Do you have the tools you need to outperform in a market where sector selection is becoming increasingly more important?
So, as if this job wasn’t hard enough already, we all need to begin to focus a lot more on sector selection and investment style selection compared to the ’08-’15 period, a time when we could simply own broad indices and rely on the Fed’s QE and 0% rates to make the tide rise.
And, since July 2016, the difference in sector performance has been staggering. From July 8th (when stocks fully recouped the Brexit drop) to December 31st, the S&P 500 rose 5.1%. But, sector performance varied significantly:
- Banks surged, with our preferred bank ETF rising 45%.
Meanwhile, the sectors that had outperformed for years suddenly started lagging, badly.
- Utilities dropped 7.5% from July to the end of the year, lagging the S&P 500 by more than 12%.
- REITs dropped 8.1% from July to the end of the year, lagging the S&P 500 by more than 13%.
So, how an advisor was allocated made a big difference to performance in 2016!
We recognized that this shift began in July, and that’s when we started talking to our paid subscribers about the “Great Rotation” out of defensive sectors and into cyclicals. That’s also when we started pushing the idea of a specific bank ETF as a lower risk/higher reward idea that would give managers exposure to shifting market trends.
Almost as important as the actual performance, our subscribers also had specific, well-reasoned investment ideas to discuss with clients and prospects throughout 2016, reinforcing the fact that the advisors were focused on both protecting their clients’ assets and growing their wealth!
As we start 2017, we are helping our advisor subscribers identify tactical sector opportunities that we believe can outperform for their clients.
Now, to be clear, we’re not talking about quick trades or pretending to be a hedge fund. These are tactical, medium or longer-term strategies (so time horizons of a few months to a few quarters or beyond).
And, as always, we provide the fundamental reasoning behind the selection, so advisors can understand why we like a sector. And, we monitor that strategy and provide updates as things change.
We make sure our paid subscribers have an independent analyst team that communicates with them and that quickly identifies the risks and opportunities for:
- Commodities, and
- Interprets what economic data means for the market.
Advisor Cheat Sheet is the market cheat sheet our paying subscribers use to keep up on markets, seize opportunities, avoid risks and get more assets.
With a monthly cost of less than one client lunch, we firmly believe we offer the best value in the independent research space.
As correlations between stocks and other assets drop, sector and style selection will play an increasingly important role in outperforming the S&P 500 in 2017, and we’ve included an excerpt of our recent research below.
The Case for Value
We believe that “value” ETFs can continue to outperform as they did in 2016 while at the same time offering some protection from any pullbacks in the broad market given they are more value-oriented stocks, and not too far out on the risk curve.
But, there are a lot of “value” funds and ETFs out there, so we’ve spent some time identifying the two value ETFs that offer what we think is the best combination of 1) Reasonable valuation, 2) A favorable sector make up (sectors we believe can outperform in 2017 are heavily weighted in these ETFs compared to the S&P 500) and 3) A recent history of outperformance, specifically post-election.
Valuation: Despite the surging bullish sentiment towards stocks, I remain cautiously optimistic and am not quite ready to throw caution to the wind and jump into cyclical, growth-oriented ETFs with high P/E ratios and high betas.
So, the value segment offers better exposure to growth while at the same time retaining a reasonable valuation to help cushion any negative performance should we see a pullback in early 2017. To that point, our first preferred value ETF has a P/E of just over 18 (so basically in line with the S&P 500) while our second preferred ETF has a P/E of 17.5, slightly below the S&P 500.
Sector Makeup: It’s no secret that we believe financials can continue to outperform in 2017 given likely higher rates and less regulation while healthcare remains a top contrarian pick due to negative sentiment and (in our view) over-exaggerated political risk. Meanwhile, industrials and energy should continue to benefit from improving growth and deregulation.
Our two preferred value ETFs have about 60% of assets allocated to those four sectors, compared to just 45% for the S&P 500 – and that overallocation to those four sectors could continue to produce significant outperformance (more on that below).
Preferred Value ETF #1 has 68% of all assets spread across financials (27%), healthcare (9.7%), energy (13%), consumer staples (7.6%) and industrials (10.2%).
Preferred Value ETF #2 has 71% of its assets spread across the same five sectors, with the main difference being healthcare at an 11.5% allocation and industrials at an 8.7% allocation. It won’t make that much difference to performance, but we like the over-allocation to healthcare in ETF #2 a bit better than ETF #1 (but again, that’s somewhat splitting hairs).
Recent Outperformance: Value ETFs handily outperformed the S&P 500 in 2016.
- Our two preferred value ETFs rose 18.4% and 17.4%, respectively, in 2016 compared to 9.54% for the S&P 500.
- Since the election (Nov. 8) our two preferred value ETFs have risen 9.09% and 8.67%, respectively, again handily outperforming the S&P 500’s 6.40% return. Given the general set up for stocks remains the same as it was post-election, we believe these value ETFs can continue to outperform in this environment.
Exposure to a continued “Great Rotation.” A final reason we like the value space is the potential to benefit from a rotation into higher growth stocks from
1) Portfolio Managers that need to increase beta but are too risk averse to go into pure growth-oriented ETFs, and
2) To a lesser extent money that’s coming out of bonds and into stocks as an inflation hedge.
During slow growth periods, defensive and income-oriented sectors have outperformed, regardless of valuation. That certainly was true over the past several years and utilities, REITs and consumer staples surged to very high relative valuations and consistently outperformed.
However, when economies see growth start to accelerate (as we are potentially seeing now), investors rotate out of income-oriented, defensive sectors (like utilities and REITs). And while some money goes straight into cyclicals and growth funds, a lot of money instead shifts into value sectors of the market.
The reasoning is simple: Investors are skeptical about whether the outbreak of growth is sustainable, and as such value provides more upside than defensive sectors… but investors aren’t overpaying for exposure. Basically, it’s a good first step towards a more aggressive allocation. We could see that continue in 2017 as economic growth improves.
Usually, it’s only in the later stages of the economic acceleration that investors rotate wholesale into growth styles, as the acceleration in the economy has become so entrenched that people are confident enough to reach for additional reward and incur additional risk.
So, in addition to the specifically attractive characteristics of our two preferred growth ETFs, they also offer us exposure to a continued rotation out of defensive sectors and towards higher-beta, more cyclical stocks and sectors while not putting us too far out on the risk curve if economic growth fails to break out.
Paid subscribers know our two preferred value ETFs and already have the talking point they need discuss this idea, and others (banks, healthcare, European exposure) with clients and prospects.
Plus, they have the macro talking points to show clients and prospects they understand the risks facing markets as we start 2017, risks that include: Disappointment from the new administration, higher inflation, surging bond yields/declining bond portfolios, global political unrest (China, North Korea, etc.).
We have armed our paid subscribers with the specific investment ideas and macro talking points to reassure current clients and impress prospects.
As we start 2017, I am extending a special offer to new subscribers of our full report that we call our “2-week grace period.”
If you subscribe to Advisor Cheat Sheet today, and after the first two weeks you are not completely satisfied, we will refund your first payment, in full, no questions asked.
Grow Your Business in 2017
Going forward, all of us here at Advisor Cheat Sheet are committed to helping our paid subscribers navigate this market and start 2017 strong – and that means correctly interpreting the critical events in the first quarter.
Specifically, there are Four Key Events advisors and investors will need to get “right’ if they want to navigate this market successfully in 2017:
1. Trump’s Policies – Will They Meet Very Lofty Expectations (Jan 20th). Don’t be surprised if we see a “Buy the President Elect, Sell the President” market reaction in 2017 as investors could book profits once Trump assumes the Presidency. That’s because the single biggest question for markets is whether the actual policies put forward by the new government will meet the very lofty market expectations, and there is serious risk of a disappointment. We’ll be focused on leading indicators that will tell us whether these policies look likely, because if they don’t, stocks could drop sharply.
2. Fed Meeting (Jan 31st). It’s not a coincidence that the “hawkish” December Fed meeting caused a pause in the stock rally. By the time the next Fed meeting occurs, we’ll have a lot more information on inflation and growth, and it’s entirely possible that the Fed signals another rate hike is coming. If that happens, the 10-year Treasury yield could surge to 3%, and that will hit stocks, regardless of what Trump is doing.
3. Semi-Annual Currency Report (March/April). What if Trump starts a trade war with China? I’m not saying it’s going to happen, but the market is so enamored with potential pro-growth policies that it’s largely ignoring the fact that Trump wants to take a hardline stance on trade. Last month, Trump appointed Peter Navarro, author of the book Death by China to head a Trade Council. If the Treasury Department labels China a currency manipulator, automatic tariffs are imposed and a trade conflict would likely ensue.
4. Fed Meeting, (March 15th). At this point, we’ll know a lot more about the policies coming out of Washington, and if we’re going to see a lot more fiscal stimulus, then Yellen herself has said the Fed will react with higher rates to prevent inflation. This March Fed meeting is the first of 2017 with an updated “Dot Plot,” so if the Fed wants to communicate more hikes in ’17, this is the first opportunity to do so. That will send the Dollar and bond yields sharply higher, which will be a headwind on stocks.
Our paid subscribers know we will give them the succinct analysis they need to communicate effectively with their clients and strengthen their relationships.
That’s the kind of analysis that leads to More Clients and ultimately More AUM.
So, why not make an investment in yourself and your business for 2017? We are confident it will produce returns many times greater than the $65 per month subscription cost.
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