By now, it obvious to everyone that we are in a bear market. We have seen about a 30% decline from the U.S. stock market’s peak in the third week of February 2020. Whether and how much it gets worse from here is an open question.
Investors whose portfolios have been heavily concentrated in equities throughout this year have taken large losses, and that includes the target-date retirement funds where 401K funds are invested if investors do not make specific elections. The S&P500’s year-to-date performance is negative 28.50%. Even buy-and-hold investors who allocate 60% to equities and 40% to treasuries have seen their portfolios plunge more than 15% YTD. But momentum investors and their advisers have performed better in many cases. Why?
The answer is that defensive asset classes like long-term U.S. treasuries and gold have demonstrated positive price momentum over the last several months to the extent that it made sense to incorporate these assets in a portfolio many months before the bear market began. The momentum of these asset classes has buffered momentum portfolios which have taken a much smaller drawdown than ones that did not.
The following chart compares the monthly total return of a tactical momentum portfolio like the ones that Stillpoint manages compared to three alternatives: (1) a popular S&P500 index exchange-traded fund (ticker: SPY); (2) a low-fee target date retirement fund for a 40-year-old investor; and (3) a portfolio that allocates 60% to equities and 40% to 10-year U.S. treasuries.
The buy-and-hold portfolio splits its equity component into the U.S. large cap stock market (SPY) and the foreign developed world stock market (EFA) in equal parts. The Stillpoint portfolio also includes a reduction for a common 1% adviser fee, while the other alternatives do not include such a fee deduction.
Data sources: ETFreplay.com and stockcharts.com. Data is total return data, incoporating dividends. Note that the foregoing returns do not represent returns in an actual portfolio where price points for buying and selling will create variations in returns. Additionally, the Stillpoint portfolio above was not utilized for all Stillpoint clients and primarily in retirement accounts. Past performance is no guarantee of future performance.
In every month but one (January 2020), the momentum portfolio outperformed the buy-and-hold portfolio, and the Stillpoint portfolio protected the downside better that the alternatives that were totally or mostly concentrated in equities.
Compared to the 60/40 buy-and-hold portfolio, Stillpoint’s relative outperformance was strongest when the buy-and-hold portfolio was weakest. This occurred because the momentum portfolio tactically became more defensive in February and March than the buy-and-hold portfolio was positioned. Specifically, gold and U.S. treasuries enabled the portfolio to play defense in a way that the buy-and-hold portfolio could not, even though the buy-and-hold portfolio had allocated 40% to 10-year U.S. treasuries, itself a strong defensive play.
The Stillpoint portfolios were constructed by looking at the performance of a wide range of asset class exchange-traded funds (ETFs) on a 3-, 6-, and 12-month basis. By conducting this examination, the relative outperformance of gold and U.S. Treasuries was unmistakable.
Of course, any portfolio with a heavier concentration of equities and smaller or no concentration with treasuries has performed far worse than the Stillpoint portfolios. Indeed, many target-date portfolios in 401K plans have heavier concentrations of equities in their portfolios, and those portfolios have struggled mightily in 2020, as did the low-fee 2045 target-date retirement fund did above.
It should be noted that momentum portfolios do not always outperform buy-and-hold portfolios. Typically, momentum portfolios lag buy-and-hold portfolios in bull markets. But over a full business cycle, which includes a complete bull and bear markets, momentum portfolios typically have the edge.
If you are considering incorporating some momentum into your portfolio, please contact us to discuss your particular objectives and situation.