Research Snapshot: Our Own Look at the Post-Election Rally

Washington on Wall Street

Needless to say, 2016 brought a lot of volatility, both in markets and emotions. In this snapshot, we describe how our research system had us positioned, what changes we have made as events unfolded, and how we are positioned currently.

Post-Election Rally: A Deeper Look

In 2016, Value and Economically Sensitive Stocks (“High Beta”) appeared to be due for a rebound. Our research had us positioned most heavily in these areas, as they presented the best opportunity, in our view. They had lagged meaningfully for about 18 months.

While it required patience, their recovery was quick (but not complete), and the Trump election got much of the credit. In reality, the rebound had been building well before the election.

In terms of our objective factor-based research (we track 135+ factors that profile the fundamentals of over 4000 stocks), Chart 1 shows this meaningful shift. Some quick highlights:

  • We’ve seen a flip in factor leadership—from Low Beta and selected Growth, to High Beta and broader Value.
  • In 2015, investors rewarded defensive stocks (illustrated by the Low Beta factor), combined with a handful “fast growers” showing big price momentum (primarily the “FANG” stocks[1]). Value and High Beta (“offensive stocks” tied to economic growth) were lagging dramatically. Valuation was not important in short-term investor decisions.
  • Our historical models have shown that this divergence is unsustainable, and 2016 shows how they inevitably began to rebound. By year-end, Value factors and High Beta went from extremely negative performance to highly positive. They significantly beat Low Beta[2].

Factor Comparisons

Implications for Positioning

Fundametrics had positioned us for the Value + High Beta recovery reasonably well. We believe the trend has not fully run its course, but the divergence between Low/High Beta and Value/Growth has closed meaningfully. This recovery has benefited client portfolios. It has also allowed us to make some portfolio adjustments.

What we have done over the past year in response to these dynamics: 

  • In December, we increased our weighting to several growth factors, as they were lagging after the surge in value. See Chart 2. Of course, we are value investors by philosophy, and this won’t change. Still, our system seeks to recognize when extremes in value begin to occur so that we can tweak portfolios appropriately. We have always included growth factors (showing underlying improvement in fundamentals like earnings) as a diversifying, secondary component in our stock selection process.
  • We still have above-average weighting to economically-sensitive stocks (“high beta”), but it has gradually shifted from about 50% to 40% as they rallied. Defensive stocks are still below-average in weighting but have risen from 15% to 20%.
    • Overall, defensive stocks are still historically expensive. Their P/E multiples are still near 21X on average, vs. about 17X historically.
    • Cyclical stocks are now around 19X—a bit above historical averages as well, but within reason. 
  • We adjusted portfolios across various asset strategies as well:
    • We maintained our above-average allocation to non-US stocks (especially emerging markets), which we have been putting in place for two years. These stocks offer better long term potential than US stocks, in our view.
    • In December, within the US, we began reducing US small cap in favor of US large cap. We had tilted toward small stocks in May 2015, but their rally has made them less attractive as a group.
    • We continued selectively finding opportunities in fixed income for appropriate accounts (TIPS, longer maturities, and municipals with attractive tax equivalent yields).

Value-Growth Tilt

The Rally Fades?

Since December 9th, the market rally has paused with the S&P 500 essentially flat in returns. This slow-down could be for a host of reasons—maybe investors became pessimistic after a burst of optimism over a potential pro-business agenda, less regulation, lower taxes… perhaps valuations got ahead of themselves… maybe investors were worried earnings season would disappoint.

For what it’s worth, since the rally faded, we have broadly seen a return to the selective-growth, defensive mindset of 2015. The top performing factors have been our Growth Composite (second best performer), Low Beta, and Higher Yield. These have become incrementally more attractive since 2015, although most are not yet “on sale” or present attractive risk/reward.

What Next?

For the short term, earnings season in January and February will provide insight into whether the post-election rally will resume or not. Early signs are encouraging (large banks have had favorable results so far), but expectations are also high. Earnings for several sectors need to catch up to support stock prices. Signs of improving capital spending and growth forecasts will be necessary, too.

More broadly, there are several big themes emerging that will influence stock prices. Monetary policy must give way to fiscal policy for developed economies, global “currency wars” may emerge as the US and China balance domestic interests with global obligations, and governments may become more inwardly focused, perhaps moving away from a global point of view.

Despite these macro shifts, underlying fundamentals matter and will determine investment success over the long term. This is why we spend so much time refining and understanding our factor-based research.

 

Past performance is no guarantee of future results, and all investments are subject to risk of loss.  




[1] The FANG stocks were Facebook, Amazon, Netflix, and Google. This handful of stocks dominated market performance in 2015.

[2] Over longer periods, Low Beta does not dominate (nor does High Beta, for that matter). For this reason, we do not use Beta as a component to our buy/sell decisions. But Beta offers a good description of market sentiment at any point in time.

CornerCap Email Updates

Sign up to receive CornerCap Investment Counsel updates.

Market Insights Archive

Fundametrics® Research Process

Small-Cap Insights