Insights and Actions – “Active or Passive Investing”

February 14, 2017

“The inherent irony of the efficient market theory is that the more people believe in it and correspondingly shun active management, the more inefficient the market is likely to become.” – Hedge Fund Manager Seth Klarman, February 2017

General Comments

While ETFs continue to see massive fund flows, it seems that we may be moving into an environment that will be better-suited to prudent active managers. We suggested that President Trump’s election ushered in a new environment, and we positioned our clients’ portfolios to own more of the beneficiaries of that environment. One of the best performing economic sectors in January was the materials sector, and that is a sector where we own a significantly greater allocation than would be recommended by copying the exposure of the index.   Our tactical positioning across sectors, combined with our active stock selection, added real value for our clients.

Data Points and Global Economic Indicators

We mentioned that we look for three components to a healthy stock market. We look for improving earnings, modestly rising interest rates, and the confidence to invest. Interest rates were stable during the month, providing no clear message either way. On the bright side, we did continue to see an improving outlook for corporate earnings. Most impressively was the dramatic increase in both consumer confidence and small business confidence. Both of those indicators are now above the levels prior to the beginning of the Great Recession. The increase in small business confidence was nothing short of spectacular, and that gives us increased confidence that this rally will continue.

While our overall tone is positive, we note that there are always some data points that cause us a bit of indigestion. Recent weakness in durable goods and retail sales are among the more disappointing data points. We also are watching recent weakness in household formation which is a longer-term demographic indicator that deserves our attention. Still, we see the economic indicators as supportive, and we have made no changes to our positioning.

Asset Allocation

We continue to remain fully invested and have made no change to our asset allocation.

Sector Allocation

We have made no changes to our sector weights, and we continue to have heavy exposure to financial services, industrial, energy, and material names. We also remain exposed to technology companies where we continue to find above-average growth.

Conclusion

New Presidents have typically had a difficult time in the early months of their administration as their inexperience tends to lend uncertainty to the market. Even so, the market has been able to shrug off the seeming chaos and continue to climb the wall of worry. We are encouraged with the markets latest set of record highs, and see that as validation the domestic and global economic environments are improving. Further, our data points suggest there is no likelihood of an imminent market top. Overlay the impressive market performance with the prevailing low interest rates, and we cannot find any reason to make any changes as of this writing.