By Justin Carbonneau (@jjcarbonneau) —
Each market environment and year we can look back and say what worked and what didn’t. And while it’s easy to do that in hindsight, short-term performance of strategies and factors is almost impossible to predict. Given that we run over 20 different stock selection strategies, ETF model portfolios and even country and sector approaches, we can use all of this risk and return data to help us understand what has worked, what hasn’t, and where the opportunities may be going forward.
A Banner Year for Many Stock Strategies
If we were to close the books right now, in early November, it would be one of the best years for many of our active stock selection models ever. While a surprise to most, it’s not uncharacteristic for our models to exhibit very strong performance in the first year or two coming out of a recession and bear market, and while the downturn in early 2020 was short-lived, it was an official, albeit quick, recession and +30% decline in large cap stocks accompanied by massive monetary and fiscal stimulus.
In many market environments performance is lead by a certain type of stock, whether it be growth, value or specific sectors or industries. In 2021, the year started off very strong for value stocks, many of which were cyclical companies, and this helped some of our value-oriented approaches, and more recently we’ve seen a shift back to growth. When looking at the top performers using the 10-stock monthly model portfolios the top of the list is mostly dominated by our models with some combination of growth and fundamental strength, although our Value Composite Investor and Private Equity Investor models (which looks for small cap stocks with leverage) are among some of the best performers. Investors have rewarded companies with upward earnings revisions as the very top performer so far is the Earning Revisions strategy we base on the paper, How to Profit From Revisions in Analysts’ Earnings Estimates written by Wayne Thorp
The two areas that have struggled in 2021 are somewhat opposites – pure momentum and quality. The one model we run that looks at momentum and consistency of momentum has struggled as the trend of outperformers in the market has been choppy. Second, lower quality stocks have been outdoing very high quality, which tend to exhibit less volatility than the market, so the models that have a heavy emphasis on quality factors are at the bottom of the list.
Here is a snapshot of the full model line up along with relative model performance. These are the 10-stock monthly rebalanced portfolios.
The Case for Blending
Being able to pick which model might be best in any given year is impossible, which is why blending models can be useful. We create blends using two different methods. One is considered an ensemble approach, which means we are taking stocks that score highly based on unique investment models and putting them together into one portfolio (i.e. the Top Five Gurus portfolio) and the other is looking for stocks that score highest based on a composite score across all of our strategies (i.e. the Validea Hot List). This method is considered a “consensus”-like approach where those strategies that are better long-term performers get a higher weighting in the overall consensus score.
Going from Worst to First
In our Country, Sector and Industry portfolios we track model portfolios that utilize the consensus approach in trying to identify the top stocks in each of these areas. The top performing sector/industry portfolio may surprise some because it was one of the industries that got hit the most – that is the energy area. On the flip side, consumer non-cyclical and utilities, which tend to be less risky types of stocks, have failed to keep pace with the broader market.
The past 10-12 years have been a fantastic time to be an U.S. investor, particularly those who have just bought the S&P 500. We track models that pick the top stocks in different countries and regions, using the consensus approach previously described, and the U.S. continues to remain on top this year even as other parts of the world have rallied. As a result, relative valuations between U.S stocks (high) and stocks in Europe or parts of Asia (lower valuations) are attractive and this could lead to a long-term opportunity for those investors willing to allocate more toward international stocks with attractive valuations.
Wrapping It Up
With a little under two months to go before the end of the year, the likelihood is we will look back on 2021 with some amazement, a bit of confusion and some important lessons. The first thing is the market can exhibit more strength than many can realize when the ingredients are right (i.e. interest rates, alternatives, demand from retail investors, liquidity). The second point is in order to get the really great returns of concentrated equity investing, you need to be in the strategies during these big years because a lot of the long-term returns come from these moves. The third important point is you don’t always have to try to pick 1-2 models and a blending-based approach can take some of the guesswork out of the decision-making process and put you in a number of strategies that give you the opportunity to capture winning periods like this. Lastly, it can pay to look at the areas of the market that haven’t kept pace because at some point those segments of the market will likely catch up and mean revert – higher quality and low volatility stocks, consumer non cyclicals and international stocks may be some of the areas that play catch up or benefit the next time the market pulls back.
Performance Disclaimer: Returns presented on Validea.com are model returns and do not represent actual trading. As a result, they do not incorporate any commissions or other trading costs or fees. Model portfolios with inception dates on or after 12/30/2005 include a combination of back tested and live model returns. The back-tested performance results shown are hypothetical and are not the result of real-time management of actual accounts. The back-testing of performance differs from actual account performance because the investment strategy may be adjusted at any time, for any reason and can continue to be changed until desired or better performance results are achieved. Back-tested returns are presented to provide general information regarding how the underlying strategy behind the portfolio performed in our historical testing. A back-tested strategy has the benefit of hindsight and the results do not reflect the impact that material economic or market factors may have had on advisor’s decision-making if actual client assets were being managed using this approach. The model portfolios offered on Validea are concentrated and as a result they will exhibit high levels of volatility and their performance can be substantially impacted by the performance of individual positions.
Optimal portfolios presented on Validea.com represent the rebalancing period that has led to the best historical performance for each of our equity models. Each optimal portfolio was determined after the fact with performance information that was not available at portfolio inception. As a result, an investor could not have invested in the optimal portfolio since its inception. Optimal portfolios are presented to allow investors to quickly determine the portfolio size and rebalancing period that has performed best for each of our models in our historical testing.
Both the model portfolio and benchmark returns presented for all equity portfolios on Validea.com are not inclusive of dividends. Returns for our ETF portfolios and trend following system, and the benchmarks they are compared to, are inclusive of dividends. The S&P 500 is presented as a benchmark because it is the most widely followed benchmark of the overall US market and is most often used by investors for return comparison purposes. As with any investment strategy, there is potential for profit as well as the possibility of loss and investors may incur a loss despite a past history of gains. Past performance does not guarantee future results. Results will vary with economic and market conditions.
Justin J. Carbonneau is VP at Validea & Partner at Validea Capital Management.
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