The Weekly Insight Podcast – Timing Isn’t Everything
There are always many ways to look at the stock market. The trendy way this week is to look at May’s performance of the S&P 500 and tout that it was the best May since 1990. And it’s true. We’re never going to complain about a month in which the market is up 6.15%!
Past performance is not indicative of future results.
Or there’s the pessimist’s way. Yes, May was great. But all it did was get us back to where we started the year. Also true.
Past performance is not indicative of future results.
The bigger truth is that if you let us pick any random date, we could make a compelling argument for either a dominant bull run or a struggling bear. Time – especially short periods of time – is not a good measure of where the market may be going in the future. It’s an easy story for the news, but not a way to manage money.
What matters more are the boring, not newsworthy things like economic conditions and earnings growth. That info won’t generate clicks online, but it can inform us of our path forward.
And that information has led us to make some changes in portfolios last week that are notable for investors. But before we get to what we did, let’s take a look at why.
One of the things we know is that there are two broad types of pullbacks in the market. The first is what we experienced over the first half of this year: a correction driven by fear and uncertainty. The second is more serious: a correction driven by a recession. The market responds very differently (historically) to the two types. As you can see below, recession driven corrections are much deeper (-36% on average vs. – 21%) and last much longer (~300 days vs. ~100 days).
Past performance is not indicative of future results.
Which begs the question: are we going to get into a recession? Oddsmakers today have significantly reduced the odds of a recession in just the last few weeks.
Source: MRB
Past performance is not indicative of future results.
But the gambling markets aren’t the best source for truth here. The bond market, on the other hand, is. You’ll recall the conversation in early April around tariffs when it was stated the “bond market freaked out”. That’s true, sort of. But that freak out has quickly been retraced.
When we look at the bond market – especially to see how bond traders are pricing in the risk of negative economic performance – we look at the spread between high yield debt and traditional corporate debt. When the bond market thinks a recession is coming, spreads quickly blow out and expand to levels well above 5.00%. Today that spread is just 2.32%. The bond market isn’t scared right now.
Past performance is not indicative of future results.
So, then the question becomes how are companies faring in this environment? Yes, the economy seems to be fairly stable. But what about earnings given the potential for tariffs? Clearly, they are reigning back their expectations and that could be damaging to the market, right?
Sort of. Many companies have reduced their earnings expectations. And that has forced analysts to cut their targets for growth in the market. But so far, we’ve seen significant earnings growth for Q1 and Q2 seems on pace to significantly exceed expectations. And the bar for Q3 & Q4 is fairly low. There’s no reason to expect a significant reduction in earnings from these levels given the information we have today.
Past performance is not indicative of future growth.
Which brings us to what we did in portfolios last week. We made a fairly significant shift in two of our larger strategies: Balanced & Conservative Growth.
You’ll recall that last year we took some risk off the table in these strategies. It’s worked out very well for clients. And we’re still very happy with those positions.
Instead, we acted in the high-yield debt portion of the portfolios. High yield debt provides a nice income, but it can also act like equity when things get rough. So, while it is, technically, fixed income, it doesn’t provide protection from the storm like other positions in our portfolios such as IEF and FBND.
Given the shrinking size of the yield spread, we determined we’d be better off exposing more of the portfolios to equities vs. high yield. Accordingly, we cut our high yield positions by 6% and allocated that equally to mid-cap (PEMGX) and large-cap value (PVAL) managers. If earnings truly remain strong, the market is flat for the year, and the economy is in good shape, this is an excellent way to take advantage of the opportunities ahead.
And – since we know everyone is worried about the impact of tariffs – it should be noted that these areas of the market are some of the least exposed to sales outside of the United States. They should be best positioned to avoid any significant impacts.
Past performance is not indicative of future results.
As we discussed above – the timing of this decision may look particularly good or particularly bad depending on the time frame through which you measure it. But timing isn’t everything. We’re thinking about our clients’ financial health over a very long window. And we’re confident this is another good step for the long-term health of clients’ portfolios.
Sincerely,
