Closing Out a One-of-a-Kind Year
To say 2020 was unique is an understatement. The year seemed surreal — almost like living in a dream. No one could have predicted the significant effects of a pandemic, as well as the personal, governmental and societal ramifications. As the year progressed, we discussed the amazing and defiant reactions in the markets. The way stocks rebounded from a severe bear market — and ended the year at record highs — is nothing short of amazing. The markets experienced the largest waterfall decline since 1929, and then the fastest subsequent recovery from a 30% decline. During this time, we have seen negative oil prices, record-low interest rates, and the biggest non-war stimulus in the country’s history. The speed of the March decline was so fast, that by the time most investors realized what was happening, the markets had already started to rebound. In effect, the speed of it likely saved us from our emotional selves. This year’s market action was the perfect example of the benefits of staying invested. Markets love to defy expectations – both personally and collectively.
Model Portfolio Performance and Positioning
The fourth quarter of 2020 was positive, despite election and pandemic concerns. The S&P 500 advanced over 12% for the quarter. Areas that have lagged all year, (e.g., small-caps, energy, emerging markets) staged a tremendous catch-up rally in the fourth quarter. For the year, the technology and consumer discretionary sectors were by far the best performing, up over 42% and 32% respectively. These sectors thrived in the pandemic’s “work/shop” from home environment. Energy, utilities, financials and real estate were the sectors with negative returns, with energy being the worst performer (down over 37% for the year). While the growth-oriented names outperformed for the year, the cyclical value areas significantly played catch-up in the fourth quarter, on the hopes that the positive vaccine news would open and normalize the economy. Continued hope for additional fiscal stimulus is another factor propelling these names — and will be a major theme for 2021.
The Managed Income model was up 2.4% for the quarter and ended up just over 2% for the year.
The primary objective of Managed Income is to preserve capital on an inflation-adjusted basis, with a secondary objective of income. The portfolio is conservative by design. It seeks to minimize all the various risks inherent in all assets classes such as volatility, credit, interest rate and inflation risks. Most conservative-oriented asset managers are income-oriented first. In today’s historic low-yield environment, this causes many of them to stretch for yield and take risks they otherwise would not take. While there are legitimate concerns about soaring prices and stretched valuations in the stock market, most forget the same situation exists within the bond market. Bonds have been a good offset to the risks of stocks for quite some time. But at these low rates and high prices, most of the benefits have been realized. Going forward, they will not be able to provide the same cushion as before. If inflation ever rears its head again, bonds will get crushed. The Federal Reserve has explicitly stated their intention to keep rates at present levels through at least 2023 — if not beyond. Fiscal stimulus and a rebounding economy could cause the long-absent specter of inflation to finally return. The model is one-third Treasury Bills, one-third Treasury Bonds, and one-third in consumer staples, small-cap, and value stocks. Each segment of the model is designed to gain exposure to an area of return while simultaneously offsetting a different risk from the other segments. For example, the Treasury Bill (and/or “cash-like” instruments) segment has a low interest rate and credit risk but high inflation risk. The Treasury bond segment has low credit risk but high interest rate risk. The equity segment has low inflation risk but high credit risk. The objective is to preserve capital and get a net positive difference over time from the offsetting risks.
Among our equity and growth strategies, Fast Movers was again the best performer by far and was up around 25% for the quarter and over 138% for the year. This is our most aggressive growth model and holds many technology and biotech names, which have been beneficiaries of the “pandemic economy.” Tesla is still the top holding for now and has been a stellar performer. Some of the “pandemic economy” names such as Zoom, Moderna, and Docusign have been reduced to make way for Chinese companies like Pinduoduo (Internet Retail) and Baidu (China’s “Google”) along with Align Technologies (makers of “Invisalign” braces) and now Peloton (exercise equipment). We have taken profits during the year in the holdings of this strategy to keep the position sizes in line with model allocations for risk management. While this strategy had an amazing year, it is important to remember that due to the volatility and position sizes within the model, we recommend exposure to be no more than a quarter to a third of one’s overall portfolio. This strategy currently has a 25% allocation within our Top Flight model.
The Fundamental 20 strategy was up over 8 percent for the quarter and about 16.8% for the year.
This strategy constitutes about 40% of our Top Flight model. The overall holdings were steady for most of the year with very few changes. Going into the new year, the model has five new holdings comprised of AbbieVie (Drug Manufacturer), Bio-Rad Labs (Medical Devices), Colgate-Palmolive (Household/Personal Products), eBay (Internet Retail), and Otis Worldwide (Specialty Industrial Machinery).
The ETF Relative Strength strategy was up about 11% for the quarter and up over 10% for the year. At the end of the year, it switched from the Industrial sector (XLI) and into Small-Caps (IWM) and, for the first time in a long while, Emerging Markets (EEM). Both holdings are 7.5% of Top Flight and together comprise 15% of the Top Flight allocation.
New strategy update:
In our last newsletter, we introduced a new equity growth strategy named Liquidity Factor. This strategy focuses on opportunities in stocks that are relatively ignored and/or have low liquidity. We believe an exposure to these less-liquid names can provide an attractive alternative and diversifying factor to our growth strategies. Focusing on stocks that are relatively ignored by the market is an approach many asset managers are not willing to take — nor do they have the skills to execute it effectively. We tested this strategy for some time and began using it last quarter. The new strategy is comprised of 10 stocks with 2% weightings each, and it comprises 20% of the Top Flight model allocation. This strategy replaced our Seasonality strategy, which had been lagging over the years. We are pleased with the initial roll-out, as the strategy was up 16% for the quarter. Three new names were added going into 2021: Intuitive Surgical (Medical Instruments), JB Hunt (Integrated Freight & Logistics) and Verisk Analytics (Consulting Services and Data Analytics).
In July we took a 10% position in a few stocks that were depressed (due to the current restrictions from the pandemic) but could rebound significantly as/if the economy opens. We decided to take our profits in these names ahead of the election to slightly hedge our position. We took a 2% position each in Marriott, Cheesecake Factory, Delta Airlines, Ruth’s Chris Steakhouse and OneMain Financial. As a group they were up about 24% since we bought them in July.
|
Strategy |
Approximate % Return year-to-date* |
|
Fast Movers |
138.4 |
|
Fundamental 20 |
16.8 |
|
Liquidity Factor |
16.0 (4th Quarter only) |
|
Top Flight |
34.0 |
|
|
|
|
Managed Income |
2.2 |
|
|
|
|
Asset Class Benchmarks: |
|
|
S&P 500 TR |
18.4 |
|
DJIA |
7.3 |
|
NASDAQ |
46.3 |
|
Russell 2000 – small cap |
20.0 |
|
EAFE – Foreign equity |
0.8 |
|
S&P GSCI – commodities |
-6.1 |
|
T-Bonds |
8.0 |
|
Gold |
24.3 |
|
Emerging Mkts |
18.7 |
|
Bond Agg |
7.5 |
|
T-Bills |
0.4 |
*All Data in local currency and price only unless specified as total return (TR). Sources: MSCI, Barclays, Commodity Systems, Inc (CSI, YCharts), IDC, Ned Davis Research, Inc., S&P Dow Jones Indices. See Disclosures on page X for information on performance, risks and benchmarks.