As long-time readers are likely aware, I believe in trying to keep portfolios “in tune” with the primary market trend. In this case, we’re talking about the bull market in stocks, which began either on March 9, 2009, September 26, 2011, or February 8, 2016, depending on your time-frame/cycle perspective.
While the bears tell us that the end is nigh and there are many, many reasons to be afraid (as in, very afraid) about what comes next in the stock market, the key is that this remains a bull market until proven otherwise.
However, it is also important to remember that all good things come to an end at some point. And with folks really not interested in seeing their 401K’s turn into a 201K again, well, everybody on the planet seems to be looking for the next big debacle.
In conversations with financial advisors this week, I was asked a couple times about what issues keep me up at night. My first response was that I actually sleep pretty well, largely because I have what I believe to be a pretty solid risk management plan in place from a longer-term, macro perspective.
But from there, I admitted that there were a few things that give me pause. And while I don’t wake up at 2:30 am worrying about them, I have given these issues considerable thought over the past year – during the waking hours of the day, of course!
The “Safety Play”
One of the key problems that causes me to scratch my head and ponder what might come next is the action in what the investing public perceives as the safety stocks. Things like utilities, high dividend payers, and the increasingly popular “low vol” space.
These areas have been persistently popular over the last several years, due, in my opinion, to the idea that investors don’t want to get fooled again – ala 2000-02 or 2008. But with the stock market having marched higher for many years now, investors don’t want to get left behind either. Therefore, the play for many appears to have focused on these “safer” areas of the stock market.
Exhibit A here is the performance of the utilities. This sector has long been known as a safety play due to the fact that utilities tend to pay strong dividends and are not allowed to become significantly overvalued due to the regulations on how much money the companies can earn. So, if you feel like you must be invested in the stock market, buying utilities are viewed as a safer way to go.
However, the returns of the sector have been uncharacteristically strong for some time. For example, the Utilities Select Sector SPDR ETF (NYSE: XLU) was up 14.95% through the end of August (per Morningstar) versus 10.39% for the S&P 500 index. This follows a gain of 16.05% in 2016 versus 11.96% for the S&P (including reinvested dividends). In fact, since 2014, the cumulative return for the XLU has been 63.3%, which is more than 40% higher than the 44.2% seen for the blue-chip S&P. And since 2011, the utilities ETF has provided investors with a return that is equivalent to the overall market. So, what’s not to like, right?
The problem is the recent outperformance alone tells me that the space has gotten popular and that the “safety play” has likely become a very crowded trade.
From my seat, the issue is that whenever a “trade” becomes overly popular, it usually doesn’t end well. Why? Because at some point, for some reason, the “trade” starts to reverse and then all the “fast money” rushes to the exits at the same time. This, of course, causes a swift downdraft and before you know it, your safety trade can become the same as the overall market – or worse.
So, this is my fear for all those people flocking to the perceived “safety” of not only the utilities but also the high divy and so-called low volatility stocks. In short, I am concerned that if the bears were to find a raison d’etre in the near term, the traditional safety plays could fail to do their jobs this time around.
Perhaps the bigger point this morning is that there is no silver bullet for managing risk in this game. Times change. Markets change. Securities change. And the bottom line is that advisors and investors alike need to have a deep and thorough understanding of what “is” happening in the market – and then act accordingly – as opposed to succumbing to the latest sales pitch from Wall Street.
Thought For The Day:
Worry often gives a small thing a great shadow. -Swedish Proverb
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of Tax Reform
2. The State of the Economic/Earnings Growth (Fast enough to justify valuations?)
3. The State of Geopolitics
4. The State of Fed Policy