We believe education is the strongest defense against the vagaries of the market. Each quarter we’ll share with you our perspective and some context about the economy and markets. We hope you find our Relative Strength newsletters interesting and informative.
1st Quarter 2018
Happy New Year and welcome to the start of the fifth year of this secular bull market!
The fourth quarter saw a continuation of the 2017 theme of low volatility. We did see some internal rotation within the markets, with the Technology sector taking a breather, but not losing enough Relative Strength (RS) to indicate a long term change. In October we saw Metals and Mining lose favor to Biotechnology. In addition, Chile fell out of the top tier of the International Matrix and was replaced by a World (ex US) Index position.
In the bigger picture of the six major asset classes, US Equities and International Equities maintained the top two positions. There was very little change in their individual rankings. Further down the asset class list, Fixed Income remains number three but lost RS to Commodities during the quarter. Commodities have continued to gain RS since the first of the year and are closing in on the number three spot.
According to Dimensional Fund Advisors, the number of companies listed on global stock market exchanges has increased from about 23,000 in 1995 to 33,000 by the end of last year. So while the number of companies in the U.S. has shrunk the number of companies worldwide has exploded.
These are very important trends that have a variety of meaningful implications for investors. As it relates to International Equity exposure, more choices can be a good thing if investors have a logical framework to analyze this broad universe of securities. We are partial to using relative strength to evaluate any given universe of securities, but perhaps the rationale for doing so is even greater for International Equities. It is one thing for a fundamental analyst to become an expert in U.S.-listed securities. There is a common currency, one government, one set of regulations, and so on, but when it comes to International Equities, an investor is dealing with much, much greater complexity of fundamentals. However, for a relative strength-driven strategy, it always comes back to price, which makes international investing no more complicated than investing here in the U.S. from a portfolio construction perspective.
This trend of more and more securities being listed abroad and fewer here in the U.S. is something worth considering. Being able to provide options for International Equities is another important way that we can help you navigate growing global investment opportunities.
The Income Portfolio added a global equity income fund during the quarter. This addition bolsters the International Equity exposure in the Income Portfolio.
A pause or correction in this market is likely sometime this year. We would view any pullback as a buying opportunity within the context of an overall bull market. A consolidation of recent gains would be healthy for the secular bull.
While the number of companies in the U.S. has shrunk the number of companies worldwide has exploded over the past 20 years.
Ben Carlson, quoting research from Dimson, Marsh and Staunton in their Global Investment Returns Yearbook 2017, has some fascinating stats on worldwide publicly listed companies today versus just 20 years ago.
Confirmation bias, which is “the tendency to search for, interpret, favor, and recall information in a way that confirms one’s preexisting beliefs or hypotheses (Wikipedia, 8/2017)” can be deadly for investors.
There is not one of us who is immune to this. We all have biases that affect our investment decisions and we contend that being proven “right” in any investment is just as important as making money for most market participants. Our pride is on the line! And what compounds the problem with confirmation bias is the effect of doing a significant amount of research on a given investment idea. The more research that we do (and the more that we look for confirming evidence to support our investment thesis) the more closed we all become to contradictory evidence.
Consider the following excerpt from this SumZero article on the topic.
While the effect has recently been brought into the popular imagination by books like Michael Lewis' The Undoing Project, it has been well known in the world of value investing since the days of Ben Graham. Spending hundreds of hours researching a stock anchors analysts to their work, leading them to systematically and subconsciously ignore downsides, risks, and other warning signs that would otherwise discredit their sunk work and render it useless.
According to CRSP data, there were more than 9,100 U.S.-listed public companies in 1997. Today, that number is down to slightly more than 5,700. The Wilshire 5000, an index used as a proxy for all U.S. securities with readily available pricing data, holds just over 3,600 stocks as of the start of this year, down from more than 7,500 in 1998. So the number of stocks that trade on the exchanges has basically been cut in half over the past 20 years or so. There are a number of reasons for this change -- increased regulations to go public, fewer IPOs, lax anti-trust laws, venture-backed companies staying private longer and a winner-takes-all marketplace in many industries.
Investors are worried that the shrinkage in the number of U.S. companies means that wealth and the markets themselves are becoming more concentrated in fewer and fewer hands. Fewer investment options could make it harder for investors to find adequate investment opportunities. For those investors who share these worries our advice would be to look abroad for more investment opportunities. While U.S.-listed companies have seen their ranks diminish since the 1990s, there are now more public companies than ever worldwide.
Given this, more work does not necessarily equal better investment performance. Looking at data from SumZero, the world’s largest buy-side investment research platform, we can see this effect in action. We analyzed over 10,000 ideas submitted by thousands of analysts since 2008, and came to a surprising conclusion.
The average word count of these investment ideas is about 1700 words. If we segment these ideas into distinct buckets, we can see that ideas with a higher than average word count return almost 10% less than ideas with a below average word count. Thus, lengthier reports don’t generate greater returns than much shorter reports; in fact they perform worse!
Investment research based on the inertia of sunk work can lead to bad investment decisions. If you find that you're gaining conviction in an idea as you spend more time looking at it, question whether or not this is because of confirmation bias.
Enter Relative Strength as the antidote for confirmation bias! With reliance on charts/relative strength, an investor is embracing the wisdom of the crowds. Rather than fight the market, we’re going to seek to capitalize on the market. Rather than seek for more and more research to support an investment thesis, we are going to rely on the most basic (and important in our opinion!) relationship that there is for a given security---the relationship between supply and demand for the security.
Tumlin Levin Sumner Wealth Management of Raymond James