May 2019 Size and Style Update
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Optimism around US-China trade relations quickly soured in May as talks about a bilateral agreement broke down, sending the stock market into a free-fall. The S&P 500 lost 6% while the Nasdaq fell 8%. Small Value stocks nearly entered correction territory as the entire market sold off.
Sell in May?
Market correction occurs more frequently than your birthday and, while this selloff doesn’t even qualify as a correction at this point, volatility is the price stock market investors pay for the long-term return premium offered by stocks. This type of volatility is a feature rather than a bug, ensuring stock valuations do not get out of hand.
It should be noted that both the US and China have incentives to reach a deal as additional tariffs are a negative for all parties involved. While pessimism abounds, economic conditions stand in stark contrast. First quarter GDP growth was a robust 3.1% and 76% of S&P 500 companies reported earnings above estimates. Companies often beat estimates, but this rate is higher than the 5-year average, indicating analysts and investors had been overly pessimistic. Revisions to second quarter estimates are more optimistic than usual even in the face of trade concerns.
Morgan Stanley made headlines predicting an imminent recession if tariffs spiral out of control. While the yield curve did invert as investors flocked to safety, a measure that could signal trouble, treasuries appear overbought and the Fed said it would consider cutting rates if trade issues start negatively impacting the economy. Furthermore, leading economic indicators paint a positive picture, making recession concerns seem premature.
How are the market conditions impacting our Size and Style positioning?
We continue to see a lack of momentum either direction with regards to Size. Some months are pro-large companies and some months are pro-small companies, seemingly at random. Until momentum picks up one direction or the other, we will target a neutral posture with Size.
Size Cycle - Rolling 36-Month Return Differentials
The cycling dynamic of Size may be stalled but it remains evident with Style. Momentum has shifted from Growth towards Value and that is where we are positioning portfolios. While Value has struggled relative to Growth over the last decade, it is the segment of stocks historically offering higher long-term returns.
Style Cycle - Rolling 12-Month Return Differentials
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