FAILURE TO ACHIEVE!

Capital Market Comment
April 10, 2018
Frank Mastrapasqua, Ph.D.
Principal, Chairman & Chief Investment Officer

The many new products and strategies that have emerged in this bull market cycle are being tested.  The volatility exhibited in February and March is likely to show investors/traders/institutions that these products have failed to achieve their objectives.  Momentum investing, hedge funds, algorithms, Robo investing, ETF sector rotation, smart beta, etc. are Wall Street creations that will leave investors questioning their value and wondering who is the “real” beneficiary of these supposedly sophisticated strategies.  The mathematical formulation of the historical data, the precision that is implied, and the expectation that these relationships are stable will prove to be very questionable.  The fallout from February and March will emerge in coming months and the dysfunctional nature of these strategies/products will be evident in the poor results.  Just reported on April 3rd by Bloomberg, David Einhorn’s Greenlight Capital lost 14% in the first quarter with his largest long positions falling 5.6% and short positions losing 5.5%.

Another victim is Bill Ackman’s Hedge Fund, Pershing Square, according to CNBC.  The fund’s decline last month brought 2018 performance to -8.6%.  In 2017, a strong market year, the fund lost 4%.  That result followed -13.6% in 2016 and -20.5% in 2015.

Focusing upon fundamental company data, macroeconomic trends, and maintaining the emotional discipline to ignore the media’s and the Administration’s rhetoric should prove very beneficial.  Most certainly, the trade conflicts that have emerged have been unsettling to the market and remains a serious concern.  Substance vs. style has been difficult for markets to understand and the escalation of the rhetoric does little to settle the uncertainty.  No one knows for sure where the trade issue will lead and that remains the problem.

However, reflecting upon the impact of our earlier experiences with tariffs – the 1930 Smooth Hawley Tariff in particular – serves as a reminder of “what not to do.”  A tariff was placed upon 20,000 imported goods.  Our experience of the 1930’s does have a way of allowing “fear of the worst” to creep into expectations.  The international monetary structure was vastly different and inflexible at that time.  It was an inflexible gold exchange system vs. today’s flexible exchange rates.  More importantly, during this current period of confusion and uncertainty, more attractive valuations are being created.  The S&P 500 earnings yield had risen above 6% and the dividend yield to 2%, while at the same time the 10-year Treasury was yielding less than 2.8% with the rate on a 10-year German bond at 0.5%, and a 10-year Japanese bond at essentially zero.  To the extent that the market remains in the doldrums, this disparity will widen with the earnings and dividend yields increasing.  It is only a matter of time before the equity and fixed income markets move toward equilibrium with equities the likely beneficiary.

With uncertainty surrounding trade conflicts, the changing of the guard in the Administration, and the President’s focus upon Amazon, not enough attention has been paid recently to earnings and revenue fundamentals that will be reported later this month.  The effect of the tax cut and synchronized global growth should take center stage with impressive results reported.

We are likely to be at the beginning of a string of quarters benefiting from this phenomenon.  The utilization of the cash-flow generated from these developments and the repatriation of overseas cash will become increasingly evident.  Stock buybacks, dividend increases, mergers and acquisitions, and capital spending are all likely to be employed.

Any thawing on the trade front could be therapeutic for investors and thus add to the fundamental landscape.  That prospect remains just that: “a prospect.”  One thing that seems certain is that the tweets will continue to come and market participants will need to adjust.  The algorithms produce the initial response, then the momentum players follow.  Investors need to take advantage of such volatility and remain focused upon the fundamentals.  Such action will ultimately be rewarded.  Volatility works in both directions.