Note: we have been busy with consulting projects for the past few months, and therefore we did not publish market review letters for October or November.
As we mentioned several months ago, our investment approach has produced much better returns than the benchmark S&P 500 this year. This is due to two factors:
- We made a very profitable change in asset allocation in March. When the stock market was near its lows, we advised moving from cash into triple leveraged ETFs. This is discussed in another blog post entitled Our Investment Strategy Has Far Outperformed a Buy-and-Hold Approach This Year.
- Our model portfolio is outperforming the S&P 500. This is discussed below.
On February 19, 2020, shortly before the outbreak of the virus caused a violent market selloff in March, we published a model equity portfolio with the goal of outperforming the S&P 500. The portfolio contained 40 stocks and ETFs, as seen in the blog post Model Portfolio: Mid-February 2020.
We recently calculated the performance of this portfolio from 2/19/20 through the end of November. Over this period, the portfolio produced a gain of 9.4%, compared to a gain of 7.0% for the S&P 500. Thus the portfolio has outperformed the market by roughly 2.4% in just over nine months. The data is shown below:
Figure 1 Performance of Model Portfolio – from February 2020 to 11-30-20
(Note: these calculations are price changes and do not include dividends, but the portfolio is well-diversified across all the major market sectors, so its dividend yield will be very close to that of the S&P 500).
This performance was achieved with absolutely no turnover, holding the same group of stocks for the past nine months (thereby disproving the idea that “your approach would require too much turnover.”)
Clearly we would not just mindlessly hold a portfolio without taking any action as the market went through its large V-shaped move this year. In fact we have identified a number of valuable ideas for buying and selling at various times over the past nine months, but have not been publishing them as changes to the model portfolio.
As mentioned above, the key to creating outstanding investment performance this year was to buy aggressively when the market was near its lows in March. This is exactly what we advised in our blog posts in March, when our strategy was to buy triple leveraged ETFs because the market was becoming extremely oversold.
At this point, in early December 2020, we have decided to make a few changes to the model portfolio, because of significant developments in the global macro environment, particularly the announcement of an effective vaccine for the virus.
On November 9th, news of a vaccine sparked a stock market rally on views that the virus pandemic could be brought under control in the next six months or so, leading to a strong economic recovery. The news also led to a selloff in the bond market, as the benchmark 10-year Treasury yield rose from 0.82% to 0.96% in one day.
In our view there is a risk that interest rates could keep rising in the months ahead, and 10-year Treasury yields could return to pre-pandemic levels in the 1.50% range if the economy continues to improve (see chart below).
Figure 2 Treasury bond yields could rise back to the 1.50% level
In recent weeks the homebuilding stocks have come under selling pressure as bond yields have risen. Low mortgage interest rates have been one of the main factors supporting the strength of the housing market, but if bond yields continue to rise, there is a risk that the homebuilding stocks may underperform.
When we set up the model portfolio we purposely overweighted the homebuilders, based on the very strong fundamentals of the industry. But at this point the group’s relative strength has deteriorated and we think it would be prudent to reduce exposure in this area. Therefore we are selling most of the homebuilders from the model portfolio, namely D.R. Horton (DHI), Lennar (LEN), Pulte Homes (PHM) and KB Home (KBH). Also we are selling Lockheed Martin (LMT), and in the health care sector we are reducing our overweighting by selling Medtronic (MDT) and Charles River Labs (CRL).
These sales represent about 12% of the equity portfolio. To maintain our weighting in the consumer discretionary sector, we are adding roughly 2% positions in Kohl’s (KSS) in the retail group, along with two names in the advertising group, Omnicom (OMC) and The Trade Desk (TTD) (note: TTD is sometimes considered a technology stock, but its business is digital advertising.) These stocks are overbought on a short-term basis, so we would prefer to wait for a pullback to buy them. However for the sake of simplicity in making changes to the model portfolio, we will add them now, to replace the homebuilders. In the industrial sector we are replacing LMT with Fedex (FDX).
When we first published the portfolio we were underweighted in the financial sector. But now with the potential for a steeper yield curve, the bank stocks have started to act well, so we are moving to an overweighting in financials by adding a position in XLF, the financial sector ETF.
Rather than making numerous other adjustments to fine tune the portfolio, we will just make these few changes for now, in order to keep turnover at a minimum.
In addition, although our model portfolio holds mostly large cap stocks and is focused on outperforming the S&P 500, we believe that all equity portfolios should now hold some exposure to small cap stocks. After the dramatic outperformance of the big cap growth category in recent years, the big caps have become expensive, while the small caps are undervalued. The relative strength of the Russell 2000 index has turned up over the past few months, and we believe this trend could continue.
Please contact us to discuss our investment process in more detail, and to put our years of investment experience to work for you.
Jonathan Strauss, CFA
513 – 379 – 2792 (cell / text)
jon@straussresearch.com