Art of the Turnover
Doug Walters
With March Madness underway, teams hitting the hardwood are trying to avoid turnovers, while in Washington turnover continues creating uncertainty for investors.
Market Review
Contributed by Doug Walters
U.S. equity markets are struggling to find direction, with the S&P 500 giving back some of last week’s gains. Uncertainty is elevated as international trade remains front-of-mind for investors, and the Trump administration once again looks to its bench for some fresh legs.
Going to the Bench
Investors are still trying to evaluate the impact on the economy of the recently announced tariffs. These may be a slam dunk for U.S. steel manufacturers in the short term, but the longer-term implications remain uncertain. Complicating the market interpretation of these events are changes to the President’s team. Investors were concerned that the exit of chief economic advisor Gary Cohn (a staunch opponent of tariffs) might be a sign of more tariffs to come and a trade war. Yet Trump’s substitute for Cohn is Larry Kudlow, who was a sharp critic of the tariffs. This choice likely went some way toward calming investors, who were also considering the implications of a new Secretary of State at a time when international relations are frayed.
Time will tell if the high turnover in the President’s administration is successful or not. In investing, turnover in investments has been shown to be bad. We discussed this with an analogy to soccer goalies in our recent market timing white paper. Studies show that high investment turnover leads to underperformance. We aim to always look for investments that we believe we will be able to hold for years, not months or days. Looking for that Cinderella story or chasing what is hot is more likely to lead to rags than riches. Speaking of Cinderella stories, we put your March Madness brackets into perspective in our Spotlight section.
Spotlight: Bracketology
A few years ago Warren Buffet offered $1 Billion to anyone who could pick every winner in their NCAA basketball tournament bracket. The renowned investor was not taking a huge gamble as the odds of a perfect bracket are astronomical. A random bracket has a 1 in 9 Quintillion chance of being perfect. According to Professor Jeff Bergen, even a skilled picker who understands odds (e.g. a #16 seed is highly unlikely to beat a #1) can only improve their odds to 1 in 128 Billion (video). Rather than vie for Buffet’s prize, you would be much better off playing Powerball the next time it nears $1 Billion as your odds there are about 1 in 292 Million. On occasion, we get approached by individuals looking for the next great get-rich-quick investment. But that is not investing; it is gambling. Avoid the allure of the big, elusive prize. A consistent process, backed by academics and tested in the real world, is the best way to reach your long-term goals.
Strategy Update
Contributed by Max Berkovich ,
STRATEGIC ASSET ALLOCATION
David vs. Goliath
Large capitalization growth stocks are leading the U.S. equity markets on the back of a stellar performance in the Technology sector. The week has been characterized by equities opening strong and failing to deliver as the clock runs out on the trading day. Bond markets continue to play defense, finishing the week nearly unchanged, though spreads between the short and long end of the yield curve tightened again. Speaking of large-cap…
- In 2017, large-cap stock P/E ratios (excluding companies with negative earnings) were higher than small capitalization stocks.
- Generally, small capitalization stocks demand a higher P/E ratio than large capitalization stocks, as they offer stronger prospects for future growth.
- In the last 20 years, there were only a few notable periods when small-cap was cheaper than large-cap; in 2010 and again 2000-2002.
- With prospects for tit-for-tat tariff levies with America’s trade partners, traditional logic says smaller companies, that are less reliant on global markets, should outgun the global Goliath. This advantage, coupled with a relative valuation appeal, leaves us cheering for the underdog.
STRATEGIC GROWTH
Full Court Prestige
The Materials sector was the laggard on the week, while the Consumer Discretionary sector was the leader thanks to an earnings report from…
- Ulta Beauty, Inc. (ULTA) the beauty products retailer reported its 4th quarter results that initially looked light. Guidance was also shy of expectations, but investors chose to focus on the positives. The positives include 50% growth in e-commerce for the quarter, 2.6% growth per purchase and a $0.65 per share benefit from tax cuts. The company expects 100 new location openings and earnings per share growth of 20% for 2018. While the retailer of mass and prestige brands is experiencing a slowing sales growth rate, the company continues to expand its earnings and online sales.
STRATEGIC EQUITY INCOME
Dishing it Out
The Utilities sector responded positively to some stability in interest rates and ended up the leader on the week. Industrials, on the other hand, continue to feel the pressure from tariff headwinds. In other strategy news…
- William-Sonoma Inc. (WSM), the kitchenware and furnishings retailer, cooked up a consensus topping quarter and dished out upside guidance. Both William-Sonoma and Pottery Barn brands posted sales growth of better than 4%, and the West Elm brand was up over 12% in the quarter. The online business was up 8.4% for the quarter, and the company now claims 52.4% of all sales come online. The company also rewarded investors with a 10% dividend boost and an additional $500 Million stock buyback program.
| Indices & Price Returns | Week (%) | Year (%) |
|---|---|---|
| S&P 500 | -1.2 | 2.9 |
| S&P 400 (Mid Cap) | -0.7 | 1.8 |
| Russell 2000 (Small Cap) | -0.7 | 3.3 |
| MSCI EAFE (Developed International) | 0.3 | -0.1 |
| MSCI Emerging Markets | 0.7 | 5.0 |
| S&P GSCI (Commodities) | -0.7 | -0.3 |
| Gold | -0.7 | 0.8 |
| MSCI U.S. REIT Index | 1.1 | -8.3 |
| Barclays Int Govt Credit | 0.0 | -1.7 |
| Barclays US TIPS | 0.2 | -1.7 |
Week Ahead
Another FORM of Madness Next Week
Federal Reserve meeting should garner some heavy interest Wednesday afternoon.
- No upset is expected. The Fed is widely expected to raise the federal funds rate to 1.75% from 1.50%.
Oracle Corp. (ORCL) is scheduled to report their third-quarter earnings on Monday.
- The shift to the cloud has reignited growth for the company.
- Experts predict Oracle is planning to quadruple the number of their data-centers over the next two years.
Redbook Index, Markit PMI, and Existing Home Sales are the highlights of anticipated economic data. For most, these reports are about as exciting as the play-in games of the NCAA tournament (but for us, it is all worth watching. Go Syracuse!).
- Redbook Index measures same-store sales growth, which has been above the 10-year median level since the summer of 2017.
- Markit PMI (Purchasing Managers Index) is a leading economic indicator. Both service and manufacturing indexes are estimated to improve slightly in March, which indicates companies are seeing growing demand for products and services.
- Existing Home Sales remains at a healthy level, while the inventory of available houses for sale has declined to a 20-year low.
Meetings of the G20 and European Union Council will take place on Monday.
- Cryptocurrency made it to G20 agenda, to discuss a “common response” on regulation of the rogue financial vehicle.
- The EU Council will meet in Brussels to discuss Brexit in more detail. Last December, the EU had said they had made good progress on resolving key disagreements and expect full transition by the end of 2020.
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