Market Update and Model Portfolio Reviews 4/30/2019
For the month of April, domestic large cap equities** closed out another strong month, up 4.05% in April and up year-to-date 18.25%. To contextualize just how fast the equity rebound has been year-to-date: if we annualized the equity rebound year-to-date and extrapolated this return through year-end, the market would need to post a total return of 66.5%. We do not find the markets rallying pace sustainable moving into the second half of the year. We maintain the perspective that, broadly speaking, U.S. domestic equities could use a breather. Within domestic sectors, we find the healthcare sector to be attractively priced in light of political headwinds holding down the sectors year to date performance. The proposed “Medicare for All” bill appears to be the primary driver of the relative sector underperformance even with stronger relative sector forward earnings potential. On April 15, we moved to overweight the healthcare sector. Hindsight bias suggests this was four trading days too early. Our investment positioning is based on the view of a low probability outcome of meaningfully disrupting the current healthcare landscape. Additionally, we do not find any sound ways to implement the “Medicare for All” bill as it has such a downstream impact to much of the overall economy. The healthcare and social assistance industry employs the largest percentage of the domestic workforce. The downstream implications of this would certainly impact the largest % of the working population. U.S. demographics suggest that there will be continued growth in the health industry. A “Medicare for All” bill still must be paid for somewhere, be it impacting jobs in the healthcare space, raising taxes or both. The Affordable Care Act (“ACA”) opened up access to health insurance for all, even those with preexisting conditions. The private health insurance industry is still the major funding arm of the ACA. From an investment perspective, we believe our overweight to the space will fare well relative to the broader market, as well as from a total return standpoint. On the bond side of the equation, Investment Grade Bonds* were flat on the month, up 0.03% as rates rose steadily through the first half of the month and trended back down to where rates started the month. We believe that interest rates will stay fairly anchored throughout the yield curve for the second half of the year, due to the balancing act between higher employment and mild wage growth versus below-target inflation for the Federal Reserve Policy to set interest rate guidance lower or higher. With a modest interest rate range bound in mind, we moved to deploy the higher cash levels from all of the models into a barbell strategy. We added a mix of shorter maturity investment grade corporate floating rate exposures, shorter maturity treasury exposures, and shorter maturity corporate high-yield exposures. To offset the credit risk in the corporate investment and non-investment grade, we added additional treasury duration through longer-dated treasury maturities. If our anchored interest rate theme is wrong, we would likely feel more of the pain from a steepening yield curve for the carve-out of the cash recently deployed across all models. We believe there is risk that inflation may surprise to the upside later in the year, but the trend in record low unemployment may surprise to the upside in the second half of the year as well, keeping rate policy consistent through the second half of the year. The deployed cash carve-out’s primary role is to serve as dry powder to utilized tactically as we continue to see rich valuations across many asset classes (including fixed income) in a more pronounced risk off market environment. Our quick take on the April jobs report was that is was strong on a net basis, but we caution these numbers considering larger layoffs taking place. People coming into the workforce can skew to the stronger unemployment rate but a lot of these jobs are lower-paying jobs. On the month, our primary detractor was our high-duration treasury coupon strip exposures and initial overweight to the healthcare sector. Our mid-month deployment of cash helped to offset the relative detractors, but the strong performance of the equity portion of both benchmarks is the primary story for relative performance. The equity component of the model’s domestic benchmarks closed at a new all time high on April 30th.
U.S. small-cap debt builds up: Authers, J., & Leatherby, L. (2019, April 3). The Decade of Deleveraging Didn’t Quite Turn Out That Way. Retrieved May 01, 2019, from https://www.bloomberg.com/graphics/2019-decade-of-debt/
Domestic small cap companies, in the interim, seem to have stalled their momentous debt borrowing binge since June of 2018. This appears to be more of a short-term cyclical stall, and we believe the debt binge will continue through both maturing and refinancing that debt as it matures and issuing new debt as rates have trended lower from mid 2018. In our January 2018 review, we stated: “The continued upward trend in consumer credit debt, coupled with the highest amount of corporate debt outstanding in history, in our opinion, is a screaming red flag for the business cycle if interest rates continue to move higher.” This played out in the fourth quarter last year, but it still has not gone away. Given that markets have performed favorably for the first four months of the year, it would seem like a reasonable time to tap debt markets for more funding, as rates have been shifting lower throughout the year. Keep in mind: the financial sector is the largest component of the Russell 2000 (Domestic Small Caps), and the chart to the left is factoring in non-financial sector debt for small caps.
DISCLOSURE (Click links for sources. If in print, sources available upon request). Calculations & Definitions available upon request. Measured by the Barclays US Aggregate Bond Index* - Morningstar. S&P 500 Total Return Index**. See “Model Disclosure” page for important disclosures and information. Views and opinions are of Alternative Capitalis, LLC and are not intended as investment advice or recommendation(s). Past performance is no guarantee of future results. Total Period Measured 12/31/2016 – 4/30/2019. “Inception” refers to Inception to Date. Inception calculation assumes end of day market prices on 12/30/2016 for starting period values to calculate Inception to Date figures. Performance presented net of highest advisory fee. The results do not represent actual trading and actual results may significantly differ from the theoretical results presented. Past performance is no guarantee of future results.
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Alternative Capitalis, LLC is a registered investment adviser. Information presented herein is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Model Performance Disclosure: The performance shown represents only the results of Alternative Capitalis, LLC’s model portfolios for the relevant time period and do not represent the results of actual trading of investor assets. Model portfolio performance is the result of the application of the Alternative Capitalis, LLC’s proprietary investment process. Model performance has inherent limitations. The results are theoretical and do not reflect any investor’s actual experience with owning, trading or managing an actual investment account. Thus, the performance shown does not reflect the impact that material economic and market factors had or might have had on decision making if actual investor money had been managed. Model portfolio performance is shown net of the model advisory fee of 1.25%, the highest fee charged by Alternative Capitalis, LLC. This reflects a change from Alternative Capitalis, LLC highest fee charged to a client(s) account from 1% to 1.25% annually. April 1, 2018 model performance to most recent date presented adjusts for the higher 1.25% annual fee. Model portfolio performance is shown net of the sample trading costs based on our Custodian’s, TD Ameritrade Institutional, trading costs. Performance does not reflect the deduction of other fees or expenses, including but not limited to brokerage fees, custodial fees and fees and expenses charged by mutual funds and other investment companies. Performance results shown include the reinvestment of dividends and interest on cash balances where applicable. The data used to calculate the model performance was obtained from sources deemed reliable and then organized and presented by Alternative Capitalis, LLC. The performance calculations have not been audited by any third party. Actual performance of client portfolios may differ materially due to the timing related to additional client deposits or withdrawals and the actual deployment and investment of a client portfolio, the reinvestment of dividends, the length of time various positions are held, the client’s objectives and restrictions, and fees and expenses incurred by any specific individual portfolio. The performance calculations are based on a hypothetical investment of $100,000 for both the model and benchmarks presented. On July 23, 2018, we corrected previously reported month end performance reports to account for transactions costs (trading fees) related to rebalancing model portfolios. The month end reports effected ranged from 2-28-2018 to 5-31-2018. Prior reports accounted for transaction costs related to trading fees. The four reports have been corrected and updated on Alternative Capitalis, LLC website (www.altcapitalis.com). 2-28-2018 had the largest variance in incorrect performance reported with an average of 9 BPs (“basis points”) (0.09% or 9/100 of 1.00%) of overstated positive performance in the models and ranged as high as 15 BPs to as low as 2 BPs. A comparison chart of the variances in reported performance can be provided upon request. Benchmarks: The performance results shown are compared to the performance of the performance of a blended ETF (exchange-traded-fund) portfolio comprised of the following two ETF’s symbols, SPY & AGG, are described below. The benchmarks used are investable ETFs and their performance calculation is inclusive of the highest fee charged to a client(s) account, 1.25% annually. This will reduce the total return of the investable benchmark by the annualized rate of 1.25%. The ETF symbol SPY (SPDR® S&P 500® ETF Trust) which seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500® Index (the "Index"). Visit https://us.spdrs.com/en/etf/spdr-sp-500-etf-SPY for more information about the ETF. The S&P 500® Index results do not reflect fees and expenses and you typically cannot invest in an index. The ETF symbol AGG (iShares Core U.S. Aggregate Bond ETF). The iShares Core U.S. Aggregate Bond ETF seeks to track the investment results of an index composed of the total U.S. investment-grade bond market. (the "Index"). Visit https://www.ishares.com/us/products/239458/ishares-core-total-us-bond-market-etf for more information about the ETF. The index composed of the total U.S. investment-grade bond market results do not reflect fees and expenses and you typically cannot invest in an index. The benchmark is blended representing a weighting of a percentage (%) to SPY and percentage (%) to AGG based on the respective model weights below. Unless otherwise indicated, the benchmarks are not rebalanced to maintain their original weighting over the period measured. Instead, they are comprised of the starting allocation and will shift given the prevailing market environment over the period measured. Return Comparison: To benchmark the results, the ETF (exchange-traded-fund) symbol SPY (SPDR® S&P 500® ETF Trust) which seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500® Index (the "Index"). The S&P 500 was chosen as it is generally well recognized as an indicator or representation of the stock market in general and includes a cross section of equity holdings. In addition, the ETF symbol AGG was chosen as a benchmark. The iShares Core U.S. Aggregate Bond ETF seeks to track the investment results of an index composed of the total U.S. investment-grade bond market. The total U.S. investment-grade bond market was chosen as it is generally well recognized as an indicator or representation of the bond market in general and includes a cross section of debt holdings. For each respective model benchmark the performance measurement weightings are as follows to SPY / AGG %: 20/80, 30/70, 40/60, 50/50, 60/40, 70/30, 80/20, 90/10 % respectively for Ultra Conservative, Conservative, Moderate, Balanced, Growth & Income, Growth, Aggressive, Ultra Aggressive. 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Information presented herein is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. The results presented before 12/31/2016 for model performance assume that the weights initially held on that date were held at the unset of any performance presented before 12/31/2016. This assumes results based on discretionary models that are not purely quantitative or rules based. Global Benchmarks: The performance results shown are compared to the performance of the performance of a blended ETF (exchange-traded-fund) portfolio comprised of the following three ETF’s symbols, VT, BNDX & BND, are described below. The benchmarks used are investable ETFs and their performance calculation is inclusive of the highest fee charged to a client(s) account, 1.25% annually. This will reduce the total return of the investable benchmark by the annualized rate of 1.25%. Additionally, the ETF’s that lack the track record to cover the entirety of the period presented have been backfilled with index data that Alternative Capitalis, LLC deems appropriate as a proxy of the chosen ETF’s hypothetical track record. Below is the summary of backfilled data and time period:
The ETF symbol BNDX (Vanguard Total International Bond ETF). The Vanguard Total International Bond ETF attempts to track the performance of the Bloomberg Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index (USD Hedged). Visit https://investor.vanguard.com/etf/profile/BNDX for more information about the ETF. The ETF symbol VT (Vanguard Total World Stock ETF) seeks to track the performance of the FTSE Global All Cap Index, which covers both well-established and still-developing markets. Visit https://investor.vanguard.com/etf/profile/VT for more information about the ETF. The ETF symbol BND (Vanguard Total Bond Market ETF). The Vanguard Total Bond Market ETF attempts to track the performance of the Bloomberg Barclays U.S. Aggregate Float Adjusted Index and attempted to track the Bloomberg Barclays U.S. Aggregate Bond Index through December 31, 2009. Visit https://investor.vanguard.com/etf/profile/BND for more information about the ETF. The benchmark is blended representing a weighting of a percentage (%) to BND, percentage (%) to VT and percentage (%) to BNDX based on the respective model weights below. Unless otherwise indicated, the benchmarks are not rebalanced to maintain their original weighting over the period measured. Instead, they are comprised of the starting allocation and will shift given the prevailing market environment over the period measured. Return Comparison: To benchmark the results, the ETF symbol BNDX (Vanguard Total International Bond ETF) attempts to track the performance of the Bloomberg Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index (USD Hedged). The Vanguard Total International Bond ETF was chosen as it is generally well recognized as an indicator or representation of the global bond market, ex-U.S. bonds, and tracks an investment-grade, non-USD denominated bond index, hedged against currency fluctuations for U.S. investors. The ETF symbol VT (Vanguard Total World Stock ETF) seeks to track the performance of the FTSE Global All Cap Index, which covers both well-established and still-developing markets. The Vanguard Total World Stock ETF was chosen as it is generally well recognized as an indicator or representation of the global stock market and tracks a market-cap-weighted index of global stocks covering approximately 98% of the domestic and emerging market capitalization. The ETF symbol BND (Vanguard Total Bond Market ETF) attempts to track the performance of the Bloomberg Barclays U.S. Aggregate Float Adjusted Index and attempted to track the Bloomberg Barclays U.S. Aggregate Bond Index through December 31, 2009. The Vanguard Total Bond Market ETF was chosen as it is generally well recognized as an indicator or representation of the U.S. Domestic bond market, and tracks a broad, market-value-weighted index of U.S. dollar-denominated, investment-grade, taxable, fixed-income securities with maturities of at least one year. For each respective model benchmark the performance measurement weightings are as follows to BND/VT/BNDX %: 66/20/14, 57.8/30/12.3, 49.5/40/10.5, 41.2/50/8.8, 33/60/7, 24.7/70/5.3, 16.5/80/3.5 and 8.2/90/1.8 % respectively for the Ultra Conservative, Conservative, Moderate, Balanced, Growth & Income, Growth, Aggressive and Ultra Aggressive Global Benchmarks. DRAWDOWN ASSUMPTIONS: Domestic Benchmark -36.90%, Global Benchmark -41.00%, and Growth & Income Model -18.00% (see “Third Party Disclosures” page). Limitations of the assumptions include, but are not limited to, backfill index bias, time period bias and assume no changes to the model presented over the drawdown period. An advisory fee of 1.25% is also included in the calculation for the model and benchmarks over the drawdown period. Transaction fees for the model over the drawdown period are excluded as positions are assumed to be held constant. The benchmark drawdowns use the as calculated drawdowns over the periods measured from 10/9/2007 to 3/9/2009 for the domestic benchmark and from 10/31/2007 to 3/9/2009 for the global benchmark. The Growth & Income Model uses third party software to present a hypothetical drawdown in which calculations of the current holdings were not available during the drawdown period relative to the benchmark. There is no guarantee as to the accuracy of the third party drawdown assumptions nor should one draw any conclusions as to the accuracy and likelihood of the data presented. The Growth & Income Model drawdown assumption is based on a third party report dated September 24, 2018 (This report is available upon request).
The results do not represent actual trading and actual results may significantly differ from the theoretical results presented.
Explanations & Disclosures Continued:
Third Party Disclosures
IMPORTANT: The projections generated by HiddenLevers regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Assumptions on rates of return and standard deviation used in this analysis are based on historical return data for each security and asset class. Past performance is no guarantee of future results. Results may vary with each use and over time. You cannot invest directly in a benchmark or index. Index results do not reflect fees, expenses, or sales charges incurred when making investments. Methodology Used to Generate this Report: Definitions: Beta - Beta measures the relationship between an investment and a major market index (the S&P 500 is used in this report). A beta of 1.0 means that a 1% rise in the S&P 500 could lead to a 1% rise in the investment, while a beta of -0.5 means that a 1% rise in the S&P 500 could lead to a 0.5% drop in the investment. The beta for an investment is determined by using regression analysis to measure the relationship between the returns of the investment and the returns of the S&P 500. HiddenLevers uses 10 years of data to measure the beta for an investment. For investments with less than 10 years of history, all available historical data is used. Cross Correlations - HiddenLevers measures the correlation between every pair of investments in the portfolio. The correlation results can vary between 1 and -1, where a correlation of 1 means that two investments move together perfectly over time, and a correlation of -1 means that two investments move in opposite directions over time. Expected Return - This is the 5-year total return of the portfolio based on the stress test scenarios selected for the report. The system takes the weighted average of the economic scenarios to calculate a one-year return, which is then compounded to determine the five-year return. Lever - HiddenLevers tracks different levers (economic indicators) like CPI, US GDP Growth, and oil prices, and uses movements in these levers to define economic scenarios. Lever Impact - The lever impacts section describes the impact of different economic levers on the portfolio as a whole. An S&P lever impact of 1.0, for example, means that a 1% rise in the S&P 500 is projected to lead to a 1% rise in the portfolio. HiddenLevers similarly measures the impact of a range of economic levers on the portfolio. Maximum Drawdown (MDD) - this is measured as the largest percentage drop in a position during the timeframe of measurement. Click the + sign on the Risk Measures box to see the timeframe of measurement for Max Drawdown in the top right hand corner of the box. Scenario - A scenario is a representation of a major macro-economic or geopolitical event which has the potential to impact investment returns. HiddenLevers models scenarios as a set of up-or-down movements in any of the economic indicators (levers) in the system. Scenario Impacts - Using HiddenLevers' stress testing model, an upside and downside impact are projected for the portfolio in each scenario. Most scenarios are modeled with multiple potential outcomes, with both positive, neutral, and negative outcomes considered. The best and worst projections are derived from running the different scenario outcomes against the portfolio in HiddenLevers model. The scenario-based stress testing model is discussed in detail in the Method section below. Sharpe Ratio - The Sharpe Ratio is the a measure for calculating risk-adjusted return, and this ratio has become the industry standard for such calculations. It was developed by Nobel laureate William F. Sharpe. The Sharpe ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk. HiddenLevers calculates the Sharpe ratio by subtracting short term (1M) T-bill rates from the portfolio's annualized total return, and then dividing by the portfolio's volatility (annualized standard deviation). Stress Test Risk/Reward - The Stress Test Risk/Reward compares the portfolio's potential downside risk against the 5 year expected return of the portfolio. Downside Risk: This is the maximum downside calculated across all of the scenarios included in the report. 5 Year Expected Return: HiddenLevers first calculates the expected return for the portfolio by calculating the one-year weighted average expected return across all included scenarios. The one-year expected return is then compounded to obtain a 5 year return estimate. Historically, major downside events occur roughly twice a decade, making 5 years an appropriate timeframe for comparison of long term returns and downside scenario risk. Volatility - HiddenLevers measures volatility as the annualized standard deviation of an investment or portfolio, expressed in percentage terms. The standard deviation is calculated using weekly data points, and is then annualized by multiplying by the square-root of 52 (number of periods in one year). Method: This report describes one or more potential scenarios, and shows the HiddenLevers-model based performance for the portfolio in each scenario. The steps below are performed to generate the projections: Scenario -> Levers -> Assets (Stocks etc) -> Portfolio Return A scenario pushes levers up or down, which in turn push assets up or down, which in turn impact a portfolio's modeled return in the scenario. As defined above, a scenario is modeled as a set of movements in the levers. Regression analysis is used to determine the historical (prior 10 year) relationship between each lever and each asset in the portfolio. The model is then run 2500 times for each scenario/portfolio combination. In each iteration, the model projects the returns for each asset using the historical regression coefficients for each lever, and using the scenario assumptions on how each lever will change. The model varies the regression coefficients for each iteration using a normal distribution around their mean (similar to a Monte Carlo model's varying of expected returns across iterations), and aggregates the results of the 2500 iterations to find a mean portfolio return with a 95% confidence interval. The confidence interval is displayed on the report as "margin of error" for each scenario. Limitations and Assumptions: This report describes one or more potential scenarios that may or may not occur. Each scenario discussed in this report is defined by the economic assumptions listed in the Macro Impact section of each scenario page. HiddenLevers does not guarantee that any particular scenario will occur as modeled in this report. HiddenLevers uses historical analysis in the creation of this report, and past performance is not a guarantee of future results. The information contained in this report is not to be construed as advice and should not be confused as any sort of advice. Investors should consider this report as only a single factor in making their investment decision. Gxworks LLC, maker of software used to create this report, makes the following disclosures: Gxworks LLC's mission is to educate and provide useful macro risk analytical tools to help provide data to assist with the investment decision process. We rely on financial data, including stock prices, provided by third parties. The data is believed to be accurate, but HiddenLevers does not guarantee or warranty this data. This report is intended only as an informational tool for you and your investment advisor, and should not in any way be construed as investment advice by HiddenLevers. If you make investment decisions based on information you receive in connection with this report, you do so at your own risk and neither HiddenLevers nor its employees will be liable for any losses that you may incur. GxWorks LLC (dba HiddenLevers), its employees, officers or affiliates, in some instances, may have long or short positions or holdings in the securities or other related investments of companies mentioned herein. Users of this should conduct their own independent research and due diligence and consult with their investment advisor before making any investment decisions or recommendations. Hidden Levers does not endorse Alternative Capitalis, LLC. Past Crashes: Financial Crisis 9/1/08 - 3/9/09 This scenario covers the timeframe from September 1, 2008 through March 9th, 2009, and measures the historical change of each lever over those dates. This scenario outcome reflects the economic movements between Sept. 1, 2008 and March 9th, 2009. For monthly and other less granular levers, the nearest time period is used. Timeframe: 6 Months. Please visit https://www.hiddenlevers.com/ for more information.