Your Questions Answered! Nasdaq Dorsey Wright Sr. Portfolio Manager Answers Advisors’ Most Frequently Asked Questions Right Now
As experts in Momentum investing, our team at Nasdaq Dorsey Wright is constantly answering questions from our Financial Advisor clients looking for commentary and color to share with their clients. In this article, Nasdaq Dorsey Wright Senior Portfolio Manager, John Lewis, CMT, opines on several key issues affecting the global markets and our strategies.
Advisor Question: Global Macro is having a good year; to what do you attribute the strong performance?
John Lewis: It has been an interesting year in high momentum asset classes. Two events have really had an effect on the allocation of the portfolio. First, interest rates moved sharply lower on fears of a global recession. I don’t think many people expected rates to head lower, and certainly not at the rate they did. Our strategy doesn’t own any bonds, but we do own a lot of ETFs that are directly impacted by lower interest rates. Areas like Utilities and REITs are very sensitive to interest rate movements, and have performed well this year. Things like Low Volatility are also rate sensitive, although, not to the extent of the aforementioned groups. The other theme impacting the allocation of the strategy has been the breakout and continued strength of the precious metals group. We added a lot of exposure to Gold and Silver because of the strength in those groups. If those groups can continue to remain strong it is potentially very positive for the strategy because we can capitalize on areas that aren’t reliant on large-cap US equities. For quite some time, the large-cap US equities trade has been very strong so seeing some other areas come to the top of the performance ranks is a welcome sight.
As we head in to the fourth quarter, there is a lot of rotation taking place. The leadership is pulling back. Things like large-cap technology and large-cap growth have underperformed value and other areas that have lagged. The underperformance hasn’t been enough to cause the strategy to make changes, but it does bear watching. If things continue as they have for the last few weeks we would expect some changes in the coming months to better align the strategy with the new, emerging leadership.
Advisor Question: There are signs of improvement in the trade war with China. What implications does this have for the prospects of international equities?
John Lewis: Any resolution of the trade war with China would be a welcome development because it would eliminate a lot of the uncertainty investors have been facing this year. It has definitely been a headwind for international strategies, and is one of the things we are asked about most when speaking with FAs. One interesting thing we have observed about the effects of the trade war have been the divergence between cap-weighted indexes and what is happing with high momentum stocks specifically. China is a huge weight in all Emerging Markets indexes. The underperformance there has caused enough of a drag on the indexes that Developed markets have performed in-line with Emerging markets recently. However, when looking specifically at high momentum stocks, Emerging markets have done much better. The ability to avoid some of these areas is key. There are winners and losers from any global event like the current trade war. Momentum is very good at identifying what areas and companies are benefitting, and which ones are being hurt by the policies. At the moment, we feel like momentum has done well identifying these areas and getting us allocated in the right places. It also seems like investors are underweight international equities because of the long run of outperformance by domestic markets. Should things turn, there is potential for a powerful move as investors reallocate their portfolios to areas other than large-cap US equities.
Advisor Question: By a number of measures, investor sentiment is poor even as the S&P 500 has recently broken out to new all-time highs. Do you think this has any implications for investment opportunities ahead?
John Lewis: This is one of the biggest head scratchers of the year. Investors don’t like this market at all. The levels of bearishness are similar to those at market bottoms even with markets being very close to all-time highs. Historically, major market tops haven’t happened with sentiment as poor as it is today. Investors are generally euphoric at major tops, which makes sense because the market has already sucked in all of the potential buyers. The market has proven it can remain strong even in the face of poor sentiment. This is actually very positive, and something that makes us bullish looking out in to the first part of next year. Judging by the sentiment levels, a lot of investors haven’t participated in the bull market. At some point, the sentiment will turn and it would seem there is a lot of fuel on the sidelines to propel the market higher. There are a lot of things that could potentially derail the market, but the reality is there are always a lot of things that can potentially derail the market. Until we see confirmation that trends have changed, we have to remain positive.
Advisor Question: What is the argument for taking a tactical approach to fixed income in the years ahead?
John Lewis: Rates have fallen to historically low levels. When they start moving back up again it will be painful for a lot of bond investors. The key part of the previous sentence is, “when.” Nobody knows when rates will move higher for good. It might happen soon, or it could be years from now. Being able to invest in fixed income opportunities gives us the ability to change the risk profile of the portfolio for different interest rate regimes. When rates move higher, we can de-risk the strategy and preserve the capital we accumulated when rate moves were favorable. Of course, we can’t get our rate calls right every time! We use a trend following model to tell us when to put risk on and when to take it off. We rely on the market to tell us whether our positioning is correct or not. We really like that approach in these uncertain fixed income markets. We feel that a flexible approach to fixed income is something investors should consider because the interest rate environment looking out the next 3-5 years seems so uncertain.
Advisor Question: What sectors are showing improving relative strength and which sectors are showing weakness?
John Lewis: The spread (the difference between high and low momentum stocks) has been quite volatile since the end of August. There was a very short, but large laggard rally at the end of August. That laggard rally saw a big rotation out of the leading areas like Technology and Growth, and in to lagging areas like Value and Financials. There was a brief reactionary rally in September when the leaders outperformed, but the spread has continued lower for the last three weeks of October. This behavior has had a big effect on the performance of both leading and lagging groups.
Utilities and REIT’s have remained strong because of the very low rate environment. But some of the old leadership like Technology and Growth have fallen in the ranks. They still remain strong, but are not the performance powerhouses they were earlier in the year. Financials are one group that has moved higher recently and looks poised to break out to the upside (relative to the S&P 500). While the indexes have continued to move higher, there has been quite a bit of rotation under the surface. The weakest group continues to be Energy. That group has been weak all year, and remains at the bottom of our sector ranks.
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