Rotation Nation

Everyone wants to “bet” on the winning horse at the racetrack. Everyone wants to make the winning bet in the casino or maybe one day win the Lottery.  Some gamblers will even go so far as putting their entire “winnings on one number on the roulette wheel on their way out of the casino in an attempt to make their trip life changing.  The vast, vast majority of the time, these gamblers are sorely disappointed as the odds at the casino, racetracks, and lotteries are stacked against the bettor or the gambler, particularly over the long term.  It’s just math and statistics playing out.

Thankfully, investing in the public equity markets in the US over long-term horizons measured in years, not hours, days or weeks, investors enjoy the exact opposite results of gambling.  What do I mean?  I mean the odds of being successful and having a positive outcome increases over time horizons in equities as your volatility in return profile decreases. Still many investors, who have recently chosen to let an outside RIA, Registered Investment Advisor, like Oak Harvest manage their savings or retirement savings, are new to looking at portfolios constructed by outside portfolio managers.  Our advisors often get the question, why do you own XYZ stock when ZYX is working.  Or why don’t I own more tech stocks when they are working or say energy stocks when they are working.  Or from an asset class standpoint, we often hear statements like “I want more growth in my portfolio” or “I want more income in my portfolio.”  As if the equity markets can give you what you ask for on command.

Which brings me to the title of this week’s episode, titled “Rotation Nation vs. Disciplined diversification”.  Before we press onward, please take a moment to click on both the subscribe and notification bells so you will be alerted when our investment team uploads our latest content.  Or better yet, give our OHFG team a call at 877-896-0040 to speak to our team and set up an initial consultation with an OHFG advisor to discuss your personal financial situation.

For the first 6 and a half months of 2023 the US equity markets have rallied considerably overall, but with some of the widest dispersion in returns I’ve seen in my 30 years of managing money.  Here is a comparison of returns YTD of the SP500, Nasdaq composite, and Dow Jones industrials.  I’ve chosen these as the S&P500 is a broad market cap weighted index that most investors understand, the NASDAQ Composite is a broad index of large cap growth stocks, and the INDU is a price weighted index that is more representative of dividend and low or stable growth companies paying dividends. As of mid-July, the SP500 was up 18.4%, the Nasdaq Composite up over 35%, and the low, slow growth Dow Jones up 5.3% total return including dividends. Here are those stats from Bloomberg.

Contrast this to calendar year 2022 returns for the same equity indexes.  In 2022, the broad SP500 was down over -18%, the NASDAQ Composite down over -32% and the Dow Jones index down just under -7%.  Here’s a chart for 2022 comparing those returns.

Wildly different returns on the downside in 2022. Almost 180 degrees opposite the returns in 2023.  Here’s the same three indexes since the Covid lows in 2^nd quarter 2020, and what do you see?  You start to see exactly what you would expect.  The longer the period, the more “well behaved” the asset.  The closer an asset adheres to its longer-term asset return and volatility characteristics.  In terms of risk and reward.  In terms of volatility and return.  The broader SP500 index is showing a strong positive return of a little over 83% off the Covid bottom.  The technology heavy NASDAQ composite, that fell the most during Covid is seen bettering the return of the S&P 500 marginally, near 88% return. Finally, the lower growth, higher dividend paying Dow Jones is bringing up the rear on performance with a substantial but “lagging” 2.5-year return of about 68%. However, that composite index return was about 80% capital appreciation and 20% dividends.  Materially different than the other two and materially less volatile in price.

Zooming out even farther.  Extending the lens to the 2009 GFC lows through mid-July of 2023 and what do you see?  The SP500 returned a bit over 15% per year, the NASDAQ over 18% and the Dow just short of 14%.  All great compound annual returns.  Dividends and their reinvestment accounted for next to nothing of your return in the Nasdaq. But dividends accounted for almost 35% of the total return in the Dow, and almost 20% of your return in the S&P 500.

The only way you really lost over this time period is if you panicked and sold during the large drawdowns or if you tried to rotate back and forth between a growth focus and a income focus.  If you found yourself thinking, “I need more growth in my portfolio, or I need more income” and made broad allocation changes when the markets were down any time during the last 13 years, changing your long-term goals and objectives for whatever reason, elections, Covid, Ukrainian war, China tariffs, you likely found yourself disappointed in both the growth and income in your equity portfolio.  There are no guarantees in the markets except that the exact path forward is always uncertain and making asset allocation decisions in your portfolio, be it stock and bond mix or equity style changes are best made when markets are calm, and emotions are running low. Not when markets are down and volatility high.

Let’s get more micro on the same topic.  When we look at equity investing in industries and sectors in the stock markets, and we look at shifting money back and forth from sectors, portfolio managers call this “rotation”. Year to date through mid-July, technology stocks as represented by the XLK ETF were up over 42%, healthcare stocks represented by the XLV were flat, industrial stocks up almost 13% and energy stocks one of the worst groups YTD down -3%.

These returns are almost completely opposite 2022 returns when tech stocks dropped -28%, healthcare stocks were close to flat at -2.5%, industrials up about 5%, and energy stocks one of the only winning groups on the year at up over 64%.

Going back to the lows in the GFC the sector returns plane out and become exactly what an investor would expect.  The S&P500 returned about 15.2% annually since the lows. Healthcare stocks were close to that same annual return at about 14.5% made up of about 75% capital gains or price appreciation and 25% dividends, Industrial stocks were a little better than the S&P500 on an annual basis given economic growth and the big big winner were Technology stocks returning over 20% per year without any of their gains from dividends.  No income along the way.  The “dog” sector since the GFC lows has been energy with an 8% annual return, however almost half of that has been dividend income along the way.

So what does this all mean to you an investor?

1. Diversification, at both asset class and sector levels, is the only free lunch in the markets.  When growth stock investing is loosing, dividend and slower growth investors are likely winning.  When technology stocks are doing poorly there are usually other more stable sectors that are working.  Usually healthcare, staples, and utilities. Given that and given we do not know with precision or accuracy when these trends change, it’s wise not to have all of your eggs in one basket. One asset management style or one sector.

2. It is unwise and nearly impossible for an investor to flip back and forth from measuring your portfolio in $ terms during the bad times, “I lost xxxx dollars” to “I not up as much the S&P 500” in percentage terms in good times. And finally, 3) when an investor decides to make broad asset allocation changes or major sector allocation changes to one’s portfolio, it’s best done when markets are calmer and asset prices are high.Remember that in any given year, US stocks may outperform.  Some years it’s commodities and other times its cash or fixed income.  Trying to shift large parts of your portfolio around year to year is almost certainly going to lead to subpar outcomes in reaching what are supposed to be long term financial goals.  Here is Merrill Lynch’s most recent asset class return quilt showing asset performance by category for over 20 years.

At Oak Harvest, we currently manage broadly diversified equity portfolios that balance risk and reward for our clients.  For those investors seeking higher dividend income that grows, those investors willing to forgo some potential price appreciation in favor of lower volatility, we have a dividend growth equity model.  Those investors seeking higher long-term price appreciation without the focus on dividend income, we have a Blue-Chip growth equity model. The overall tools our advisors and financial planners use are usually a combination of markets based and insurance based tools to meet your retirement goals. Our investment team is busy working on some new, and highly unique equity models, that few advisors have the experience our investment team has for our advisors to use as tools for our clients in the not so distant future. Stay tuned.  The future and stock markets are always uncertain and that is why our retirement planning teams plan for your retirement needs first, and your greed’s second.

Give us a call to speak to an advisor and let us help you craft a financial plan that helps you meet your retirement goals. Call us here at 877-896-0040 and schedule an advisor consultation. We are here to help you on your financial journey into and through your retirement years.