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AAM Viewpoints – Reflection on Inflection


On August 14 the U.S. Treasury 2-Year/10-Year Yield Curve inverted (momentarily intraday). Many market commentators and the media pointed to this event as an indication of an impending U.S. recession and the reason the S&P 500 had its 2nd worst day of the year losing 2.93%. We believe most of our readers are familiar with the linkage between inversions and recessions. However, just to be clear, since World War II every recession has been preceded by an inversion but not every inversion has been followed by a recession. Given this and other “predictors” available, we tend to be a bit amazed that investors still seem to think if event “A” occurs then event “B” must follow, and quickly. In other words, that the markets follow a playbook that just involves throwing switches at the right time based on certain signals.


We think we understand the anxiety caused by the prospects of a history-making bull market and economic expansion ending, and perhaps even ending badly. Everyone is looking for that inflection point that will indicate it is time to become more defensive. The problem with inflection points is it is extremely difficult to locate them in real time. What appears to be today’s inflection point may turn out to be tomorrow’s local maxima or minima, or worse yet a saddle point (please excuse our calculus references as we were told it would someday be useful). In other words, the “Market Timer Hall of Fame” may have no members, but the “Predicted Inflection Point Warehouse” is bursting at the seams. Given this we think investors should be more interested in finding attractive entry and exit points instead of identifying definitive inflection points.


REITs (Real Estate Investment Trusts), as measured by the MSCI U.S. REIT Index, quietly put in a new all-time high on September 4. This was their first new high since August 1, 2016. During this three-year span REITs lost as much as 21.13%, providing investors numerous attractive buying points. However, investors had to fight upstream against many strategists’ calls to avoid REITs primarily due to the prospect of higher interest rates. This was despite the fact that historic valuations were indicating REITs were attractively priced. It should be noted that REITs are not the only asset class to recently offer a great opportunity during this historic bull market.


Both Emerging Markets Stocks and Small-Cap stocks have experienced bear markets over the last two years. Specifically, Emerging Markets Stocks (MSCI Emerging Markets Index) lost 26.57% (1/26/18 to 10/29/18) and Small-Cap Stocks (S&P 600 Index) lost 27.72% (8/31/18 to 12/24/18). In addition, both have underperformed the S&P 500 over the last year and they both are trading at P/Es (price-to-earnings ratio) below their 10-year average while the S&P 500 is not. Again, we aren’t looking for inflection points where we need to throw a switch. Instead we are seeking attractive entry points that offer us the opportunity to methodically adjust our exposure up and down while we wait for the perceived pricing anomalies to play out. We believe both asset classes are trading at very attractive relative entry points.


We will close with one last example that has been getting a fair amount of attention of late, but we believe still offers some opportunity. It is the growth versus value debate. Based on monthly trailing 12-month total returns growth (S&P 500 Growth Index) has been outperforming value (S&P 500 Value Index) for 29 months in a row. Over the last 40 years growth has averaged a cycle of 15 months of outperformance over value followed by a cycle of 10 months of underperformance. Thus, the current cycle is about twice as long as the long-term average, but we should note is well below the longest cycle of 38 months. It appears this trend is starting to reverse as based on daily closes value began outperforming growth on a trailing 12-month basis on September 10. Specifically, from 9/10/18 to 9/10/19, the S&P 500 Value Index posted a total return of 5.82% compared to the S&P 500 Growth Index at 5.61%. The good news is, based on history, the transition tends to start choppy so there is no need for investors to feel rushed or panicked if they haven’t already begun a migration toward value. However, we feel they need to take advantage of what we believe continues to be a good opportunity to do so.


 


 CRN: 2019-0912-7665R


This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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