Recent market volatility during the month of May has made many investors nervous and for good reason. The market is in the midst of a change in momentum and the shift has been sudden. First, it’s important to note, the U.S. economy is recovering rapidly from the COVID-19 pandemic. Many different factors are at play in the recovery: the rollout of vaccines, the lifting of restrictions, loose monetary policy, and a massive increase in government spending. The problem is that the massive government “stimulus” checks have put the economy in a strange position, where retail sales are far above where they would be if COVID had never happened, even as the production side of the economy remains relatively weak. Pandemic unemployment benefits, paired with lack of childcare options has resulted in a strange dynamic for employment, plenty of jobs and not enough job seekers. Add to that the inflationary effect of the economic recovery and suddenly we find ourselves with very unusual market dynamics.

One of the questions we are most frequently asked is about the rotation from growth to value. Growth stocks tend to be companies that are smaller or are in more volatile sectors of the market like technology.  Tesla would be a good example of a growth company.  Value companies are usually larger and are more likely to be staples of the economy.  Walmart would be a good example of a value stock.  This rotation from growth to value which began in October, is not an unusual market event. Growth had been outperforming value for the better part of a decade, as economic conditions strongly favored growth stocks (interest rates trending lower, inflation at historically low levels, slow and steady economic growth). The chart below illustrates the relationship between growth and value over time.

Source: MPI Stylus

Typically, value does best in the recovery stage of a recession when interest rates are moving upwards and when inflation is rising. Value sectors like energy, materials and financials thrive under those conditions.  

At Spotlight we anticipated this shift and began positioning our portfolios accordingly earlier this year. Specifically, we added more active managers to our investments over the last several months. We believe active management is more successful when the market is more volatile, and we feel we have had success in selecting high quality active managers. The table shown below illustrates how well our active managers have performed in the last 12 months. All our active equity managers are outperforming the S&P 500. This is even more apparent in the fixed income space, as all four of our fixed income strategies are actively managed, and all four are handily beating the Barclays U.S. Aggregate benchmark. 

Additionally, over the past year we have implemented a risk budgeting approach to our portfolio construction.  Rather than of only looking at whether we want to overweight/underweight equities, our Investment Committee is now focused on the amount of risk we are taking with each model.  Our first step in constructing portfolios is to decide if we want to be overweight, equal weight, or under-weight risk compared to our benchmarks.  Currently all of our portfolios are equal weight to risk.  We then decide which areas of the market appear to be the most likely to out-perform and will use our “risk budget” to select excellent managers in those asset classes.  Our goal has been to take on risk where the upside potential is most attractive. Currently, in most models, we have used our risk budget to increase exposure to Value, Small/Mid Cap Companies, and Alternative funds that can go Long or Short equities depending on how the manager feels the market will perform.  Given this approach, we are comfortable that we have positioned our portfolios well for the current market conditions and believe that this approach will help you reach your long-term goals. As always, we are here to address your questions or concerns. 

This material was prepared by the Spotlight Asset Group (“SAG”) Chief Investment Officer (“CIO”) and is presented for information purposes only. The views offered are those of the author and are subject to change. This information is not intended to provide investment advice or solicit or offer investment advisory services. All information and data presented herein has been obtained from sources believed to be reliable and is believed to be accurate as of the time presented, but SAG does not guarantee its accuracy. You should not make any financial, legal, or tax decisions without consulting with a properly credentialed and experienced professional. Investing involves risk and past performance is no guarantee of future results.

2021 is off to a rocky start as equity markets declined across the board. The S&P 500 Index fell -1.01%. The world was captivated by the trading frenzy over heavily shorted stocks such as GameStop (GME) and AMC Entertainment Holdings (AMC), which drove volatility in equities to the highest levels since October. The lone bright spot was small cap stocks which continued their run of outperformance, ending the month up +5.03%.

To say that month was crazy for the markets seems like a bit of an understatement. Rampant speculation being driven by anonymous investors on a Reddit chat board called “Wall Street Bets” captivated the headlines, as what seemed to be a David versus Goliath scenario played out in one of the most public short squeezes seen in years. As retail investors jumped on board in the hopes of beating the big hedge funds at their own game, hedge funds seemed to be on their heels, cutting bets by decreasing their long equity positions to cover short bets that had turned against them, causing downward pressure across the equity markets. The drama heightened as retail brokerage firm Robinhood suspended buying activity in the targeted stocks and closed out many investors existing positions. The sensational headlines caught the eye of the regulators and politicians who immediately demanded answers and solutions to protect retail investors, despite their clear willingness to participate in the speculation. 

The challenge in moments of frenzy is being able to look beyond the noise and focus on the broader picture. Very little attention has been paid to the strong earnings that have been reported thus far. According to FactSet with 37% of the companies in the S&P 500 reporting actual results, 82% of S&P 500 companies have reported a positive EPS surprise and 76% have reported a positive revenue surprise. If 82% is the final percentage, it will mark the second-highest percentage of S&P 500 companies reporting a positive EPS surprise since FactSet began tracking this metric in 2008. Improving economic data and the increasing pace of vaccinations in the U.S. continue to support rising equity prices in the near term. While the headlines focus on the frenzy, smart investors have an opportunity to buy quality companies at an attractive price, setting themselves up to take advantage of the explosion of pent-up demand that is anticipated in the second half of the year. While it is easy to get caught up in the excitement, I would not allow the temptation to earn a quick buck in the battle against the shorts distract from the more lucrative opportunity that such a frenzy presents smart investors who are focused on the long-term. 

This material was prepared by the Spotlight Asset Group (“SAG”) Chief Investment Officer (“CIO”) and is presented for information purposes only. The views offered are those of the author and are subject to change. This information is not intended to provide investment advice or solicit or offer investment advisory services. All information and data presented herein has been obtained from sources believed to be reliable and is believed to be accurate as of the time presented, but SAG does not guarantee its accuracy. You should not make any financial, legal, or tax decisions without consulting with a properly credentialed and experienced professional. Investing involves risk and past performance is no guarantee of future results.