Summer Stall: It’s (Not) Time to Rotate

Join Chris Perras for the 5/29/2020 episode of Stock Talk!

Chris Perras: Good morning. I’m Chris Perras, Chief Investment Officer at Oak Harvest Financial Group here in Houston, Texas. Welcome to our weekly Stock Talk Podcast: Keeping you connected to your money. This podcast is entitled, Summer Stall. It’s not time to rotate. The S&P 500 is now sitting near 3,050 up almost 38 1/2% from the late March low. Volatility has dropped from about 70 to 28 to 30 by way of the VIX index. As always, financial markets have moved far faster than the economic data has moved. This always happens at the trough of an economic cycle. Waiting for the clouds to clear produces mediocre long-term returns.

As we covered last week, most investors are shocked to hear that the best performing sectors in group, since the March 23rd lows have been offence and cyclical minded stocks, high beta stocks, not the safety stocks most of the TV commentators have been pitching. Why? Because long-term investors looked at the federal reserves, looked at their moves and said, “The economic slowdown is here. It’s going to be sharp, and the recovery will be sharp as well.”

This last Tuesday and Wednesday, we had a massive move in cyclical groups X technology. Those groups, financial, small caps, and consumer discretionary and industrials lit up the news channels with the story that it’s time to rotate. It’s time to buy the junk or the laggards. Listeners, this historic data on this is almost universally consistent. Is this a good strategy you ask? The answer is, well, yes, kind of, if you’re a short-term trader, not a long-term investor.

Now, I am not recommending this strategy and certainly not recommending this for our clients. What I’m saying that is if someone were a short-term trader looking to take on risk and get the highest possible short-term percentage returns, that type of trader would buy the companies with the absolute worst balance sheets and the most economic leverage as soon as you thought the economy had troughed. For Oak Harvest, that would have been on March 23rd or 24th when Troy and I did our video entitled, Healing Signs.

Yes, short-term traders should have gone out and bought the things with garbage balance sheets, struggling businesses, and the highest beta growth stocks as well. Yes, that is buying the highest volatility and the highest beta. “Huh? What do you say, Chris? Buying volatile, junky, risky companies, not the strong balance sheets and high-quality companies everyone on TV is saying they’re buying?” Yes. You heard that correct. To get the biggest percentage returns, it would mean buying the riskiest assets a trader could find.

Guess what? First, this strategy is nearly impossible to implement. While the statistics say it’s correct mathematically, human nature makes it almost impossible to implement. Even if a trader were to implement it, what they’d have to do next, they’d have to sit with those stocks amongst almost daily gut-wrenching market volatility for about six months. Then when the clouds are clear and almost everyone else says it’s fine and it’s okay to go out buy risky assets, they’d have to go out and sell almost all of those holdings to all those latecomer investors. Then they’re going to have to go out and try to figure out what new companies to buy that are quality and how they can compound their savings over a long time horizon.

That is the second almost impossible part for an investor and trader to do. That investor, six months out, will be looking at a universe of stocks to buy that have all recovered as well as the market has. In other words, looking at a universe without higher excess returns. Oak Harvest builds diversified single stock, ETF and mutual fund portfolios. Therefore, our clients will almost always have exposure to groups, sectors and investment styles that come in and out of favor by faster short-term investors. This brings me to how Oak Harvest views the market after this eight-week rally.

For the past two weeks, states have been loosening their restrictions on virus-affected activities. With Memorial Day weekend past us, summer has kicked off and Americans, particularly under the age of 65, seem ready and raring to get back out and resume some pre-virus activities. Millennials are right back out buying homes, Florida and new vacation rental bookings are up actually 90% plus year over year. Bluntly, consumers are consuming.

With this, many short-term investors have recently bid up stocks that have been crushed by the virus. Our view is that it has been better to refrain chasing most of these names. Why? Because June brings the normal dead zone of the second quarter. As we’ve discussed in many prior podcasts, the markets normally slow down during early summer. Just like last summer, June will most likely be filled with news late in the week, usually Thursday or Friday with tweets by the president that unbalance short-term investors. In fact, we saw our first such tweet yesterday from the president when he attacked Twitter, all of social media, and China in less than a three-hour period.

Our administration’s fight with China is likely to escalate as China is now threatening Hong Kong with stricter controls, and our president searches for a scapegoat for the virus outbreak and the economic slowdown. Moreover, we’re likely to see a rise in the reported COVID cases domestically starting in June as there was a 7 to 10 day lag from increased social gatherings to increased virus activity. These things should keep volatility high and elevated above 28 to 30 and trending back to the mid-30s over the next few months.

This would equate to a 5 1/2% to 7% pullback in backfilling. At a volatility level of 30 plus, that kind of pullback can happen in as short as three days. Unless something changes in our view, we will be using any weakness in June to continue to position our portfolios positively for the second half of 2020. Why? Because as we have tried to emphasize since March 23rd, this is most likely a V bottom in both stocks in the economy. The retest the lows crowd and it’s a great depression round two crowd will be very disappointed. We’ve [unintelligible 00:06:56] almost weekly, but we have to emphasize it again.

Right now, the overall S&P 500 is finally an overbought territory according to our technical work. After we go through some slop and shop in June and possibly early July, and some increase in volatility as we previously mentioned, we are extremely positive for the second half of 2020 and the first quarter of 2021. I want to share a few other statistics similar to the V bottoms rule that we previously have shared. Clients can go ahead and log on to our web portal to access these graphics.

Since the market bottomed in mid-March, high beta stocks have outperformed low beta safety stocks by almost 40%. This is the strongest rally in offensive stocks, not offensive as in I don’t like them, but playing offense since the first few months of 2009, the market lows for the beginning of this [unintelligible 00:07:56] market. The second half of 2009 and the first half of 2010, were both huge up periods for stocks. The financial news networks have been pounding listeners this week with stories of market rotations. What they are missing is much more important. It is the basis for what we see, the second half of this year and next year. That is, they’re missing the market breadth.

The market isn’t just rotating. Market breadth is expanding. 95% of the S&P 500 is now above its 50-day moving average. This is a very rare event. These events have only happened early off the bottom of major market lows and market up moves that last year. The average historical six-month return after this has happened has been over 8 1/4%. The one-year return has averaged over 12% when this has occurred.

Moreover, while the market is short term extended, when the S&P 500 is this strong, relative to its own 50-day moving average, and it’s currently in the 99th percentile on that reading, the four, six-month return to the market have been almost 9 1/2% and the one year return has also been over 12%. These returns both say that new all-time highs are likely ahead in the second half of this year.

The team at Oak Harvest believes that the economy is going to be much improved and better than the TV networks out in the second half of this year and in 2021. Why? First, the collective energy of the global healthcare intellect is racing to develop antivirals and vaccines for this virus. We as a team are not going to bet against science, technology, and the human spirit to find a solution for this virus. Amongst the next four to six weeks of higher market volatility, give us a call. At Oak Harvest, we are comprehensive long-term financial planners. What this means, that as our client, you and your financial advisor should have a financial plan that is independent of the volatility of the stock markets.

If you are retired or in the process of retiring, give us a call at 2818221350. We are here to help you plan your financial future, help smooth your financial path into and through your retirement years with a customized retirement planning. I’m Chris Perras, Chief Investment Officer at Oak Harvest financial group. Have a great weekend.

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Speaker 2: The preceding content expresses the views of the speaker and is for informational purposes only. It is based on information believed to be reliable when created, but any-sided data, statistics, and sources are not guaranteed. The content, ideas, and strategies discussed may not be right for your personal situation and should not be considered as personalized investment, tax, or legal advice, or an offer, or solicitation to buy or sell securities. Investing involves the risk of loss and past performance does not guarantee future results.