Following Quantitative Easing?: Quantitative Easing, the Fed’s long term expansionary monetary policy, may not lead to higher interest rates despite consensus to the contrary.
Opportunity in Market Corrections: Market corrections represent great opportunities to remove overvalued or underperforming companies from our portfolios while substituting companies of higher quality.
Early this quarter, I blogged about how the end of Quantitative Easing, the Fed’s long term expansionary monetary policy, may not lead to higher interest rates despite consensus to the contrary. The thrust of my argument revolves around low current and anticipated U.S. inflation and slow or decelerating growth globally. While QE1, 2 and 3 have provided tremendous stimulus and stabilization to the financial markets, many market participants fear that the termination of QE this month will naturally lead to a reverse course for notes and bonds. My blog attempts to debunk this wisdom by pointing to current U.S. inflation and expectations for the same. At just 1.7%, both producer and consumer inflation are little threat to price stability. Additionally, most developed-country inflation is declining (with the exception of Japan) and in some cases is negative. China consumer inflation is the lowest since January 2010 and eurozone inflation is barely positive at 0.3%. Anticipated inflation globally is certainly low. Many European short-term interest rates are now negative and U.S. future inflation will likely be further constrained by the dollar’s ascent to a four-year high and low wage growth stifled by the low labor participation rate. Contrary to fearing the end to the Fed’s near zero interest rate policy (NZIRP), I think it’s time to anticipate a new beginning – QE4.
As a quality-focused equity investor, we certainly revel in those periods when companies with a durable competitive advantage outperform. Thus far in 2014, the highest quality companies in our universe have advanced 6.8% while the lowest have declined 1.0%. This disparity in performance is further highlighted by the 8.3% gain in the S&P 500 versus the 4.4% descent of the Russell 2000. High quality’s relative attractiveness has gathered momentum since the beginning of 2009 such that high quality stocks represented a two standard deviation investing opportunity at the beginning of the year. Using P/E ratios as a common metric of relative value, the spread between the S&P 500 and S&P Small Cap 600 reached an extreme 8.3 P/E points at year-end as the S&P 500 P/E was 17.3 while the Small Cap index was 25.6. While the discrepancy this year has narrowed ( the relative attractiveness difference was 5.6 at quarter-end), there is no assurance that low-quality will regain its advantage. Historically from 1974 to 2012, the performance of stocks across the quality/risk spectrum showed very little difference in returns. Contrariwise, high quality companies offered a similar level of return yet exhibited approximately one-third less volatility as measured by standard deviation.
While none of us like losing money, market corrections represent great opportunities to remove overvalued or underperforming companies from our portfolios while substituting companies of higher quality, better value or better business momentum. The assumption, of course, is that equities represent your long horizon assets matched to your long horizon liabilities such as retirement AND that the correction does not morph into a bear market. Historically within bull markets, 5% corrections in the S&P 500 occur every 7.0 months and 10% corrections occur every 25.7 months.* Since the current advance has gone more than 27.6 months since a 10% down move, I would not be surprised if the current 7.5% S&P 500 decline moved slightly deeper into correction territory cleansing a few more weak hands in the process. As the ultimate long-only optimist, I don’t think we are at the precipice of a lengthy decline. Credit markets remain stable, the Fed has really adopted a neutral stance, equities are fairly valued against competing investments and leading economic indicators show no sign of a recession in our view. Certainly foreign economic malaise tempers my outlook for U.S. earnings but without extended stock market valuations, I think the probability of a meaningful equity decline is low.
The opinions expressed are those of 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 investments portfolio. Material presented has been derived from sources considered to be reliable, but the 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.
Returns are presented gross of investment advisory fees and include 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. For example, a 0.50% annual fee deducted quarterly (.125%) from an account with a ten year annualized growth rate of 5% will produce a net result of 4.4%. Actual performance results will vary from this example. The Firm’s policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request.
Net returns are shown net of 3%, the highest fee that could potentially be charged including investment advisory fees, trading, custody, investment advisory fees and any other expenses that may be incurred in the management of the account. Actual performance results will vary from this example. The Firm’s policies for valuing portfolios, calculating performance, and preparing compliant presentations are available upon request.
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/Credit Bond Index measures the performance of U.S. dollar denominated U.S. Treasuries, government-related & 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 Year Treasury Index tracks the performance of the long-term U.S. government bond market.
The Barclays U.S. Corporate High-Yield Index covers the USD-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.
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.
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.