2Q 2019 — Range of Outcomes as Wide as Ever — but Be Sure to Include a Continuing Bull Market

K. Sean Clark
K. Sean Clark, CFA®
EVP, Chief Investment Officer

What a turnaround it has been for markets over the last six months. December saw a fierce decline driven by fears that the Fed was tightening too much and causing a global slowdown. As we head into July, global central banks have become the most accommodative in years, and markets have followed their lead higher.

The S&P 500 is up over 18%, its best start in over twenty years. While stocks have surged, even more remarkable has been the flow of money into bonds as global yields continue to head lower and lower. “Lower for longer” is now the base case for interest rates, yet the bullish monetary conditions that drove markets higher were despite the fact that global economic activity is weakening. In Europe and now China many PMIs (Purchasing Manager Indexes) are below 50, indicating economic contraction. In addition, in the U.S. the yield curve has inverted (the 3-month T-Bill – 10-year Treasury yield is now negative), and it has remained negative since May 23rd.

Bonds’ dramatic and dovish turn lies in direct contrast with the stock market’s surge, expecting an economic rebound. Which will prove to be right? We are all watching the key factor—the trade war between the U.S. and China as the two sides’ tariffs now begin to really bite economic activity.

Thinking bigger picture, investors have been rewarded by the continual bull market that began in 2009. In fact, in July, this bull market became the longest bull market on record. What’s more, the evidence pointing towards a coming economic downturn is the strongest it’s been in years. Valuations, labor markets, the profit cycle, and an inverted yield curve show that the economy is in the late cycle stages.

After such a long economic run, should investors run to safety? We believe it’s worth being watchful, but not worried, as the arguments for a bullish case are just as strong as a bearish case. The Fed has completely changed its tone and is expected to cut rates, and inflation is nowhere close to being an issue, even if growth improves considerably.

The mixed set of loud bullish and bearish indications is something new for the U.S. economy and investors, and it is a tough environment to operate in. Warning signals that show increased risks on the horizon should be taken seriously, but markets can move higher if those signals prove false. During the late stages of a bull market, breadth can narrow and small caps can lag, making top-line index gains harder to match for the diversified investor.

At Clark Capital, we continue to believe that a focus on risk management will pay off in the long run, as a bear market and weak economy, when they come, will present opportunities to first preserve capital and then later be tactically opportunistic.

U.S. Equity — Large-Cap and Growth Stocks are the Quarter’s Top Performers

The U.S. equity portion of the Multi-Strategy portfolios ranks a number of U.S. equity styles and factors using Clark Capital’s Relative Strength-based ranking methodology, and then purchases those ETFs with higher rankings (and avoids those with lower rankings), assembling them into a broad-based portfolio that attempts to outperform the Russell 3000. The portfolio focused on large-caps throughout the quarter, as small-caps lost the brief momentum that they had gained after the December bottom. Growth was favored over value, as it has been for many quarters and years.

In the table below, you can see that large-cap growth stocks have outperformed large-cap value by over 6.5% per year over the last three years–a huge gap. Small-cap growth has also outperformed small-cap value by 3.5% per year.

Index Name 2019 YTD 3-Year Annualized Gain (%) Index Forward P/E as of 1/26/18 Peak Index Forward P/E as of 6/30/19
SPDR S&P 500 Value ETF (SPYV) 16.58% 10.60% 16.18 14.4
SPDR S&P 500 Growth ETF (SPYG) 20.02% 17.13% 21.59 22.18
iShares S&P 600 Small Cap Value ETF (IJS) 13.56% 9.99% 18.36 16.18
iShares S&P 600 Small Cap Growth ETF (IJT) 13.59% 13.48% 23.95 22.84
Source: Bloomberg. For illustrative purposes only.

 

The Multi-Strategy portfolio has largely avoided value stocks, as their momentum has been poor. However, we recognize that the value factor will eventually provide an outsized chance for relative gains that we will be more than happy to jump into once a trend develops.

The following were other developments in the portfolio during the quarter:

  • For the quarter, large-cap value (SPYV) gained 3.98%, while large-cap growth (SPYG) rose by 4.48%. Small-cap value (IJS) was up 1.10%, while small-cap growth (IJT) gained 4.22%. Momentum (MTUM) stocks rose by 5.54%, while minimum volatility (USMV) led with a 6.13% gain. High Beta (SPHB) gained 3.45%. The S&P 500 (IVV) was up 4.22%.
    Among all of the stock selection strategies highlighted by Ned Davis Research, the most effective in the second quarter was mean reversion. Relative strength–the guiding philosophy behind our strategy, was the least effective strategy. As a result, our methodology faced headwinds, though of less magnitude. Our models did not show any standout leaders, as trends reversed sharply from May to June. As a result, the portfolio has owned the S&P 500 Index itself, and our large cap ETFs that are highly correlated to it.
  • Currently, our models favor large-cap over small-cap, and growth over value, with large-cap over small-cap the more noticeable effect in 2019. The fact that small-caps greatly trailed during the second quarter’s rally is a concern, as poor market breadth is a sign of being in a later stage of the market cycle.
  • The top contributors to the portfolio during the quarter were the iShares S&P 500 ETF (IVV) and the SPDR S&P 500 Growth ETF (SPYG). The top detractors were the Invesco Buybacks ETF (PKW) and the iShares Edge MSCI Quality Factor ETF (QUAL).

Top Contributors

Ticker Quarter Ending June 30, 2019 Average Weight (%) Contribution to Return (%)
SPYG SPDR Portfolio S&P 500 Growth ETF 35.1 2.03
IVV iShares Core S&P 500 ETF 20 1.23
USMV iShares Edge MSCI Min Vol USA ETF 13.46 1.08

Top Detractors

Ticker Quarter Ending June 30, 2019 Average Weight (%) Contribution to Return (%)
QUAL iShares Edge MSCI USA Quality Factor ETF 10.83 -1.25
PKW Invesco Buyback Achievers ETF 4.74 -1.17
SPHB Invesco S&P 500 High Beta ETF 8.56 0
Source: FactSet as of 6/30/19 Past performance does not guarantee future results. The holdings identified do not represent all of the securities purchased, sold or recommended for advisory clients. In the chart above, “weight” is the average percentage weight of the holding during the period, and “contribution” is the contribution to overall performance during the period. To obtain the calculation methodology and a list showing every holding’s contribution to the overall composite performance during the period, contact PortfolioAnalytics@ccmg.com.

Fixed Income — A Turn to U.S. Treasuries

The fixed income portion of the Multi-Strategy portfolios engages in segment rotation within fixed income, owning high yield bonds, U.S. Treasuries, or cash, whichever our model determines has recent relative trends in its favor. The fixed income portion of the Multi-Strategy portfolio purchased high yield bonds on January 10th and held them until June 3rd, when the portfolio moved into U.S. Treasuries.

The move was precipitated more by the relative strength shown in U.S. Treasuries more so than the weakness of high yield bonds. Markets quickly turned around after the trade as credit rebounded upon numerous dovish Fed comments and high yield credit enjoyed solid June gains. What has been remarkable is that Treasuries have continued to provide gains at the same time as markets price in further rate cuts.

Ultimately, we believe de-risking the portfolio can provide a smoother risk-adjusted ride through the credit markets. The following were other developments in the portfolio during the quarter:

  • Over 50% of the U.S. Investment Grade corporate market is now rated BBB, with the next downgrade moving them into the high yield category. With low interest rates, this is not an immediate cause for concern. However, the next time that we see a recession or major credit downgrade cycle, the price pressure on lower quality investment grade and high yield credit will be huge, and it will provide opportunities to play defense and then become a tactical buyer as sentiment turns.
  • On the quarter, the top performing holdings were the Navigator Tactical Fixed Income Fund (NTBIX) and the iShares 7-10 Year Treasury ETF (IEF). Detractors included the Bloomberg Barclays High Yield Bond SPDR (JNK) and the iShares iBoxx High Yield Corporate Bond ETF (HYG).

Top Contributors

Ticker Quarter Ending June 30, 2019 Average Weight (%) Contribution to Return (%)
NTBIX Navigator Tactical Fixed Income Fund Class I 49.92 0.19
IEF iShares 7-10 Year Treasury Bond ETF 7.14 0.18
ITE SPDR Bloomberg Barclays Intermediate Term Treasury ETF 4.76 0.09
LAHYX Lord Abbett Investment Trust High Yield Fund Class I 2.1 0.03
AGDYX AB High Income Fund, Inc. – Advisor Class 2.08 0.02

Top Detractors

Ticker Quarter Ending June 30, 2019 Average Weight (%) Contribution to Return (%)
HYG iShares iBoxx $ High Yield Corporate Bond ETF 6.28 -0.07
JNK SPDR Bloomberg Barclays High Yield Bond ETF 5.63 -0.07
HYS PIMCO 0-5 Year High Yield Corporate Bond Index ETF 1.38 -0.01
SJNK SPDR Bloomberg Barclays Short Term High Yield Bond ETF 1.38 -0.01
HYLB Xtrackers USD High Yield Corporate Bond ETF 1.39 -0.01
Source: FactSet as of 6/30/19 Past performance does not guarantee future results. The holdings identified do not represent all of the securities purchased, sold or recommended for advisory clients. In the chart above, “weight” is the average percentage weight of the holding during the period, and “contribution” is the contribution to overall performance during the period. To obtain the calculation methodology and a list showing every holding’s contribution to the overall composite performance during the period, contact PortfolioAnalytics@ccmg.com.

Outlook

Looking forward, our view on markets is constructive, we believe that the first half of the year’s rally will continue, but will come with more volatility surrounding Fed action and progress or lack thereof in the trade talks. We can envision a bullish upside scenario in which a broad, comprehensive trade agreement with China is announced, causing investors to upgrade expected global economic growth.

While we remain cautiously bullish amidst mixed economic data and headline risks, we are acutely aware we are in the late stages of this market cycle and believe that risk management will become increasingly more important.

The views expressed are those of the author(s) and do not necessarily reflect the views of Clark Capital Management Group. 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.
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.
A S&P ‘BBB’ rated obligation exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to weaken the obligor’s capacity to meet its financial commitments on the obligation.
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). Forward looking statements cannot be guaranteed. 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.
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. Not every client’s account will have these exact characteristics. The actual characteristics with respect to any particular client account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment.
Clark Capital Management Group, Inc. reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. The information provided in this report should not be considered a recommendation to purchase or sell any particular security, sector or industry. There is no assurance that any securities, sectors or industries discussed herein will be included in an account’s portfolio. Asset allocation will vary and the samples shown may not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. 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.
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