Waterfall Decline Followed by Solid Rally
The first quarter of 2016 was a tale of two halves, as the first half of the quarter saw a dramatic, waterfall decline that exhibited all of the signs of major panic. In this case, the panic centered around the energy space. Through February 11th, the S&P 500 was down 10.27% year to date; the small-cap Russell 2000 declined 15.93% and oil & gas exploration declined by over 20%. Many indicators of extreme negative investor sentiment made multiyear highs on February 11th, particularly credit market indicators. While the stock market decline was part of a larger decline that began in mid-2015, the rally that followed indicated that the equity bottom was indeed real. The hardest hit sectors were outperformers from February 11th until the end of the quarter, as the Russell 200 gained 17.13%, emerging markets rose 17.65%, and oil & gas exploration rose 27.34%. In contrast, the S&P 500 gained a comparatively lackluster 12.95%. Credit markets also showed substantial, broad improvement across many sectors. Our relative strength methodology continues to point us towards defensive equities. In general, our avoidance of the weakest, hardest hit sectors meant that we lost less when markets were declining, but then also gained less when the markets rallied back after February 11th. We continue to believe that our relative strength methodology is sound, and we will use it to guide us in pursuing the trends of winners and equally as important, avoiding those with losing trends.
U.S. Sector Opportunity Portfolio
|Industrials Select Sector SPDR||XLI||17.00%|
|SPDR S&P 500 ETF||SPY||15.00%|
|Consumer Staples SPDR||XLP||14.00%|
|Vanguard Telecommunications ETF||VOX||11.00%|
|Dow Jones Wilshire REIT SPDR||RWR||10.00%|
|Utilities Select Sector SPDR||XLU||8.00%|
|iShares Semiconductor ETF||SOXX||5.00%|
|PowerShares S&P Small Cap Technology ETF||PSCT||5.00%|
|S&P Metals & Mining SPDR||XME||4.00%|
|PowerShares S&P Small Cap Utilities ETF||PSCU||3.00%|
|PowerShares S&P Small Cap Consumer Staples ETF||PSCC||3.00%|
The Sector Opportunity portfolio uses a relative strength methodology to rank the top performing sectors over the intermediate-term, and by owning these sectors going forward, attempts to outperform the S&P 500. The portfolio’s defensive stance meant the portfolio fared well versus its benchmark in January and early February and then lagged behind the benchmark as markets staged a strong recovery rally in late February and March.
- Through the end of the quarter, our models found few attractive market sectors that can outperform the S&P 500. Thus we have taken a large placeholder position in the S&P 500 (SPY) itself. As the market rallied after February 11th, the S&P 500 began to slowly fall in our ranks, a reflection of a broader market rally.
- Telecommunication (VOX), Consumer Staples (XLP), and Utilities (XLU) were the highest ranked and fastest rising sectors during the quarter. These are considered to be the market’s most conservative sectors. Their strength indicates the degree of weakness and fear that markets displayed in January and February. Industrials and Materials are the sectors currently displaying the most acceleration.
- The Energy and Materials sectors were tremendous underperformers through February 11th, and have rallied considerably since then. Despite the rally, our models have not budged on Energy, ranking the sector near the very bottom of our matrix. The depth and persistence of the multi-year decline in Energy means our models must wait for a more substantial trend change before indicating improvement.
- Telecommunications (VOX), Utilities (XLU), and Consumer Staples (XLP) were the portfolio’s top contributors, while the Internet (FDN), Software (IGV), and Consumer Discretionary (XLY) areas were the top detractors.
The portfolio has become broad and quite diversified. Its current sector weightings are as follows: Industrials 17.0%, Consumer Staples 17.0%, S&P 500 ETF 15.0%, Utilities 11.0%, Telecommunications 11.0%, Technology 10.0%, Financials 10.0%, Materials 4.0%, and cash 5.0%. The portfolio does not allocate towards the Health Care, Consumer Discretionary, or Energy sectors at this time.
International Opportunity Portfolio
|iShares MSCI ACWI Minimum Volatility ETF||ACWV||15.50%|
|SPDR S&P 500 ETF||SPY||15.00%|
|Market Vectors Indonesia ETF||IDX||10.00%|
|iShares MSCI EAFE Minimum Volatility ETF||EFAV||7.50%|
|iShares New Zealand ETF||ENZL||5.00%|
|iShares Thailand ETF||THD||5.00%|
|iShares Ireland ETF||EIRL||5.00%|
|iShares Australia ETF||EWA||5.00%|
|iShares Taiwan ETF||EWT||3.00%|
|iShares South Korea ETF||EWY||3.00%|
|iShares Malaysia ETF||EWM||3.00%|
|Global X MSCI Argentina ETF||ARGT||3.00%|
|iShares Turkey ETF||TUR||3.00%|
|iShares Philippines ETF||EPHE||3.00%|
|Market Vectors Russia ETF||RSX||3.00%|
|iShares Brazil ETF||EWZ||3.00%|
|iShares Denmark ETF||EDEN||2.50%|
The International Opportunity portfolio’s stated mission is to allocate tactically between international country and region ETFs that are displaying significant relative strength, and in doing so to attempt to outperform the MSCI All Country World Ex USA Index. The market’s longer-term defensive tone can be seen most clearly in international markets, where many developed and emerging markets saw over 20% declines from their peaks, and many of the declines were substantial. Given our relative strength-based methodology, the portfolio was conservatively positioned throughout the quarter, though that has begun to change as the rally gains further legs. Here are some important developments in the portfolio during the quarter:
- U.S. markets have outperformed global markets for a number of years now, and there is no slowing of that trend. As a result, we maintain a large position in the S&P 500. We have seen the momentum of U.S. outperformance begin to slow, however.
- Latin America and emerging Asia are displaying the most relative strength momentum, and as a result, we have added Argentina (ARGT), Brazil (EWZ), Russia (RSX), South Korea (EWY), Thailand (THD), Malaysia (EWM), the Philippines (EPHE), and Indonesia (IDX) to the portfolio recently.
- Europe remains a substantial underweight, and we own only small positions in Ireland (EIRL) and Denmark (EDEN).
- Japan was a substantial weight in the portfolio for much of 2015, but its relative strength collapsed in 2016, and we completely exited Japan by the middle of the quarter.
- Indonesia (IDX), All Country World Minimum Volatility (ACWV), and EAFE Minimum Volatility (EFAV), were the portfolio’s top contributors, while Hedged EAFE (HEFA), Japan (EWJ), and EAFE Small Cap (SCZ) were the top detractors.
The portfolio’s regional allocations are as follows: 27.0% to emerging Asia, 23.0% to low volatility ETFs, 15.0% to the U.S., 10.0% to developed Asia, 7.5% to developed Europe, 6% to Latin America, 3% to the Middle East, 3% to emerging Europe, and 5.5% to cash.
Style Opportunity Portfolio
|iShares USA Minimum Volatility||USMV||20.00%|
|iShares Core Dividend Growth ETF||DGRO||20.00%|
|iShares S&P 500 Value ETF||IVE||20.00%|
|iShares High Dividend Equity ETF||HDV||15.00%|
|iShares MSCI Quality Factor ETF||QUAL||10.00%|
|Guggenheim S&P 500 Equal Weight ETF||RSP||10.00%|
The Style Opportunity portfolio ranks a number of U.S. equity styles and factors using Clark Capital’s relative strength-based ranking methodology, and then assembles them into a broad-based portfolio that attempts to outperform the S&P 500. During the quarter, the long-standing trend favoring growth over value may have peaked, and the evidence is mixed as to whether it has reversed. Growth stocks, particularly the Consumer Discretionary and Health Care sectors, became laggards, and the Energy sector rebounded. Financials, however, the largest component in value indexes, continued to struggle. Our models thus no longer favored value or growth but rather stable large cap stocks that pay dividends and/or have high quality balance sheets. Here are some additional key developments in the portfolio during the quarter:
- Dividend paying stocks are now a large portion of the portfolio, as the two largest positions are High Dividend (HDV) and Dividend Growth (DGRO). Dividend paying stocks are predominantly large cap and many are slower-growing companies. The market’s favoring of dividend paying stocks over growth stocks reflects a defensive stance and a renewed focus on valuations.
- Mid and small cap stocks had broken down during the last half of 2014, but since the market bottom on February 11th, they began to outperform. Our relative strength matrix, however, only shows strength in mid caps (particularly mid cap value), and they are the segment with the most relative strength acceleration. Small cap stocks remain near the bottom of the ranks.
- The top contributors during the first quarter were the iShares MSCI Quality Factor (QUAL), and the iShares Core Dividend Growth (DGRO). The top detractors were the iShares S&P 500 Growth ETF (IVW) and the SPDR S&P 500 ETF (SPY).
Global Tactical Portfolio
|Consumer Staples Select Sector SPDR||XLP||12.00%|
|iShares Core High Dividend ETF||HDV||9.00%|
|iShares USA Minimum Volatility ETF||USMV||9.00%|
|Vanguard Telecommunications ETF||VOX||9.00%|
|Utilities Select Sector SPDR||XLU||9.00%|
|iShares MSCI ACWI Minimum Volatility ETF||ACWV||6.00%|
|iShares Ireland ETF||EIRL||6.00%|
|iShares New Zealand ETF||ENZL||6.00%|
|CurrencyShares Japanese Yen||FXY||6.00%|
|SPDR Gold Trust||GLD||6.00%|
|Market Vectors Indonesia ETF||IDX||6.00%|
|S&P Metals & Mining SPDR||XME||6.00%|
|iShares Semiconductor ETF||SOXX||3.00%|
|Industrials Select Sector SPDR||XLI||3.00%|
The philosophy of the Global Tactical portfolio is to use our proprietary matrix ranking the relative strength of various asset classes (stocks, bonds, commodities, currencies, fixed income and cash) to allocate to those asset classes with the highest rankings. The portfolio currently emphasizes defensive, high quality equities, but we do see international equities and risk-on positions quickly rising in our relative strength rankings. The following were key portolio developments during the quarter:
- The portfolio now allocates 84% to equities (66% U.S. and 18% international), with 6% allocated to Gold (GLD) and 6% to the Japanese Yen (FXY). Cash is at 4%.
- Relative strength trends are in transition, and the portfolio reflects that, with a heavy emphasis on defensive segments such as Utilities, Staples, Telecommunications, and high dividend payers. However, Gold, Gold Miners, and commodity-based equities are on the rise in our ranks, and that should be reflected in the portfolio during the second quarter.
- Utilities (XLU), Consumer Staples (XLP), and Telecommunications (VOX) were the portfolio’s top contributors on the quarter, while Small Cap India (SCIF), Ireland (EIRL), and Cocoa (NIB) were the top detractors.
- Gold, Gold Miners, and various materials and commodity-based market segments are showing the most relative strength momentum, and we expect to increase exposure to these areas in the coming weeks.
|VelocityShares Inverse VIX Short-Term||XIV||10.00%|
|Neuberger Berman Absolute Return Multi-Manager||NABIX||8.00%|
|Neuberger Berman Long Short Inst'l||NLSIX||8.00%|
|BlackRock Global Credit Long/ Short Instl||BGCIX||8.00%|
|TFS Market Neutral Fund||TFSMX||8.00%|
|AQR Managed Futures High Volatility I||QMHIX||8.00%|
|361 Managed Futures Fund I||AMFZX||8.00%|
|iShares Core S&P Mid-Cap ETF||IJH||7.00%|
|iShares Russell 2000||IWM||7.00%|
|iShares Core MSCI Emerging Markets ETF||IEMG||5.00%|
|iPath Bloomberg Cocoa ETN||NIB||2.00%|
The Alternative Opportunity portfolio contains a well-diversified mix of themes which breaks down as follows: alternative-oriented mutual funds 48.0%, tactical global equity 27.0%, fixed income 13.0%, commodities 4.0%, currencies 2.0%, and cash 6.0%. The following are some important events and themes that occurred in the portfolio during the quarter:
- The portfolio added credit-oriented fixed income during the quarter, including High Yield bonds (HYG and JNK) and Convertible Bonds (CWB) as credit trends turned positive after what appeared to be a panic bottom in February.
- The top contributors to return for the quarter were Mid Cap Stocks (IJH), Emerging Markets (IEMG), and Copper (JJC), while the top detractors were the NASDAQ 100 (QQQ), a Multi-Manager alternative fund (NABIX), and Cocoa (NIB).
- The portfolio added Copper during the quarter, and it has performed well as China’s economy has been perceived to be turning around. Commodities in general are likely to take on a growing role in the portfolio as it appears the worst of the commodity rout has come to an end.
- The core alternative-oriented mutual funds in the portfolio are chosen not only for their managers’ strong records and deep research team but for their comparative lack of correlation to equity markets. We continue to emphasize lack of correlation in the portfolio because the Alternative portfolio’s core mission is to provide genuine diversification for investors.
Fixed Income Total Return
|Barclays Intermediate Term Treasury SPDR||ITE||39.00%|
|iShares 3-7 Year Treasury ETF||IEI||29.00%|
|iShares 7-10 Year Treasury ETF||IEF||20.00%|
|Barclays Long Term Treasury SPDR||TLO||10.00%|
The Fixed Income Total Return portfolio entered 2016 in a fully defensive position as of December 9th, 2015. The defensive bias immediately paid off, as credit markets underwent a dramatic decline as the year began. The decline gained momentum into February, and it became a waterfall decline as panic surrounding the Energy and Materials sectors and European banks led to mass selling. To illustrate the extent of the damage, the option-adjusted spread (OAS) on the Barclays High Yield Index reached over 8.3% on February 11th, its highest level since 2009. Coming into the year, the Barclays high yield OAS was 6.60%, and by February 11th it had risen to 8.39%, a 27% increase in just six weeks. To see yields on high yield bonds at levels last seen in 2009 is understood to indicate extreme fear but also a substantial opportunity. Those extreme yields did not last long, and investors quickly agreed that high yield bonds now represented an opportunity. High yield bonds rallied sharply as markets bottomed on February 11th, and the rally was furious. Our models quickly responded, as high yield bonds rallied sharply and Treasuries declined in trading action which often indicates a significant turning point – action that accelerates the movement of our model. Just over two weeks after the market bottomed, our models turned positive on high yield debt, and on February 29th we liquidated our U.S. Treasuries position entirely and moved 100% into high yield bonds. High yield bonds continued to rally in March, and our model remains quite positive today, if slightly off its highs. We are pleased that during the first quarter, the portfolio achieved its primary goals of preserving capital and being tactically opportunistic within the high yield bond sphere. Here are some additional developments from the portfolio during the quarter:
- In addition to three high yield bond ETFs, the portfolio owns six high yield bond funds. Each of the funds have been solid long-term performers in the high yield category. All of the funds have at least $1 billion in assets.
- The resulting duration of the portfolio is 3.95, with a current yield of 6.94%. The portfolio’s yield to maturity is 8.34%. The average maturity is 6.77 years.
- On the quarter, the portfolio’s top contributors were Treasury ETFs, the iShares 7-10 Year Treasury (IEF), the Barclays Long-Term Treasury SPDR (TLO), and iShares 3-7 Year Treasury ETF (IEI). The portfolio’s top detractors were the Barclays Short-Term High Yield Bond SPDR (SJNK), PIMCO High Yield (PHIYX), and PIMCO High Yield Spectrum (PHSIX).
Sentry Managed Volatility Portfolio
|Navigator Sentry Managed Volatility Fund||NVXIX||95.00%|
Hedging one’s equity exposure during a strong market for equities – or even just a flat market for equities – is an exercise in patience and understanding the proper role of a hedge in a broader portfolio. When our assessment of the markets are broadly bullish – as they are for 2016 – the Navigator Sentry Managed Volatility Fund attempts to manage the cost of hedging while maintaining a minimal hedge required to safeguard client assets. Under these circumstances, the Navigator Sentry Managed Volatility fund is a net loser in client portfolios, waiting for its day when protection will shine.
Just as the first quarter was a dichotomy for equities, so it was for the equity hedged fund. The fund served its defensive purpose and produced gains during January and February, as the S&P 500 declined over 10% into mid-February. Once markets bottomed, the costs of hedging and hedged positions became losers, and the fund took on losses. As the market rally continued, the fund ended up producing losses for the quarter. While the fund did serve as a hedge to equity market losses early in 2016, equity markets quickly recovered, and the fund overall produced its expected drag on portfolios during rising markets. We continue to believe that for conservative investors, a hedged equity strategy will allow participation in market gains while reducing the risk of a major loss.
This material is not financial advice or an offer to sell any product. Not every client’s account will have these exact characteristics. The actual characteristics with respect to any particular client account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment.
Clark Capital Management Group, Inc. reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. The information provided in this report should not be considered a recommendation to purchase or sell any particular security, sector or industry. There is no assurance that any securities, sectors or industries discussed herein will be included in an account’s portfolio. Asset allocation will vary and the samples shown may not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. Clark Capital Management Group, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Clark Capital’s advisory services and fees can be found in its Form ADV Part 2A Appendix 1 Wrap Fee Brochure which is available upon request.
The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. & Canada.
These portfolio holdings and weightings reflect portfolio models that may or may not have changes since publication. Actual client holdings and weightings may or may not differ. Performance since position initiated reflects the performance of security from the closing price of the day before the initial purchase date. This performance does not reflect actual performance of any actual client position or account. In addition, performance does not reflect total performance of a specific position as allocations are often reduced or increased. This performance does not reflect the deductions of any fees. For information on fees see the Form ADV Part 2A Appendix 1 Wrap Fee Brochure for Unified Solutions. This research has not been reviewed by FINRA. The S&P 500 Index is an unmanaged market capitalization weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance. It represents approximately 75% of the U.S. equities market. Index returns do not reflect fee deductions. Benchmark index performance provided by Bloomberg and includes dividends. It is not possible to make an investment directly in any index.
Non-Reliance and Risk Disclosure: This material has been prepared by Clark Capital Management Group. This material should not be construed as an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. We are not soliciting any action based on this material. It is for the general information of our clients. It does not constitute a recommendation or take into account the particular investment objectives, financial conditions, or needs of individual clients. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. The price and value of the investments referred to in this material and the income from them may go down as well as up, and investors may realize losses on any investments. Past performance is not a guide to future performance. Future returns are not guaranteed, and a loss of original capital may occur. We do not provide tax, accounting, or legal advice to our clients, and all investors are advised to consult with their tax, accounting, or legal advisers regarding any potential investment. All indices are unmanaged and cannot be invested into directly. The volatility (beta) of a client’s portfolio may be greater or less than its respective benchmark. It is not possible to invest in these indices. High Yield Fixed Income are lower-rated securities, have credit risk, and are especially price sensitive when interest rates rise. Components with international securities may be more susceptible to political, economic, and financial events, or natural disasters than U.S. securities. In the Alternative investments, Real Estate has risks associated with direct ownership; valuations of real estate may be affected by economic or financial conditions or catastrophic events resulting from forces of nature or terrorist acts. Currencies have risk related to political, economic, or financial events, or natural disasters; a country’s debt level and trade deficits; government intervention in the currency market; and currency exchange rates. Energy investments have risk from volatility of global prices, regulation by governments and contractual price fixing, asset class risk, and currency risk. Commodities are affected by global supply and demand; domestic and foreign interest rates; political, economic, financial events, or natural disasters; regulatory and exchange position limits; and concentration within a commodity. Absolute investment strategies may deviate substantially from overall market returns; foreign securities, particularly those of emerging markets, are susceptible to political, economic, and financial events, or natural disasters; the use of derivatives may have a large impact on the segment as may use of investments involving leverage. Global Infrastructure investments include investment in companies that principally engage in management, ownership, and operation of infrastructure and utility assets. Global infrastructure investing includes security, political, and geographical risks, among others. Commodity investments are vehicles used by investors to gain exposure to commodities and commodity futures. There are a number of ways investors can gain exposure to commodities. Transactions in commodities carry a high degree of risk, and a substantial potential for loss. Emerging Markets are typically countries in the process of industrialization, with lower gross domestic product (GDP) per capita than more developed countries. International investments involve special risks such as fluctuations in currency, foreign taxation, economic and political risks, and differences in accounting and financial standards. Emerging market investments are more risky than developed market investments. Returns and principal invested in stocks are not guaranteed. Small stocks are more volatile than large stocks and are subject to significant price fluctuations, business risks, and are thinly traded.
Special Risk Disclosure related to U.S. Registered Exchange-Traded Funds (“ETFs”) and Exchange-Traded Notes (“ETNs”): To the extent this communication contains information pertaining to U.S. registered ETFs or ETNs, consider the investment objectives, risks, and charges and expenses of the ETFs and ETNs carefully before investing. Each ETF and ETN has filed a registration statement (including a prospectus) with the SEC which contains this and other information about the ETF or ETN as applicable. Before you invest in an ETF or ETN, you should obtain and read carefully the prospectus in the registration statement and other documents the issuer has filed with the SEC for more complete information about the product. You may get these documents for free by visiting EDGAR on the SEC website at www.sec.gov. Alternatively, you may obtain a copy of the prospectus for each of the ETFs and ETNs mentioned in these materials by contacting the ETF sponsoring company. ETFs are redeemable only in Creation Unit size aggregations and may not be individually redeemed; are redeemable only though Authorized Participants; and are redeemable on an “in-kind” basis. The public trading price of a redeemable lot of the ETFs may be different from its net asset value. These ETFs can trade at a discount or premium to the net asset value. There is always a fundamental risk of declining stock prices, which can cause losses to your investment. Most leveraged and inverse ETFs “reset” daily, meaning that they are designed to achieve their stated objectives on a daily basis. Due to the effect of compounding, their performance over longer periods of time can differ significantly from the performance (or inverse of the performance) of their underlying index or benchmark during the same period of time and as such are not meant to be held for the long term. This effect can be magnified in volatile markets. Prior to entering into a transaction in leveraged or inverse ETFs, you should be aware of the general risks associated with such transactions. You should not enter into leveraged or inverse ETFs transactions unless you understand the nature and extent of your risk exposure. You should also be satisfied that the leveraged or inverse ETFs transaction is appropriate for you in light of your circumstances and financial condition.
The relative strength measure is based on historical information and should not be considered a guaranteed prediction of market activity. It is one of many indicators that may be used to analyze market data for investing purposes. The relative strength measure has certain limitations such as the caluclation results being impacted by an extreme change in a security price.