The volatility we have seen in the markets over the past month can be chalked up to what analysts call “sector rotation” This occurs when one sector that has generated large gains over the recent period suddenly becomes overvalued in the eyes of traders, and is sold off in a concerted effort to lock in profits. These periods of momentum can last for months or years until, without warning, they are hit hard by profit takers.
In this most recent rotation, the darlings of the past couple of years were names like Amazon, Google, LinkedIn, Netflix and Whole Foods. After being bid up to dizzying heights, they declined 20-30% in this past month. The proceeds from these sales is rotating into more value-style industries. We are tracking the flows to oil and gas exploration, utilities, real estate and high dividend paying companies.
Rotations like these happen very quickly and damage is usually quite severe. Even the most highly rated managers get caught in the quick decline. Since these rotations occur very quickly and normally just transfer assets from one sector to the next, we feel the best strategy is to diversify across the various sectors available so that when the transfers occur, we own the companies that receive the new cash. This reduces volatility while also eliminating the temptation to try to time the sector highs and lows.
Case in point: during this most recent selloff in the technology and small company sectors, the large value, international and growth-income funds held up very well. Bond funds and real estate actually surprised and gained in value during the period.
The quick moving markets today require a solid strategy and patience. World events and the 24/7 news feeds bring every worldwide conflict and disaster into our homes instantaneously and cause anxiety that can affect investment decisions. We consider these short term events that rarely impact long term performance.
Since the market lows of March 2009, we have experienced a strong five year move upwards in prices that have eclipsed the old highs and then some. Expectations become a little too optimistic and we get temporary declines to bring levels back down. An example of the return to unreasonable expectations is the IPO (Initial Public Offering) market. Of the most recent four companies coming to market, only one was even remotely close to being profitable. This is simply just rolling the dice with not very good odds.
If we divert our attention away from the recent volatility, the economic and corporate data is positive. U.S. growth has rebounded from January/February softness, corporate earnings remain healthy, and the Federal Reserve is not really thinking about tightening the money supply until next year. European growth is making progress and China seems to be stabilizing and forming a bottom in their growth. While growth here and around the world does not look to rise at a record setting pace, it is growth nonetheless.
These bouts of sector volatility re-affirm the strategy of diversification with quality managed portfolios to help mitigate that volatility. Our regular contact with the selected investment analysts and managers we use reinforces our continued optimistic outlook going forward.