After a spectacular 2019 (S&P 500 Total Return Index +31%), the US market has continued its run to start the new year, up 3% through yesterday’s close. The S&P 500 TR Index has now gone 70 consecutive trading days without a 1.0%+ move in either direction, rising 12.5% over that span. This positive trend coupled with a rare lack of volatility has been driven by two primary catalysts:
The US/China phase one trade deal has eased anxieties over further trade war escalation
The Federal Reserve’s significant balance sheet expansion as it intervenes to provide extra liquidity to short-term funding markets
In terms of portfolio management, the steadily rising market has led GGS to perform trades in most client accounts to rebalance beta back to target.1 Beta measures the volatility of a security in relation to the market (we use the S&P 500), and the portfolio beta is the weighted average of all the security betas in the portfolio. The average stock has a beta of roughly 1.0, while the average bond has a beta of roughly 0. As stock prices rise and bond prices stay relatively flat, the beta of a mixed stock/bond portfolio will naturally rise as stocks’ weight in the portfolio increases. Therefore, a typical trade lately has been to sell/trim equities in a client portfolio and increase fixed income holdings, in order to keep the portfolio beta at the agreed upon target risk level.
We weigh many factors when considering what stock to trim or sell for this purpose, as we can often accomplish more in this trade than simply lowering a client’s beta back to target. Some of the primary factors we consider:
Our current ranking of the security – we often choose to sell or trim the stock in the client’s portfolio that we currently like least on a forward-looking, risk-adjusted basis. These rankings are updated daily based on our stock selection methodology.
The weight of the security in the portfolio – we often choose to trim stocks with current weight significantly above target. Regardless of the company in question, we always try to avoid holding concentrated positions in any one security. Too many negative unknown events can happen at the individual company level and it greatly increases the risk of the portfolio.
Geographic, Industry and Sector weights – If the client’s portfolio is overexposed to any particular geography, industry or sector, we are likely to chose a stock in that area to sell or trim. This will reduce the risk that a negative event impacting any given geography, industry or sector will have a significant effect on the client’s portfolio.
For 2020, these are some of the key upcoming themes/events we will be paying attention to:
Central Bank Policy: As mentioned above, a significant driver of the recent rally has been the Fed’s intervention in short-term repurchase markets. These operations have reversed more than half of the September 2017 to September 2019 balance sheet drawdown,2 and many have likened it to a new form of Quantitative Easing. Whether Chairman Powell continues this expansion or dials back the Fed’s intervention will likely have a significant impact on the market, and this topic may be discussed in Powell’s January 29 press conference.
US Politics: With Iowa (Feb 3) and New Hampshire (Feb 11) just weeks away, the Democratic primary will be in focus. The key question for the market is whether a moderate (Biden) or a more progressive candidate (Sanders, Warren) captures the nomination. A progressive nominee with a chance of beating President Trump in the fall would likely cause some consternation for the market, especially in sectors like Healthcare. Remember that it would require the US Senate majority to flip Democratic as well for any significant policies of a Democratic president to be enacted into law, most notably any change/rollback of the 2017 tax cuts. The other aspect of the 2020 election worth mentioning is that it is expected to keep President Trump’s trade policy in check, at least until after the election. Most observers believe it is unlikely that the White House takes extreme trade actions this year for fear of roiling the economy ahead of the election.
Corporate Earnings/Valuations: The recent rise in the S&P 500 has not been accompanied by significantly higher future earnings estimates, and the current forward-looking Price/Earnings multiple is now at levels that have not been sustained since 2002.3 While multiples can always go higher (see 1999-2000), it is more likely that continued corporate earnings growth will be the key to stock market performance in the coming years. Two key earnings growth variables to watch will be rising wages and whether global growth picks up again now that the US/China trade tensions have cooled.
US Regulators: With AAPL (4.8%), MSFT (4.6%), GOOG/GOOGL (3.2%), AMZN (2.8%) and FB (1.9%) currently making up roughly 17% of the S&P 500,4 any increased risk of US anti-trust regulation targeting these Tech giants could have a significant impact on the market. Worries about the power of these companies are bipartisan so this could occur regardless of the November election.
1 Beta rebalancing does not apply to all clients. For example, clients targeting a portfolio beta of 1.0 or higher typically have all equity portfolios.
2 See https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm
3 Data from Bloomberg
4 Data from Bloomberg
This article is provided for informational purposes, not as personal investment advice. This article contains certain forward‐looking statements which indicate future possibilities. There is no guarantee views and opinions expressed herein will come to pass. Past performance is no guarantee of future results. Any reference to a market index is included for illustrative purposes. It should not be assumed that your account performance or the volatility of any securities held in your account will correspond directly to any comparative benchmark index.