capital’s Form ADV Part 2A. The Firm’s policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request.
Clark Capital Management Group, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Clark Capital’s advisory services and fees can be found in its Form ADV which is available upon request.
The relative strength measure is based on historical information and should not be considered a guaranteed prediction of market activity. It is one of many indicators that may be used to analyze market data for investing purposes. The relative strength measure has certain limitations such as the calculation results being impacted by an extreme change in a security price. Clark Capital Management Group, Inc. reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.