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President & CEO Dan Kraninger reflects on 2016 and provides insights moving forward.
Generally speaking, in the almost two years leading up to the election, no one made money in stocks. Equity markets seesawed for almost 24 months with no clear direction. As you can see on the chart below, from 12/31/14 – 11/4/16 the S&P 500 Index made 4.3% and the more general New York Stock Exchange Composite Average lost -0.5%. Then we had the 2016 presidential election, and in the two months following we’ve seen a greater gain in stocks than we’ve seen in the last two years.
Given the tumultuous election that our country just endured, a presidential quote seemed appropriate. The impact of this change of course won’t be known for many years, but as of today one thing is clear – Democrats and Republicans alike are voting with their money and they are buying stocks. More importantly it appears in the early stages of this advance that investors will be differentiating between winners and losers.
Over the last several years, the rise of index investing has undermined one core, capitalistic concept – companies that are more efficiently producing profits deserve higher valuations. Similarly, companies that are inefficient and producing poor results deserve lower valuations. Because index investors simply reward large companies (the S&P 500 index is capitalization weighted, therefore for every $1.00 that is invested, $0.25 goes into the biggest 17 stocks), it’s been challenging for active managers to demonstrate value. For example, here at NorthCoast, size or market capitalization doesn’t play a role in our stock selection process. Why? Because historically there has been no added benefit to buying big over small, let alone buying big over other factors such as profit growth or sales growth. We focus on factors that, over time, make money at a higher rate than simply size alone. This factor differentiation has hurt some of our portfolios over the last two years. However since the election, it appears that investors are beginning to move money into names that make more economic sense and for us, this is a welcome change.
Mean reversion is common in financial markets – strategies or techniques that do very well for a period of time tend to attract interest and money, become overvalued, and then tend to muddle through a period of underperformance. Thus, a cornerstone principle of any allocation strategy, let’s say a 60/40 stock/bond allocation for example, is to rebalance. Theory being one takes profits from the successful strategy and buys more of the underperforming asset. This technique over time is very productive. As I mentioned in my last letter, I think the bond bull market that lasted for decades is over. So given this, here are two considerations – 1) if your portfolio is bond heavy, consider reallocating those bond positions. Set some time aside with our advisors to discuss our income and zero beta investment strategies — both designed to deal with a rising rate environment. 2) Consider further investment in growth stock strategies like CAN SLIM® or Vista — growth stocks have underperformed the last two years but have attractive long term track records that will benefit as investors begin to differentiate away from indexes.
Past Performance is not indicative of future results. All investments involve risk, including loss of principal. One cannot directly invest in an index.