Stonewater Financial’s collaborator Ryan Isherwood presents:
Note: This article was written by Ryan Isherwood, CFA, CMT & Founder of Significance Capital Management in collaboration with Stonewater Financial.
Q3 was a continuation of the momentum we have seen in markets since the March lows as fears continued to ease. We didn’t make many tactical changes in the quarter and are trying to stay balanced as we head into a period with headline volatility. We continued to ride our secular growth winners who seem to be benefitting no matter the environment. There is still a lot of uncertainty regarding how long the pandemic will take play out but as each day passes we are closer to the end, the market will anticipate that long before the headlines do. It appears that there could be a U-shaped bottom forming in some of the cyclical names which is different from V-shaped recoveries we have seen in the past few cycles. We are cognizant that it is unusual for growth stocks to be such strong leaders off of a major market low. If momentum starts to show up in cyclical stocks in a more profound way it would cause us to shift more of the focus into that area of the portfolio. The election could be a catalyst to change some of these relationships. A weaker dollar is something that could also turbo charge some of the deep cyclical commodity sensitive names which have been laggards for a long time. While we are currently tilted towards growth we think that the upside risks to more cyclical strength are greater than the downside risks. We continue to use our style tools to navigate the volatility and add alpha opportunistically.
While there could be some digestion around election results we think it will be good to get the political uncertainty settled. A long drawn out fight would be negative while we can see an avenue towards a positive outcome with a Blue Wave (stimulus/infrastructure) or with the current status quo being maintained with divided government. Fed policy has been well telegraphed year out so investors will have some degree of certainty in fiscal and monetary policy, which is generally good for investors.
Disclaimers.
Ryan Isherwood/Significance Capital Management and their services are not affiliated with LPL Financial and Stonewater Financial.
The opinions expressed in this material do not necessarily reflect the views of LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
Market Review
It was another strong quarter of returns in equity markets as the Russell 1000 was up 6.08%. Gross of fees the Enhanced Alpha composite modestly underperformed the benchmark returning 3.92%. Despite the market marching higher in each month of the quarter there was some volatility to contend with, most notably a brief but sharp pullback from July into August in an unwinding of the yen carry trade. Our defensive stocks outperformed during this period but the bullish undertones erased much of this outperformance as the market recovered the balance of the quarter.
The Federal Reserve started an easing cycle by cutting 50 bps and forecasting further easing before the year is out. We said last quarter that “we continue to be on guard for unexpected outcomes.” And we think the action on the long end of the yield curve did provide a measure of surprise as rates ratcheted higher. We read that as confirmational that the Fed navigated this environment successfully and the result is likely to be a soft landing. According to Bank of America, active managers are overweight defensive assets while underweight the most cyclical ones. We think this sets up well for a prototypical early cycle environment-despite the market being near the highs. This could lead to relative outperformance in materials, transportation and financial stocks. It is notable to us that in recent weeks post the Fed cut we have seen what could be a longer term bottom in yields and commodity prices
Portfolio Positioning and Outlook
During the quarter we reduced our growth tilt and have started to shift more towards value. We have tried to stay balanced for these last couple of quarters given we thought the risks to a hard vs soft landing were relatively balanced. Towards the end of the quarter we started to add more risk into pro cyclical areas including, copper, steel, smaller cap size and a slight creep towards undervalued international stocks. Seasonality as we head into the election makes us a little cautious as historically people don’t want to be too aggressive into that uncertainty. The election year dynamics pose unique risks as typically investors abhor uncertainty. Election season corrections in 2016 and 2020 were excellent opportunities to add risk once the election was past. It is not so much who wins the election that matters in our opinion but mainly that the uncertainty is removed. Breadth has improved and improving breadth to us signals that we are likely early cycle and value is likely to be a better bet from here than growth. We think the unwind of the yen carry trade was the “volatility event” we had forecasted last quarter. We saw commodities reverse from what we think was an important absolute and relative level consistent with a historical bottoming process and a secular bull market. If that is the case we are likely in a transition period away from growth and toward value.
Commodity leadership in the past has been synonymous with smaller cap and international markets doing better. We think the dollar is key to this thesis as for it to gain significant momentum we would like to see further weakness. If commodities are embarking on another leg higher it is likely that the dollar has topped from a secular level and has years of declines ahead of it. Given the current fiscal situation and the unlikelihood that either party will show any type of fiscal restraint we think that the fundamental underpinnings of a dollar bear market are there. The US and specifically our mega cap growth stocks have led the secular bull market globally could be about to transition to more breadth driven advance. We think that the international markets ex-US are set up in a similar spot to where the US was in 2013 which was one of the strongest advances with great breadth that we have seen in this secular bull market. We have a coordinated global easing process for the first time since the financial crisis which is likely to be an important driver of flows into undervalued assets.
Though the indicators are not unanimous yet, we think the evidence is mounting that we are in the early stages of a style shift in favor of cyclical value. It is likely that this inflection is not just cyclical in nature but could also be a secular turning point which could offer us significant ability to add alpha in the coming quarters. While the mega caps have had bullet proof fundamentals for some time the valuation is wide enough where they could start to go sideways while other parts of the market drive things higher. We started moving the portfolio that way during the quarter, we let other people pick bottoms and then add as the evidence mounts that our thesis is correct. We have plenty of room to add to positions. We think the technical and fundamental evidence is that this commodity bull market is likely to be driven by the need for more energy. Fossil fuels will certainly play a part in this but areas like Copper and Uranium we think are well positioned to be leaders in an emerging new bull market in commodity stocks. We have moved more money out of defensive assets than growth thus far but we are near our minimum weight in defensive stocks again so any further supplementing of the cyclical value trade will be funded by secular growth names.
Disclaimers.
*The Russell 1000 Index consists of the 1,000 largest companies by market capitalization in the Russell 3000 Index, which represents approximately 90% of the total market capitalization of the Russell 3000 Index. It is a large-cap, market-oriented index and is highly correlated with the S&P 500 Index. Indexes are unmanaged and cannot be invested in directly.
** The S&P 500 is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States. Indexes are unmanaged and cannot be invested in directly.
Ryan Isherwood/Significance Capital Management and their services are not affiliated with LPL Financial and Stonewater Financial.
The opinions expressed in this material do not necessarily reflect the views of LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
