0 COMMENTS

Stock markets took a much anticipated “breather” during the third quarter.  Most equity indexes traded in a tight range between slightly negative and slightly positive.  This ended a run of six consecutive quarters of firmly higher stock markets that dates back to the original pandemic selloff (Q1 2020).  The S&P 500 was the lone positive performer this quarter as it eked out a return of .58%.  The Dow, the NASDAQ, and the MSCI EAFE indices were lower by 1.46%, .22%, and .33% respectively.  Small Cap stocks were a negative outlier by declining 4.36% (Russell 2000 Small Cap Index) during the same time period.  The good news is that this stock market pause had little effect on an otherwise strong year.  Since January 1st, 2021, the S&P 500 is up 15.91%, the NASDAQ is up 12.67%, and the Dow is up 12.12%.  International stocks have failed to keep pace with other indices with a year-to-date return of 8.84%.

The battle between growth stocks and value stocks in 2021 continues without a clear winner.  For the first five months of 2021 value stocks appeared to be reversing a decade long trend of outperformance of growth stocks.  From the end of 2020 to May 31st, 2021, value stocks (Russell 3000 Value Index) beat growth stocks (Russell 3000 Growth Index) with a total return of 18.97% to 6.16%.  However, growth stocks regained dominance from May 31st, 2021, to August 31, 2021, with growth stocks increasing 13.11% to values gain of 1.41%.  This again flipped in September as playing defense became the main priority.  During the month of September growth stocks lost 5.49% and value stocks lost 3.38%.  Add it all together and for 2021 value has outperformed growth 16.56% to 13.49%.

The primary application for investors, in the struggle between growth and value, is that both types of investments need to be in portfolios.  These asset classes behave differently in various economic environments and together provide a better risk adjusted return than exposure to just one.  Another observation is that there is now a clear and established trend of a growth to value asset class rotation.  It is a perfect time for investors to audit their portfolios to ensure value stocks are adequately represented.

In other financial markets interest rates experienced almost no change in the third quarter, as did the price of gold, while oil surged higher.  The 10-year government bond began the third quarter at 1.47% and ended the quarter at 1.49%.  Similarly, the price of gold barely moved as a troy ounce was priced at $1,772 on June 30th and $1,758 on September 30th.  By contrast, the price of a barrel of oil made a significant change by increasing 5.89% ($70.89 to $75.03) during the same period.  The movement in the price of oil is significant as it remains a major input to many industries.  These climbing energy prices increase the possibility of sustained inflation.    

Looking Forward

The economic environment is now coming into much better focus.  The unknowns from 12 months ago are now knowns (will there be a vaccine for COVID-19, who will be the next president of the United States, and will the global economy continue to re-open).  Additionally, the Federal Reserve has clearly flipped its stance to removing liquidity and raising interest rates.   Portfolio managers are also keenly aware of the near-term restraints to the economy of supply chain disruptions and a worker shortage.  It has been a very long time since investors have had so much certainty.   The great news is that investor certainty is highly correlated to positive stock markets.  Stocks love certainty.

The obvious approach to investment allocation is to be diversified, be active, and be a little bit selective.  The mindset of investing in just the S&P 500, a small number of stocks, or only in indices needs to be eliminated.  The future success of investors is dependent on introducing asset classes that have not yet realized their intrinsic value.  Investment opportunities with great potential are easily found in the value sector, developed foreign markets, and emerging markets.  Investors should reacquaint themselves with the periodic table of asset class returns (will be provided by D’Arcy Capital upon request).  This table demonstrates how different asset classes outperform at different times.  It also illuminates that what has been the best type of investment for the last 10 years is not the best type of investment for the next 10 years.

In addition to diversification, the avoidance of passive management, and selectivity, it is vital that investors remain aware of inflationary forces.  Supply shortages, worker shortages, higher raw material prices, and increasing demand are all inflationary.  Investors can defend against inflation by maintaining exposure to stocks, purchasing inflation protected bonds, and reducing cash balances.

This is also a great time for investors to review the fixed income (aka bond) portion of their portfolio.  Interest rates are increasing, and higher bond yields are beginning to emerge.  This is not the time to abandon bonds.  In fact, the biggest threat is the proliferation of synthetic bond strategies that have found their way into investor accounts.  In the search for yield, investors have ignored risk. This has led them to own leveraged funds, long-term bonds, call writing strategies, and structured products.  These all contain much greater risk than a portfolio of individual bonds.

D’Arcy Capital continues to find exceptional opportunities in the value sector, small cap stocks and both developed and emerging foreign markets.  In the bond universe individual municipal bonds remain attractive as do inflation protected bonds and total return strategies.

Recent Posts

Leave a Comment