Commentary Archive 2019

Commentary Archive 2019 background

Commentary Archive 2019

Disclosure

Performance results are based on estimates. Although the information contained in the commentary sections have been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. Past performance is not necessarily indicative of future results. Different types of investments involve varying degrees of risk.

SECOND QUARTER 2019

Hanseatic Market Commentary

Stocks performed well in the second quarter, up about 3.4% for the average U.S. stock fund. But the ending gain belies the market’s roller coaster path over the course of the quarter: up in April, down sharply in May and then a strong June rally that took the S&P 500 to new all-time highs.

Looking back, the market’s behavior from a psychological standpoint was a bit paranoid. In April, things were going well for investors, particularly after the chaos in the previous two quarters. But the tenor of the market changed dramatically in May when the disappointing news about the U.S.-China trade talks erased the optimism that had been priced-in during the April rally. Instead, the market became focused on the impact of tariffs on consumers and business confidence. Then in June, things changed again as the market arrived at a consensus that the Fed would save everything.

Investors, perhaps wary of the volatility over the past eighteen months or the length of the bull market, continue to move their money to the haven of bond funds rather than stocks. A net of $97 billion was put into bond-focused funds during the second quarter according to Investment Company Institute estimates. In contrast, U.S stock funds had an outflow of nearly $19 billion.

One of the primary reasons we continue to be positive about the stock market for the months ahead is that in addition to our model work, there is no evidence from a macroeconomic viewpoint that we are close to recession. For instance, the Conference Board’s Leading Economic Index reached a new uptrend high in May. This index fluctuates during an economic expansion, but the final peak has been at least 7 months before the next recession in the past 50 years. Other economic indicators with lead times before the onset of a recession include retail sales, unemployment claims, and credit spreads. All of these indicators are positive in the sense that there is no evidence of 2019 recession risk. Housing has been the primary macro concern. In the past 50 years, a median of 28 months has lapsed between new home sales expansion and the start of the next recession; so far the cyclical high was 19 months ago.

Why does any of this matter for the stock market? It is because recessions almost always lead to bear markets, and bear markets which occur outside of recession, e.g. 1987, are rare. So, understanding the probabilities associated with a near term recession is complementary to our hedge model work.

Fed policy, as always, is a key element in the outlook for stocks. Following the near-bear market in last year's fourth quarter, the Fed moved from hiking rates in December 2018 to a more "patient" stance in January to its current position of signaling that a rate cut is probable at the July 31st FOMC meeting. The Fed’s change from a hawkish to a dovish stance in such a short period of time has been rather remarkable. This shift has been driven by strong evidence of low and relatively stable inflation, weakening global economic growth and concerns that tariff wars could further weaken the global economy.

U.S.-China trade conflicts continue to pose significant risks to both the U.S. and the global economy. Talks are resuming and we continue to believe that economic self-interest will ultimately lead to real progress at the negotiating table. However, the issues are complex: the Huawei issue remains unresolved after the G20 meeting between Trump and Xi and the current round up is unlikely to lead to a final resolution. Trade uncertainty remains the primary risk for the equity markets

We continue to believe that the economic, monetary and earnings environment is positive for stocks and has the potential to support further gains over the second half of 2019. Valuations remain favorable for U.S. stocks. The S&P 500’s forward 12-month price-to-earnings ratio is within historic norms, and valuations relative to interest rates and inflation remain attractive. It is also important to note that stocks are currently historically inexpensive relative to bonds.

We do believe that large capitalization stock measures such as the S&P 500 are extended following the strong June rally and are potentially vulnerable to near term disappointments on the trade or earnings front, or periodic bouts of renewed volatility. This is not to say that these stocks can’t continue the June rally near term, but further upside progress would put the S&P 500 in an overbought and relatively high risk position. We believe that the seasonally strong fourth quarter will likely offer better opportunities for further appreciation in stocks.

HANSEATIC QUARTERLY STRATEGY PERFORMANCE AND ATTRIBUTION

LARGE CAP EQUITY (LG)

The Large Cap Equity strategy return was up 4.47%, the Russell 1000 Growth benchmark return was up 4.64%. The strategy’s second quarter underperformance was derived from relative underperformance in seven of eleven sectors. Industrials, Financials, and Materials contributed 0.92%, 0.11%, and 0.09% respectively to the relative performance. Communication Services, Staples, Technology, Healthcare, and Real Estate detracted 0.51%, 0.29%, 0.15%, 0.12%, and 0.10% respectively from relative performance. Consumer Discretionary and Energy detracted a combined 0.13% from relative performance. Utilities had no impact. The portfolio is overweight Consumer Discretionary and underweight Communication Services.

ALL CAP GROWTH EQUITY (AG)

The All Cap Growth Equity strategy return was up 5.96%, the Russell 3000 Growth benchmark return was up 4.50%. The strategy’s second quarter outperformance was derived from relative outperformance in five of eleven sectors. Healthcare, Staples, Materials, Consumer Discretionary, and Energy contributed 1.28%, 0.81%, 0.35%, 0.28%, and 0.05% to relative performance. Technology, Industrials, Communication Services, Real Estate, and Financials detracted 0.63%, 0.39%, 0.19%, 0.07%, and 0.04% from relative performance. Utilities were flat. The portfolio is overweight Staples and underweight Communication Services, Healthcare, Industrials, Tech, and Real Estate.

ALL CAP GROWTH CONCENTRATED EQUITY (CD)

The All Cap Growth Concentrated Equity strategy return was up 4.46%, the Russell 3000 Growth benchmark return was up 4.50%. The strategy’s second quarter underperformance was derived from relative underperformance in six of eleven sectors. Materials and Communication Services contributed 1.19% and 0.55% to relative performance during the quarter. Consumer Staples, Technology, Healthcare, and Industrials detracted 0.71%, 0.36%, 0.31%, and 0.21% from relative performance. Consumer Discretionary and Real Estate detracted a combined 0.20% from relative performance. Financials contributed 0.01% while Energy and Utilities were flat. The portfolio is overweight Materials and underweight Industrials, Consumer Discretionary, Healthcare, Technology and Real Estate.

ALL CAP TAX EFFICIENT EQUITY (TE)

The All Cap Tax Efficient Equity strategy return was up 0.80%, the Russell 3000 benchmark return was up 4.10%. The strategy’s second quarter underperformance was derived from relative underperformance in eight of eleven sectors. Notable sectors were Healthcare, Materials and Real Estate contributing 1.23%, 0.48% and 0.48% respectively to relative performance. Technology, Financials, Energy, Industrials, and Consumer Staples detracted 2.57%, 1.13%, 0.51%, 0.48% and 0.26% respectively to relative performance. Consumer Discretionary, Communication Services and Utilities detracted a combined 0.53% from relative performance. The portfolio is overweight Consumer Discretionary, Technology, and Healthcare and underweight Financials, Energy, Consumer Staples and Industrials.

MID CAP EQUITY (MC)

The Mid Cap Equity strategy return was up 2.72%, the Russell Midcap Growth benchmark return was up 5.40%. The strategy’s second quarter underperformance was derived from relative underperformance in seven of eleven sectors. Industrials, Technology and Materials contributed 0.43%, 0.37% and 0.26% respectively to relative performance. Utilities were flat during the quarter. Healthcare, Consumer Discretionary, and Communication Services detracted 1.83%, 1.22% and 0.26% from relative performance. Financials, Real Estate, Consumer Staples, and Energy detracted a combined 0.43% from relative performance. The portfolio is overweight Technology, Consumer Staples, and Utilities and is underweight Consumer Discretionary, Communication Services, and Healthcare.

SMALL CAP EQUITY (SC)

The Small Cap Equity strategy return was up 3.49%, the Russell 2000 Growth benchmark return was up 2.75%. The Small Cap Equity strategy’s second quarter outperformance was derived from relative outperformance in five of eleven sectors. Technology, Healthcare, Utilities, Consumer Discretionary, and Financials contributed 1.80%, 1.28%, 0.61%, 0.44% and 0.14% respectively to relative performance. Real Estate was relatively flat. Industrials, Communication Services, Consumer Staples, Materials and Energy detracted 2.14%, 0.59%, 0.55%, 0.19%, and 0.06% from relative performance. The portfolio is overweight Technology and Utilities and underweight Industrials, Healthcare, Real Estate, and Materials.

GROWTH & INCOME EQUITY (GI)

The Growth & Income Equity strategy return was up 3.72%, the S&P 500 Total Return Index return was up 4.30%. The strategy’s second quarter underperformance was derived from relative underperformance in six of eleven sectors. Notable were Technology, Materials, and Energy contributing 0.81%, 0.49%, and 0.23% respectively to relative performance. Healthcare and Utilities contributed modestly with 0.09% and 0.06%. Consumer Discretionary, Consumer Staples, Financials, Communication Services, and Industrials detracted 0.67%, 0.45%, 0.42%, 0.31%, 0.25%, and 0.17% respectively from relative performance. The portfolio is overweight Utilities, Real Estate and Technology and underweight Consumer Staples, Communication Services, Consumer Discretionary, Healthcare, and Financials.

BALANCED RISK (BR) (May 2019 and June 2019 only)

The Balanced Risk strategy return was up 1.99%, the S&P Target Risk Moderate Index return was up 1.50%. The strategy’s second quarter outperformance was derived from positive performance in Utilities, Staples, Investment Grade Corporate Bonds, Intermediate Term Bonds, and Emerging Markets Bonds respectively. High Yield equities detracted modestly from performance. The portfolio is ~60% defensive and high yield equites and ~40% fixed income.

CONSERVATIVE RISK (CR) (May 2019 and June 2019 only)

The Conservative Risk strategy return was up 3.21%, the S&P Target Risk Conservative Index return was up 1.75%. The strategy’s second quarter outperformance was derived from positive performance in Intermediate Term Bonds, Investment Grade Corporate Bonds, Emerging Markets Bonds, Staples, and Utilities respectively. High Yield equities detracted modestly from performance. The portfolio is ~30% defensive and high yield equites and ~70% fixed income.

LATIN AMERICA EQUITY (LA)

The Latin America Equity strategy return was up 6.66%, the MSCI EM Latin America Index return was up 3.55%. The strategy’s second quarter outperformance was derived from positive performance in eight of eleven sectors. Most notable were Utilities, Industrials, Technology, Communication Services, Energy and Consumer Staples contributing 2.58%, 2.52%, 0.77%, 0.28%, 0.25%, and 0.23% respectively to performance. Financials and Consumer Discretionary contributed a combined 0.15% to performance. Materials detracted 0.12% from performance. There was no exposure to Healthcare or Real Estate. The portfolio is overweight Utilities and Industrials; and is underweight Financials, Materials, Consumer Discretionary, and Consumer Staples.

FIRST QUARTER 2019

Hanseatic Market Commentary

For the first quarter of 2019, U.S. stocks rebounded strongly. The S&P 500 rose 13.1% this quarter and recorded its best start to a year since 1998. This was also the largest one-quarter gain since 2009. Joining the S&P 500 in its impressive 2019 start were the Dow Industrials, the Nasdaq composite and the Russell 2000. The 30-stock Dow gained over 11% while the tech-heavy Nasdaq rallied more than 16%. The small-cap Russell 2000 gained just over 14%.

The most important economic event in the quarter was the Fed’s change to a dovish tone for monetary policy, influenced by the wild volatility and significant decline in capital markets in the previous quarter. Fed Chairman Powell suggested that rates may be on hold for many months after hiking four times last year. Also important is that the Fed will end, or at least significantly slow, its balance sheet run-off. This is notable because the balance sheet reduction could have the economic impact of one to two interest rates hikes, according to some estimates.

While the equity markets welcome the more accommodative monetary policy, it comes at the expense of a gloomier economic outlook, as updates to the Fed’s voting members projections for 2019 economic growth was lowered to 2.1% for 2019 and 1.9% for 2020. The notion that Fed policymakers expect lower growth over the next two years, even with rates at or lower than the current level, is a difficult pill to swallow for fixed income investors especially. In response, the 10-year treasury yields fell in late March to a 14-month low and yields on 10-year German bonds, the debt of the Eurozone’s largest economy, fell into negative territory.

After strong market rallies in January and February, market anxiety rose in March, primarily because of the shape of the yield curve. In particular, the short end of the curve inverted as the spread between the 10-year and 3-month T-bill yields became negative on March 22, the first time since 2007. In the past, an inverted curve has been an uncanny signal of impending recession. While the inversion garnered a lot of headlines and revived recession worries, we would note that the most important spreads across the yield curve are the 2-10 and the 10-30, neither of which have inverted. In any case, the yield curve can be a long leading indicator, with a recession developing a year or even two years following an inversion. Nor does the inversion guarantee a recession. It is also difficult to believe a recession is imminent when the Conference Board Leading Economic Index is so strong and shows no sign of deterioration.

While we do not believe that the shape of the yield curve is currently of economic concern, it is not to say that there are not some clear current risks to both the economy and the markets. One is the prospect of a rise in inflation due to a very tight labor market. This has implications for profit margins, but there is also the fact that any measurable increase in inflation above the Fed’s 2% target will command attention from a policy standpoint.

The most serious of the potential risks in this environment is the uncertainty surrounding the trade negotiations, especially with China. We believe a solid agreement, especially one that addresses China’s most egregious trade practices could revive confidence in making long term investment decisions. Absent a solid agreement, markets may be disappointed by a “light” deal that only promises China’s purchase of more U.S goods. There may also be challenges as Congress votes on the impending U.S-Mexico-Canada agreement this summer.

From a sector standpoint, the leadership continues to reside with Technology and Healthcare. In both of these sectors, the breadth has been positive with performance not dependent only on the largest stocks. Going forward, we would certainly welcome better performance from the Energy and Financial sectors in particular. These important sectors have been mired in cyclical declines relative to the benchmarks for the past year. On a positive note, both absolute and relative performance has improved for Housing, Industrial and Energy stocks.

Another significant change has to do with the China and Eurozone stock markets. All of these markets peaked in January 2018 and declined sharply over the following year. At the end of 2018, for instance, the iShares China Large Cap ETF was down over 25%. In early January, international equity markets bottomed along with the U.S market and have rallied strongly since. We model and rank over 40 country stock indices and international benchmarks. By our measures, China is now the strongest equity market in the world, likely discounting the perception of improved economic performance in the months ahead.

Despite the impressive first quarter rally, investor sentiment is decidedly bearish. Fund managers’ allocation to equities sank to their lowest level in two and a half years in March (BAML). Their equity exposure is concentrated in defensive issues like REITS and Utilities, and their cash balances are unusually high. This bull market may be the longest in history, but it may also be the least loved. From 2009 through January 2019, U.S equity ETFs and mutual funds experienced net outflows in contrast to the large inflows normally seen over the course of a bull market. Stock market indices have historically ended with exuberance and some form of excess. That is not the current profile of the stock market.

Stocks, of course, will not continue the first quarter’s pace of gains going forward, but we do think stocks will likely be higher than current levels at year end. Notwithstanding the risks noted above, we believe the combination of positive probabilities from our market models, an accommodative monetary policy and a positive sentiment picture constitute a favorable market environment.

HANSEATIC QUARTERLY STRATEGY PERFORMANCE AND ATTRIBUTION

LARGE CAP EQUITY (LG)

The Large Cap Equity strategy return was up 15.19%, the Russell 1000 Growth benchmark return was up 16.10%. The strategy’s first quarter underperformance was derived from relative underperformance in six of eleven sectors. Consumer Discretionary, Healthcare, and Energy contributed 1.50%, 0.86%, and 0.26% respectively to the relative performance. Materials were relatively flat. Communication Services, Financials, and Staples detracted 2.01%, 0.41%, and 0.41% respectively from relative performance. Industrials, Real Estate, and Technology detracted a combined 0.70% from relative performance. Utilities had no impact. The portfolio is overweight Healthcare, Consumer Discretionary, and Technology and underweight Communication Services.

ALL CAP GROWTH EQUITY (AG)

The All Cap Growth Equity strategy return was up 11.36%, the Russell 3000 Growth benchmark return was up 16.18%. The strategy’s first quarter underperformance was derived from relative underperformance in seven of eleven sectors and a large cash position (~35%) at the beginning of the quarter for risk management. At the end of January and February cash was ~25% and ~11% respectively, by the end of March all risk models had turned off and the strategy was fully invested. Healthcare, Materials, and Energy contributed 0.98%, 0.24%, and 0.10% to relative performance. Communication Services, Technology, Financials, Industrials, and Staples detracted 1.88%, 1.05%, 0.90%, 0.82%, and 0.63% from relative performance. Real Estate and Consumer Discretionary detracted a combined 0.86% from relative performance. The portfolio is overweight Technology and Healthcare, and underweight Communication Services.

ALL CAP GROWTH CONCENTRATED EQUITY (CD)

The All Cap Growth Concentrated Equity strategy return was up 10.84%, the Russell 3000 Growth benchmark return was up 16.18%. The strategy’s first quarter underperformance was derived from relative underperformance in eight of eleven sectors and a large cash position (~45%) at the beginning of the quarter for risk management. At the end of January and February cash was ~45% and ~20% respectively, by the end of March all risk models had turned off and the strategy was fully invested. Materials and Financials contributed 1.07% and 0.23% to relative performance during the quarter. Communication Services, Industrials, Consumer Discretionary, Healthcare, and Real Estate detracted 2.07%, 1.38%, 1.18%, 1.07%, and 0.43% from relative performance. Staples, Energy, and Technology detracted a combined 0.49% from relative performance. The portfolio is overweight Technology, Materials, and Healthcare and underweight Communication Services, Consumer Discretionary, and Industrials.

ALL CAP TAX EFFICIENT EQUITY (TE)

The All Cap Tax Efficient Equity strategy return was up 18.87%, the Russell 3000 benchmark return was up 14.04%. The strategy’s first quarter outperformance was derived from relative outperformance in seven of eleven sectors. Cash at the beginning of the quarter was 18% for risk management purposes. The strategy was fully invested by the end of the first quarter. Notable sectors were Technology and Healthcare contributing 3.55% and 1.98% respectively to relative performance. Energy, Real Estate, Materials, Financials, and Consumer Discretionary were also positive contributing a combined 1.26% to relative performance. Consumer Staples detracted 1.46% from relative performance. Utilities, Industrials, and Communication Services detracted a combined 0.50% from relative performance. The portfolio is overweight Technology and Healthcare, and underweight Financials, Communication Services, and Utilities.

MID CAP EQUITY (MC)

The Mid Cap Equity strategy return was up 13.69%, the Russell Midcap Growth benchmark return was up 19.62%. The strategy’s first quarter underperformance was derived from relative underperformance in eight of eleven sectors. Cash at the beginning of the quarter was 16% for risk management purposes. The strategy was almost fully invested by the end of the first quarter. Energy and Healthcare contributed 0.33% and 0.32% respectively to relative performance. Utilities were flat during the quarter. Technology, Industrials, Consumer Discretionary, Financials, and Staples detracted 2.18%, 1.65%, 0.72%, 0.72%, and 0.51% from relative performance. The portfolio is overweight Healthcare and is underweight Industrials and Consumer Discretionary.

SMALL CAP EQUITY (SC)

The Small Cap Equity strategy return was up 8.78%, the Russell 2000 Growth benchmark return was up 17.14%. The Small Cap Equity strategy’s first quarter underperformance was derived from relative underperformance in seven of eleven sectors and a large cash position (~33%) at the beginning of the quarter for risk management. At the end of January and February cash was ~33% and ~18% respectively, by the end of March all risk models had turned off and the strategy was fully invested. Technology and Utilities contributed 0.62% and 0.42% respectively to relative performance. Materials and Communication Services were relatively flat. Healthcare, Consumer Discretionary, Industrials, Financials, Staples, Real Estate, and Energy detracted 3.81%, 2.04%, 1.43%, 0.98%, 0.49%, 0.48%, and 0.17% from relative performance. The portfolio is overweight Technology and underweight Industrials and Financials.

DEVELOPED MARKETS (DM)

The Developed Markets Equity strategy return was up 2.23%, the MSCI EAFE Index return was up 9.04%. The strategy’s first quarter underperformance was derived from a large cash position (~45%) at the beginning of the quarter for risk management. At the end of January, February, and March cash was ~45%, ~27%, and ~32% respectively. Energy and Communication Services had no exposure. Industrials, Materials, Technology, and Real Estate contributed 0.80%, 0.27%, 0.22%, and 0.06% sequentially to performance. Staples, Consumer Discretionary, Healthcare, Financials, and Utilities detracted 0.27%, 0.21%, 0.12%, 0.11%, and 0.10% from performance. At the sector level, the portfolio is overweight Consumer Discretionary and underweight Financials, Healthcare, Communication Services, and Industrials. The portfolio is overweight Hong Kong 7.80%, Norway 3.02%, Italy 3.65% and Israel 1.52%; and underweight United Kingdom 11.21%, Switzerland 6.95%, Japan 5.95%, Germany 4.69% and the Netherlands 3.55%.

INTERNATIONAL (IN)

The International Equity strategy return was up 6.01%, the MSCI ACWI ex USA Index return was up 9.55%. The strategy’s first quarter underperformance was derived from a large cash position (~41%) at the beginning of the quarter for risk management. At the end of January, February, and March cash was ~34%, ~17%, and ~10% respectively. Real Estate and Communication Services had no exposure. Materials, Utilities, Industrials, Staples, Energy, Tech, and Consumer Discretionary contributed 1.52%, 1.04%, 0.94%, 0.57%, 0.49%, 0.41%, 0.23% sequentially to performance. Healthcare and Financials detracted a combined 0.25%. At the sector level, the portfolio is overweight Materials, Utilities, and Consumer Discretionary and underweight Financials, Communication Services, Energy and Healthcare. At the market level, the portfolio is overweight EM and underweight DM. At the country level, the portfolio is overweight Brazil 11.59% (appreciation) South Africa 6.44%, and Canada 3.15%; and underweight Switzerland 6.31%, United Kingdom 6.11% and Japan 5.23%.

LATIN AMERICA EQUITY (LA)

The Latin America Equity strategy return was up 2.10%, the MSCI EM Latin America Index return was up 7.02%. The strategy’s first quarter underperformance was derived from poor performance in five of eleven sectors. Cash at the beginning of the quarter was ~31% for risk management purposes. The strategy was almost fully invested by the end of the first quarter. Most notable were Utilities, Energy, Industrials, and Technology contributing 2.24%, 2.19%, 1.45%, and 0.12% respectively to performance. Consumer Discretionary, Consumer Staples, Financials, Communication Services, and Materials detracted 1.86%, 1.16%, 0.64%, 0.16%, and 0.07% sequentially from performance. There was no exposure to Healthcare or Real Estate. The portfolio is overweight Utilities; and is underweight Consumer Staples, Materials, and Financials.

GROWTH & INCOME EQUITY (GI)

The Growth & Income Equity strategy return was up 9.60%, the S&P 500 Total Return Index return was up 13.65%. The strategy’s first quarter underperformance was derived from relative underperformance in seven of eleven sectors. Cash at the beginning of the quarter was 39% for risk management purposes. At the end of January and February cash was ~40% and ~13% respectively, by the end of March all risk models had turned off and the strategy was fully invested. Notable were Technology, Materials, and Utilities contributing 0.74%, 0.57%, and 0.45% respectively to relative performance. Healthcare contributed slightly with 0.08% and Real Estate detracted slightly with 0.02%. Consumer Discretionary, Consumer Staples, Communication Services, and Financials detracted 2.00%, 1.01%, 0.94%, and 0.93% respectively from relative performance. Energy and Industrials detracted a combined 1.00%. The portfolio is overweight Utilities, Real Estate, and Technology and underweight Financials and Communication Services.