Monthly Market Update - April 2019
As the new Chief Investment Officer at KLR Wealth Management, I am very pleased, and in fact I am truly honored, to re-start what has been a career-defining activity for me, the release of my Monthly Market Update, which I have written virtually without fail for nearly 25 years. Though my primary objective is to set expectations for portfolio positioning and performance for our clients, I also seek to provide perspective on the very uncertain world of investing.
Overview of Asset Allocation
Given that this is my first Monthly Market Update within KLR, I would like to provide context for why ongoing portfolio positioning, i.e., asset allocation is the most important contributor to investment returns. The three major ‘food groups’ in portfolio management are stocks, bonds and cash. Though this might seem obvious to many of you reading this, this point cannot be overstated. Asset allocation accounts for over 90% of a portfolio’s performance. At the risk of coming across as somewhat over-simplifying the portfolio construction process, I will break down active investment management into three levels. Since stocks occupy the greatest source of potential risk and return, I will use that asset class as a base.
- How much in stocks, i.e. versus a long-term strategic target.
- What kind of stocks, i.e. U.S. Large Cap, Developed International, Emerging Markets, REITs, etc.
- Which stocks, which I call the Coke vs. Pepsi decision.
Though so very much of Wall Street research and commentary is directed at the last of the three, the Coke vs. Pepsi decision (or Merck vs. Pfizer, or even Facebook vs. Amazon), provided the aggregate portfolio is properly diversified, the individual stock selection explains only the barest fraction of performance differential; i.e. less than 5%. The second level is far more important but still only accounts for 25-30% of the portfolio return. This leaves the first – how much do I own in stocks as a whole – for up to and perhaps more than 70% of how one’s portfolio performed versus expectations. To take an extreme example, your stocks can double in value, an increase of 100%, but if your portfolio only consisted of 1% in stocks, their contribution to aggregate return would be a whopping 1%.
The Economic Cycle’s Impact on Investment Decisions
To put this in other words, Wall Street lives in a ‘macro’ world. The major forces of the ongoing economic and financial market cycles are far too powerful to offset even the well-designed micro-level decisions, i.e. security selection. For those of you versed in Street nomenclature, we live in a ‘beta’, not an ‘alpha’ world. This ‘beta’ will be the most important investment decision we at KLR Wealth will make for our clients. We will focus primarily on the first level, also work hard on level two, and largely ‘out-source the alpha’ of security selection to those who have proven their abilities to add value over time in that respect.
And indeed we will utilize a strong intellectual framework for doing so. The Classic Economic Cycle is shown in the attached document. This is the basis on which I have been making asset allocation decisions for the past 25 years and I believe you will find it to be a very user-friendly visual. Though the ongoing dating is from me, I didn’t invent this chart, any more than I developed the concept of the Economic Cycle. It reflects the inevitable and irrevocable human behavioral tendency to converge, both on the way up and the way down. Much to the frustration of virtually every politician and policy-maker, it has never been repealed and can never be repealed. Though only known with certainty with the wisdom of hindsight, every point on the Cycle has implications for asset allocation decisions, at every level but mort particularly at the first and then the second.
Every Market Commentary will have this framework as its base, even if it goes un-stated in its content.
Current Market Conditions
Before I cover the markets of the moment, allow me a brief introductory couple of sentences. You will find me using the term fully diversified equity portfolio (FDEP) as a general reference point for the most recent percentage portfolio performance. Truly long-term oriented portfolios will have exposure to many classes of stocks (as they will to bonds if they are ‘balanced’) with the relative exposures managed by KLR Wealth.
So now onto the current moment for Wall Street. Though March wasn’t much to speak of for that FDEP – basically up a fraction with poor action in international and smaller cap U.S. stocks offsetting the nearly 2% gain in the Large Cap S&P 500 category – the very positive action in the last week of the month put a cherry on top of the ice cream that was the full first quarter of 2019. Stocks as a whole rose well into double-digits, more than 13%, making it the best start to a calendar year since 1998. Though this still left it below the levels that began the fourth quarter of 2018, which included the worst December since 1931 (gulp!), the positive momentum that concluded March then led to the roaring start to April, with portfolios gaining more than another full percent on April Fool’s Day.
Looking back at that horrible end to 2018, there were three fundamental issues that just came apart for Wall Street:
- The perception of a very unfriendly Federal Reserve, raising rates and restraining monetary liquidity;
- A rise in the level of global trade tensions that would negatively affect growth on a global basis; and
- The potential imminent end to our own domestic economic expansion which began in July 2009, and the near-certain transition to an economic recession.
These culminated market-wise in an intraday S&P 500 trough of 2,346 at about 10:15AM on December 26, down more than 20% from the 2,970 level attained on the afternoon of October 3.
We’ve risen more than 22% as of the April 1 close from that trough level, for very visible reasons. First, the Federal Reserve has effected as big an about-face in perceived policy course as has ever been witnessed on Wall Street, beginning with the first such announcement by Fed Chairman Powell on January 4, and then reinforced even more strongly twice in February and March. In fact, the current market betting odds are that the Federal Reserve will actually cut rates next, not increase them.
There is an old Wall Street saying (and I’ve got a million of them, trust me) that you ‘Don’t Fight the Fed’. If the Fed is indicating they are on a market-friendly track, you gotta play. And Wall Street has certainly played.
Second, depending on which Administration official from both the U.S. and China speaks on which day, there seems to be (with the emphasis on the conditional “seems”) major progress in coming to some kind of substantive agreement on the terms of trade that would be beneficial to both countries. We’ll only know for sure when we know for sure but in the meantime market perception is going very strongly forward. In the meantime, China’s own economic data has also “seemed” to turn for the better.
And third, though the first quarter of 2019, high-frequency (meaning reports released monthly such as retail sales and industrial production) economic data has been more than kinda, sorta on the weaker side, the mere fact of a friendlier Fed and optimism on trade has served to blow a hole in the near-term recession theory. Wall Street has adopted essentially a ‘Don’t Worry, Be Happy’ attitude. Who cares about an inverted yield curve!! Earnings, schm-earnings!! Brexit – so what!! And don’t you know that April is one of the seasonally strongest months of the year (yes, over time it is)!!
I long ago learned the lesson, the hard way as most lessons are indeed learned, that you have to respect a powerful ongoing move. Another Street saying – ‘Don’t Fight the Tape!’ You gotta play. However, in my opinion there are times to play hero, and there are times not to. And I think this is one of those latter times. I think one also has to respect the message from the end of 2018, that portfolio trees do not forever grow to the sky and that they can be cut significantly if not managed appropriately.
So my very first message, as Chief Investment Officer of KLR Wealth, is that client portfolios should be positioned to yes, participate in this ongoing rally, but from a lower-than-target equity weighting. The bull market is now more than 10 years-old, not unprecedented by any means, but still, to mix metaphors and with a more-than-a-simple-nod to the start of a great new baseball season, very likely in her very late innings. Now we all know that we can score a whole lot of runs in the 8th and 9th, but nobody will ring a bell when the final out is made. And since my own crystal ball is indeed calling for a 2nd half 2019 setback, if not before (the focus for many later Commentaries, no doubt), I would prefer to simply be able to cheer it on with a whole slug of prior gains already put in the proverbial pocket. Even if it comes with it a realization of some very hard-earned capital gains from this long-running and very, very mature bull market.
This has already gone on long enough so I’ll wrap it here. There are so many issues, sub-issues and sub-sub-issues to discuss with you, but I will leave them for the next and subsequent Commentaries. These are a pleasure to write and I hope you will find them informative and even occasionally a little entertaining. Your questions, comments and even the most assertive of disagreements always most welcome.
The information provided in this update is for informational purposes only and should not be used as investment or tax advice. Neither the information nor any opinions expressed herein should be construed as a solicitation or recommendation by KLR or its affiliates. For investment advice tailored to your specific situation and investment objectives, please contact a KLR Wealth Management professional.
Published on: 04.02.19