To put it mildly, the setup going into 2018 was remarkably good. Our PWA Macro Index was scoring near its all time high, with 84% of the data trending positive, only 4% negative and 12% neutral. Again, remarkable!
Well, as we preach herein incessantly, anything can happen in the market. And, my, how anything did in 2018!
Here's where we were in terms of sector target weightings (as a % of equity exposure) for client portfolios to start the year:
Consumer Discretionary: 12%
Consumer Staples: 6%
Note: We allow some drift among sector weights (typically 2% above or below target) so as to not have us constantly rotating, and to at times allow trends to form before we trim, add, or re-target. Plus, I typically have a bias to the higher or lower end of the range on a sector-by-sector basis; which explains the less than 100% total when you add up the above.
To get a feel for how the year unfolded, here's how each sector (per our core ETFs) performed during the first half of the year:
Consumer Discretionary: +10.8%
Consumer Staples: -9.4%
There was absolutely nothing to be gleaned from the first half of 2018's sector results from an economic signal perspective. But if you wanted to give it a shot anyway, you might've concluded that the economy was in trouble; considering the negative results for Financials, Industrials and Materials. But then again, tech and consumer discretionary (very cyclical) were doing great. So, nope, the market itself wasn't much of an economic barometer halfway through the year.
So what did the second half do to this year's results?
Here's the full year:
Consumer Discretionary: -1.2%
Consumer Staples: -10.2%
Wow! What a miserable year for stocks! And who would've thought heading in -- amid what was clearly a globally synchronized, robust economic backdrop.
Actually, while the year was indeed awful, it was really the miserable month of December (the worst in nearly a hundred years) that made 2018 a miserable year.
Take a look at just the one-month results:
Consumer Discretionary: -7.6%
Consumer Staples: -9.2%
Again, that was just one month!
Now, absolutely, you can say that the stock market is screaming "RECESSION"!!
So where are we today in terms of target weightings? Surely we've battened down the hatches, right?
Take a look (change from the beginning of the year in parenthesis):
Financials: 15% (-3)
Industrials: 15% (-3)
Materials: 15% (0)
Technology: 10% (-2)
Consumer Discretionary: 12% (+2)
Energy: 8% (0)
Healthcare: 10% (+2)
Consumer Staples: 10% (+4)
Communications: 5% (+5)
Utilities: 0% (0)
REITS: 0% (0)
While we did trim some of the cyclicals and increased staples and healthcare during the year, we're still maintaining what you'd deem, on balance, a cyclical bias to our sector weightings. Like I said in Part 2, our analysis has it that the stock price action of late conflicts with the present underlying fundamentals.
Again, while our current mix jibes with our view of general conditions -- which is, frankly, all the justification we need -- we discovered something very interesting while studying the other (only 3) steep corrections (more than 15% decline from peak) of the past 20 years that occurred amid a low-recession risk environment.
Here's a sector-by-sector look at the year-to-date results at the trough of 1998's -19.34% late summer plunge in the S&P 500 Index:
Consumer Discretionary: +9.1%
Consumer Staples: -6.7%
Save for a few sectors that held onto positive year-to-date gains, 1998 turned ugly as the S&P 500 plunged nearly 20% from its mid-July peak.
Again, remember, while most stocks were getting hammered in '98, the economy was on balance holding up.
And here's how the sectors fared one year off of that 1998 bottom:
Consumer Discretionary: +33.3%
Consumer Staples: +8.5%
Dang! Imagine how the folks who read the correction as a recession signal and sold their stocks must've felt.
Here's how things looked year-to-date at the bottom of the 2010 correction that took the S&P 500 down 16% peak to trough:
Consumer Discretionary: -3.2%
Consumer Staples: -5.3%
And here's one year off the bottom:
Consumer Discretionary: +41.6%
Consumer Staples: +23.9%
Again, very sad for the sellers.
How about 2011 year-to-date at the trough of that -19.4% correction -- during an ongoing expansion:
Consumer Discretionary: -9.1%
Consumer Staples: -2.0%
And 12 months later:
Consumer Discretionary: +31.5%
Consumer Staples: +24.2%
Clearly, the stock market is not always your best indicator of future general conditions.
And, lastly -- because it's still relatively fresh -- we'll make an exception (down only 14.2%) and include the peak to trough results of the late-2015/early-2016 stretch that encompassed two back-to-back corrections, as well as the worst start to a year in history for stocks:
Consumer Discretionary: -7.5%
Consumer Staples: -3.3%
And 12 months later:
Consumer Discretionary: +18.4%
Consumer Staples: +9.1%
You get the picture...
Now, all that said, let's be careful. As I suggested above, it's current conditions that guide our allocations, and while the stock market history of steep corrections during ongoing expansions offers a compelling case for hanging tight, there's absolutely no guarantee that history will repeat.
For history not to repeat -- that is, for stocks not to ultimately emerge from the current correction and achieve new all time highs before the onset of the next protracted bear market -- would virtually have to mean that there's a recession on our near-term horizon; which, for the moment, is a relatively low probability event. But, make no mistake, we remain open to all possibilities!
Note: To appreciate why the Fed is so presently in focus: The board responded to the 1998 selloff with two successive rate cuts. On the heals of 2010 correction the Fed announced its rollover program (reinvesting all of the interest and principal payments on the assets accumulated under its previous round of quantitative easing). In 2011 Ben Bernanke devised an accommodative twist to the then existing Quantitative Easing program (by selling shorter-term notes and buying the long-end of the curve [termed "Operation Twist"]). However, the Fed added no special accommodation in response to the 2015/2016 selloff.
In the next section we'll dig into the sector-by-sector specifics of our current mix...