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.
Market Review
It was another strong quarter of returns in equity markets as the Russell 1000 was up 3.31%*. One big driver of the market returns as well as the strategy returns was the returns of the largest stocks in the benchmark and the portfolio. According to Raymond James the average stock returned -3% which is reflective of the poor breadth in the markets. Another startling statistic is that only 24% of stocks outperformed the benchmark in the first half of the year-marking the 3rd weakest six month period since 1986. Both of those prior instances were followed by a market correction. Additionally, the Russell 2000 had its worst first half in history relative to the S&P 500**. Considering the headwinds provided by the biggest getting bigger we are pleased with being able to keep up with the market.
The Federal Reserve remains on hold and the outlook for rate cuts remains muted. The inflation data shows a trend towards cooling, while consumer data was quite mixed. The low-end consumer continues to be pressured while we are starting to see weak data points from many large companies cementing the idea that some of this weakness is bleeding over to the mid-tier consumer as pandemic era savings surpluses get depleted. Gradually weakening data has been embraced by markets as it is seen as a sign of potential additional rate cuts. While we understand that the impact of rate movements can have significant lags to them the uniqueness of this cycle with the unprecedented fiscal stimulus continues to keep us on guard for unexpected outcomes. The narrowness of the market and increasing concentration are hallmarks of late cycle behavior before a correction sets in.
Portfolio Positioning and Outlook
During the quarter we reduced our growth tilt and have taken our sector tilts to a more neutral position. We are trying to be balanced and view things as being more neutral right now. We are seeking to continue to ride our winners while having an eye to reduce risk further should the market show additional signs of weakness. The poor breadth has been a concern but we have not seen subsequent outperformance of our defensive index yet which we typically see before the market corrects. 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. The historical momentum extremes and breadth deterioration will likely lead to a volatility event in the second half of the year. We are also mindful that many of the sectors relative relationships such as technology and health care are very near levels last reached during the zenith of the tech bubble.
While we are not trying to call a top, we are mindful that many of the necessary ingredients of past tops are in place. To us, this means the risks are higher now than they have been in some time. We think it’s unlikely that a protracted market decline happens but more that a correction could mark a transition from a growth-only environment to one that would favour better breadth and cyclical value outperformance. This happened to some degree in the last three election cycles. We think the setup is similar for that to happen again. According to B of A Inventories have had the largest drawdown year over year in history. Inventory reductions this severe once they bottom tend to offer pro cyclical tailwinds to many traditional value areas such as homebuilding, transportation, commodities and financials.
We continue to monitor risk vigilantly and are on the lookout for the next major mean reversion event that will lead to an investable style shift in markets. We are patiently waiting for that by staying balanced in our approach and trusting our proprietary risk management tools will give us the proper signals when the weight of the evidence shifts.
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.
