In the Middle of Difficulty Lies Opportunity
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To say the markets have been volatile in the last few months is quite the understatement. One way of understanding the increase is to look to the Volatility Index, or VIX, which measures the stock market’s expectation of forward-looking volatility. At the beginning of the fourth quarter, the VIX was at 12. The index increased
3 fold
by December 23
rd
to measure 36, as fear took hold of investors, and losses across the board, mounted. Expectations of volatility have subsided a bit in January 2019 but the current VIX, at 18, is still
50%
higher than it was on October 1, 2018.
When markets are this volatile, and losses occur, opportunities are inevitably created. We have written extensively in the Market Digest over the last many months, that stock prices, and market valuations, were being stretched. We discussed how a handful of stocks, FAANG (Facebook, Apple, Amazon, Google Netflix) were dominating returns. Stocks are frequently delineated by the size of their market capitalization or by their valuation. Large companies, represented by the S&P 500 Index, are compared to small companies, as represented by the Russell 2000 Index. Similarly,
growth
oriented companies, like the FAANGs, are compared to
value
stocks which trade on the price of their underlying assets.
In the last few years, 2018 included, returns from stocks have been abnormally high for Large Cap Growth. In the last 5 years, the S&P 500 Growth Index has nearly doubled the total return of its counterpart, the S&P 500 Value Index, and more than tripled the total return of the Russell 2000 Small Cap Value Index. Significant return differences like these have occurred previously. The most recent extreme, was the period surrounding the tech bubble, when growth oriented stocks were all the rage and value based stocks were to be avoided. Based on history, we know these environments don’t last forever. When they return to normal, returns for the winners can be quite large. Take a look at the return of Small Cap Value (the orange line) compared to Small Cap Growth (the purple line) since the extremes of 2000.
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Indeed, if there has been one type of investment that has produced the most reliable long term premium, it has been Small Cap Value stocks. Now, much like the environment of 2000, there is even more reason to look to Small Cap Value due to the extreme gap in forward earnings expectations. Today, the forward P/E ratios of Small Cap Value stocks are priced near their 10 year low.
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It was Albert Einstein who said, “In the middle of difficulty lies opportunity.” The last few months have created some interesting investment opportunities, particularly as prices have grown cheaper. US stocks are trading below their 25 year averages for both trailing and forward P/E multiples. Yields have increased, particularly for many high quality municipal bonds. Credit spreads in many cases, have widened to interesting levels. MLPs are priced well below their historical averages with cash flows now at very secure levels, and the US has become a net exporter of natural gas.
We do not fear the change that will always occur. As investment advisors, we plan for it with each and every one of our clients and take advantage of the opportunity to exploit over-reactions when they occur.
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US equities rose for the third straight week, despite the on-going partial government shutdown. Large Cap stocks (the S&P 500) ended last week up over 10% from their recent low on December 24, 2018. Small Cap stocks (Russell 2000) had their best week in two years. The market appears to have benefited from improved investor sentiment thanks to a strong December jobs report, the Fed signaling patience and encouraging reports on US-China trade negotiations.
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Inflation
The environment for equities has grown more favorable after the latest CPI reading that shows just moderate inflation.
The Consumer Price Index for December met economists’ expectations and matched November’s moderate pace of inflation.
CPI slipped an as-expected 0.1% percent on the month and Core CPI (which excludes ex-energy and food prices) was up 0.2%.
Price pressures at the consumer level remain tame and are not raising any urgency for Federal Reserve rate hikes.
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Government Shutdown
The partial government shutdown is now the longest in our history. While most analysts believe long-term ramifications will be limited, there is no end in sight and, by some measures, economic uncertainty is at its highest point in years (see above chart). Uncertainty about the future of economic policy and the intangible effects of a prolonged shutdown could dampen the already fragile investor sentiment.
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Lego Art
Two Patriots heroes now the subjects of a unique portrait, made by school kids out of Legos.
Fifth grader, Keira Edmonds explains, “On this side it’s the amazing Tom Brady, but then on this side it’s the fantastic Bill Belichick.”
The students at Brown Elementary in Peabody, Massachusetts,
assembled the mural themselves
using more than 20,000, specially angled LEGOs designed by Disney artist, Rob Surette. Surrette didn't tell the students what the finished product would look like, instead choosing to reveal the final product at a school wide assembly last week.
Click
here
to watch the local CBS news video of the project and see it transform.
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New Market Wealth Management offers the personalization of a boutique wealth manager coupled with the knowledge and resources of a large firm. Through our
strategic partnership
with Cliffwater LLC, a leading institutional research and advisory firm, and a minority partner, New Market Wealth Management specializes in an endowment style of alternative investment previously afforded to only large institutions.
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