June 2015 Recap
In France, every July brings with it a 21-day bicycle race that has encircled the country almost every year since 1903. This year’s Tour de France was won by Chris Froome of Great Britain’s Team Sky. For over 2,100 miles he out-pedaled Colombia’s Nairo Quintana by just one minute and twelve seconds in one of the most closely contested races in the last five years. What’s interesting is how Froome did it.
Historically, the Tour de France is won on the steep mountain passes where the world’s best climbers can put five to ten minutes between themselves and their rivals. This year, Quintana proved to be the better climber; on the last two mountain stages he finished nearly two minutes ahead of the eventual winner. Unconventionally, Chris Foome’s overall victory was secured from time he gained early in the race on what is usually a meaningless stage. While this surprised many, it shouldn’t have.
Froome’s Team Sky is managed by Dave Brailsford who took the helm in 2010 when it was brand new to the pro cycling scene. From the start, Brailsford enlisted a concept he called the “aggregation of marginal gains.” He believed if you improve as many areas as possible by just one percent then those small gains would accumulate to a significant improvement. He took this approach beyond the typical areas focused on by other teams (bicycle aerodynamics, rider nutrition and training regimens). Brailsford and his coaches researched pillows to determine which would give his riders a better night’s sleep to help with recovery. They even lectured riders on how to wash hands properly to limit illness during training periods. While unconventional, Brailsford thought that his marginal gains approach could add up to Team Sky winning their first Tour de France within five years. He was wrong. They’ve won three.
Investors can learn a lot from this approach, especially now. Economic events in July are signaling that the days of relying on a market that continually moves higher to produce gains might be over. In fact, through the end of July the S&P 500 is up just over 2% and it remains bound to one of the tightest trading ranges witnessed in the last twenty years. On top of this, traditional moves like buying gold in the face of fear or trading near-term technical signals aren’t working either. And all this comes as International Monetary Fund lowers global growth estimates, the Federal Reserve is about to raise interest rates and a big tailwind to the equity markets (share buybacks) could be waning.
RANGE BOUND MARKET CONTINUES
As of July 31, the S&P 500 has climbed just 2.1% year-to-date after double-digit surges for each of the past three years. It is widely cited that the index hasn’t witnessed a 10% correction since October 2011, the second longest stretch in recent memory. On top of this, the index is trading within its smallest range since at least 1995. So far, the year-to-date low is just 6.5% below its high. On average, this spread measures 18%. Another way to look at this is just how often the S&P 500 has crossed its 50-day moving average this year. As of August 3, the index has crossed above or below the average 31 times. This is the second most number of times in a year since 1993 and we still have nearly five full months remaining in the year. A common trade by technical analysts is to use the 50-day moving average as a proxy of near-term momentum and buy when the market moves above and sell when it trades below. Anyone who has followed this traditional strategy in 2015 is suffering. Historically, when equity markets have been this range bound in the first half of the year, they have broken out in the back half. However, given what appears to be a weak growing economy and uncertainty surrounding the timing of Federal Reserve rate hikes, a sideways and choppy market might be in line for the remainder of the year.
July was a month to forget when it comes to commodities. The overall CRB Commodities Index was down nearly 10%, and every major commodity in the basket was down or flat except for orange juice and lean hogs. Energy related commodities were some of the most damaged. The overall CRB Commodities Index was down approximately 10%, but oil collapsed more than 20%, heating oil 16% and RBOB gasoline fell 13%. Interestingly, this already appears to be working its way into lower gas prices at the pump. On August 3, AAA announced that gas prices are down for the 19th consecutive day. The current national average hovers around $2.60 per gallon, down from $3.50 a year ago. Perhaps this will help spur consumer spending in the back half of the year, something the improving jobs picture has yet to do thanks largely to stubbornly low wages. One of the worst performing commodities has been gold. It sank to a five year low in July and has given up approximately 50% of the gains during its bull market run. The interesting thing about gold is the collapse occurred in the midst of the economic turmoil in Greece and the stock market rout in China. Events like these usually bolster gold price. Like the buying and selling the 50-day moving average discussed above, the textbook trade of buying gold as a “flight to safety” didn’t work. Additionally, the bigger picture question regarding the collapse in commodities is what they may be saying about worldwide economic growth. We’ve had low bond yields signaling weaker economic growth for some time, and now the pullback in commodities is screaming the same thing, especially for emerging markets. The IMF has already lowered its global growth forecast this year, and this could be signaling more slowing to come.
A notable tailwind for equity markets could be weakening. One of the drivers of per share earnings growth over the past several years has been the rapid pace of share repurchases. Corporations who had been sitting on piles of cash after the great recession began deploying it to repurchase shares, many times due to the influence of activist shareholders. This helped reduce the supply of equities as investor demand grew thanks to low yields on fixed income securities. BCA Research estimates the number of available shares on the U.S. stock market has fallen 6% over the past five years. But, enthusiasm for buy-backs is beginning to wane. Through the first quarter of 2015, corporations deployed $144 billion on share repurchases, down from nearly $160 billion in the same period a year earlier. Some argue that lower corporate profits (induced by oil price deterioration and the rising dollar) have managers reining in buybacks. This could create a downward spiral since fewer buybacks in turn slows earnings per share growth. On top of this, equity supplies may soon begin growing. After a six year bull run, private equity firms have been harvesting investments to the tune of $73 billion through the first half of 2015. This is a record for a six month period.
If market conditions in July are any indicator, not only could investors learn a lot from Dave Brailsford and Team Sky’s approach regarding marginal gains, but it might become necessary over the next few years. The days of relying on a market that continually moves higher and/or standard textbook trades to produce positive returns might be over. Ironically, this is occurring at a time when more and more investors are flooding into financial products, or using financial advisors, that solely rely on a continually rising market to achieve their goals. The Economist recently reported that with $2.9 trillion of assets, ETFs now manage more money than hedge funds. And, this is occurring as slowing global growth and diverging central bank policies create a murkier backdrop. We believe an approach that aggregates marginal gains through a disciplined plan that targets high-quality investment opportunities will become increasingly important to achieving financial goals over the next several years. As always, we encourage clients to talk to their investment advisors to discuss how this information applies to their unique circumstances.