By David Nelson, CFA
We’ve hit the point of no return for 2017. Probably a good spot to check our compass and make sure we have enough fuel to complete the journey. With the exception of a few bumps along the way the broad indices have been relatively benign. However, trading beneath the surface has been ferocious as investors scrambled from one sector to the next with each hiccup in the news cycle.
Reversion to the mean is a powerful force and we’ve seen that play out several times across a number of sectors. Late last year Financials (XLF), then and still our biggest overweight exploded higher following the election. As 2017 and the year unfolded, it became clear that the agenda wasn’t going to unfold smoothly as financials and other parts of the reflation trade stalled.
June – Reversion to the mean
Picking up the baton was Tech (XLK) along with other secular growth favorites. FANG, FAAMG and just about every other acronym based growth basket soared with a vengeance. Early in June, the 9th to be specific we had a huge intraday reversal in all of your favorite mega cap tech stocks.
AAPL, GOOGL, MSFT, FB it didn’t matter. They were all for sale on seemingly little news. That’s how it rolls in the world of robot, machine reading algo trading. Sector swings and repositioning that used to take days, weeks and sometimes months to unfold can now be accomplished in just a few hours.
Wall Street’s Gordon Gekko was fond of calling the markets a Zero Sum Game and on June 9th that’s just what it was. Tech’s losses became financials’ gain and the reversion to the mean trade was underway once again.
After several days of recovery the bloodletting continued following comments from Mr. Whatever It Takes Draghi, hinting another central bank was at least moving closer to the exit, The fear of an end to easy money swept trading desks around the world.
The explosive move higher in German 10 year yields removed a heavy overhang for the U.S. curve where yields moved higher in concert with their European brothers. All of this fed into the reversion to the mean trade mentioned earlier as traders rode into 2nd quarter sunset yelling yippie-ki-yay. When the dust settled on June, Technology arguably the most watched sector closed lower on the month despite a staggering first half return.
I doubt the business models have materially changed for some of the street’s favorite names i.e. (GOOGL), (FB), (AMZN) and others. Gun to head they will be higher a year from now but from what level is the challenge.
Now What?
Here we are once again with another set of earning’s reports on the horizon. The headline numbers will attempt to validate the second quarter price performance but it will be the guidance that sets the stage for Q3 returns.
While some like Goldman’s David Kostin are raising their estimate for this year and next he is close to consensus. Maybe more telling is a look at Bloomberg Blended Forward estimates which have started to slip.
Noise or just analysts tweaking numbers? We’ll find out soon enough. Running quantitative models that focus on the fundamentals of individual stocks can often make life a little easier. Removing our biases and some of the subjectivity along with a rules based approach provides discipline.
If the sector should be overweight it will likely show up in the numbers especially if you are Growth at a Reasonable Price or GARP investor. Currently our sector overweight’s are Financials, Tech, Industrials and Healthcare with nothing in Utilities and very little in Energy. Others are about market cap weighted.
I’ll be closely watching for any continued weakness in semi-conductors which often act like a leading indicator for Technology. This has been one of the hardest hit areas of tech recently. While valuations are still very attractive the price action is very 2000 especially after it became apparent that there was some double ordering. I have no evidence to date but the continued sell off following early morning gaps higher is worth noting.
