We are heading into a period when it is critical to make sure you understand not only the amount of risk within your portfolios, but also that you are getting rewarded for the risk you are taking. Considering current valuations, the average investor is taking on much more risk than they realize. In addition, many are not even coming close to getting rewarded for the risk they are taking within their portfolios. During a period when risk should be an area of focus, it is either misunderstood or simply ignored by too many investors.
Currently, owning both value and select growth makes a lot of sense for most investors. This gives investors income/defensive investments in combinations with long-term growth. The barbell-type approach is a great way to participate in this rising stock market while mitigating the risk of just chasing stocks. It is always easier to use a passive approach of owning a little bit of everything, or following the herd and buying the highflyers. However, when certain areas get to extreme valuations a more selective and disciplined approach is necessary.
As a case in point, eleven months ago we wrote the following:
“In 2010, the energy sector represented over 12% of the S&P 500. By June 30, 2020, its weighting had fallen to 2.8%. During this time period, the technology sector went from 18.8% of the index to 27.5% as technology significantly outperformed energy. In fact, the energy sector underperformed the S&P 500 in 7 of the last 9 years, as well as during the first half of 2020. Energy was the worst performing sector in 5 of those 9 years in addition to 2020 YTD.”
Since that time, XLE, the energy select SPDR ETF, is up 41% and energy is, not surprisingly, the best sector performer for the first half of 2021. Buying quality into sell-offs has been one of our best strategies to reduce risk during market extremes. When you combine that with partial profit taking and adjusting asset allocation more conservatively when valuations are at or near extreme levels, this makes for a winning long-term investment equation. After all, it was also Sir John Templeton that said, “The only hope you’ve got to produce a superior investment record is to do something different from what the crowd is doing.”
Alan B. Lancz and Associates, Inc. started factoring in inflation over a year ago, well before it was on most investor’s radar. The actual numbers are far worse than the government reported numbers, and show no indication of being transitory, as members of the Fed often state. Here are the real facts that affect most Americans:
- Home prices are averaging a remarkable $350,000, the highest ever.
- The spread between factory workers and restaurant workers wages is the narrowest ever.
- Average rents are up between 5-10% this year.
None of the above is transitory, but more secular and rather alarming. This is one of the reasons we focused on the depressed energy sector a year ago. When you combine this with spiraling government debt, it is not that concerning in the face of record low interest rates, but what happens when interest rates rise? It is not just government debt, but corporate debt has steadily risen. High yield, or junk, bonds are at record values, despite the fact that investors are receiving the lowest yield ever. Too many investors are simply not getting rewarded for the high levels of risk they are taking, and this is in regards to fixed income as well as many stocks.
