By Mitchell Anthony
When markets behave with extreme volatility there is opportunity for traders. These trading opportunities can enhance returns, or damage returns, of an investor’s portfolio. Many times investors become traders during periods of high market volatility because of fear or greed. Mitchell Anthony Capital Management (MACM) has not succumbed to the urge to trade during periods of high volatility. This is evidenced by our recent decisions to stay invested rather than move to treasuries or cash to benefit from the fear that entered our marketplace over the last few months.
Some of our clients have questioned the wisdom of staying long equities, noting how better positioned we could be today if we would’ve left equities in September and came back to them now that equities are 10 to 15% lower.
These questions need a reply and the answer is simple and involves the fact that our dynamic growth and asset allocation portfolios are not trading portfolios but rather asset allocation portfolios. My objective in managing both of these portfolios is that of an investor who is positioning his portfolio to benefit from the environment that drives financial assets. This generally involves expectations for central bank policy, inflation, and earnings growth. The outlook for these leading indicators will determine the ideal asset allocation. For example if our economy starts to produce high inflation than investors will seek to ride this inflation and commodity prices will rise as a result. I attempt to forecast where inflation will be for the next few years and get ahead of most investors and buy these asset classes before the inflation is notable. Likewise if we have a low inflationary environment with modest or moderate growth than equities will be sought out by investors. Again, if I can forecast accurately the inflationary environment, and the growth environment, that I can position the portfolio today to be ahead of where investors will go next year.
When the growth cycle ends regardless of what is happening with interest rates or inflation it is reasonable to expect investors to leave equities and move to treasuries or gold depending upon the inflationary environment. There is still no visibility of this environment on the horizon.
My dynamically managed portfolios will typically be invested in a mix of equities, fixed income, real estate investment trusts, commodities, and cash equivalents. Today because we are experiencing a long extended period of low inflation and friendly central bank policy combined with moderate growth, it is reasonable to have high expectations that investors will want to own equities as this environment continues over the near term.
The environment that we have today involves moderate growth, low inflation, and friendly central bank policy. While expectations for inflation and central bank policy have been stable, Investors and traders expectations for growth have changed almost daily or weekly as new information about global consumption and confidence ebb and flow. Mr. Trump’s heavy-handed and Maverick like mentality for change have chipped away at confidence and as a result fear of an economic collapse have emerged and have brought down equity valuations significantly over the last two months. The sweet spot for growth in America has been the FAANG and MACM investors have benefited dramatically from our positions in these great companies that are experiencing tremendous secular growth. However during a period of fear that involves concerns about an economic collapse the fastest growing and highest valued companies are the most vulnerable to an economic collapse and as a result many traders have left the FAANG.
Should we have sold our FAANG stocks when this fear entered the marketplace in October? Obviously in hindsight the question is maybe, however given our discipline to be an investor and not a trader, the decision to make change needs to be founded upon conviction that the environment is at an inflection point and a recession is ahead. Thus far the majority of economists are not forecasting a recession but possibly a return to modest growth. As a result we have not sold the FAANG. In fact areas that have strong secular growth are the most desirable during a slowdown.
This cycle will undoubtedly end at some point. We remain focused on early signposts of the end of the cycle, and when visible we will leave equities and move to treasuries and/or gold. While we could be wrong and the cycle may well be ending right now we believe there is an abundance of evidence that makes us believe that there is much more growth ahead for this great cycle.
Again should an investor become a trader? We will not allow ourselves to become a trader for greed reasons but will allow ourselves to become a trader out of fear. There is a chance we may throw in the towel and move to cash sometime in the next few weeks for fear reasons. Obviously we have to discount the fact that we can get things wrong occasionally and we could be disconnected from the signposts of a recession that might be on the horizon, as many pessimists believe.
From the attached graph you can see that our managed portfolios have declined significantly from their highs back in September. We have had several years of double digit growth in these portfolios and 2018 began as though it was going to be another record year for total return and alpha. In September our dynamic growth portfolio was up 20% versus the S&P 500 which was up 10%. Over the last few months our accumulated alpha of 1000 bps have declined to just 200 basis points and now our margin over the S&P 500 is a slim 200 basis points. This is mostly due to the significant corrections in the FAANG stocks. If this cycle is not over, as we suspect, then these names will be making new highs nest year.
We remain cautious but optimistic.