Advisor Insight

 December 2018

"Auld Lang Syne"

Each year around this time, many Americans engage in a traditional process of self-improvement by making New Year’s resolutions. The New Year is also a busy time for financial advisors, many of whom will be meeting with clients to review accounts and update strategies for the coming year. The stock market volatility we witnessed in 2018 should be a featured conversation at every meeting.
With this in mind, many advisors will be “resolving” to make risk management a priority in their portfolio design this year. Risk should always be front and center, and there’s no time like the present to help your clients better understand the risks in their portfolios. A recent survey by Natixis Global Asset Management indicated that three-quarters (76%) of investors admit that they don’t have a solid understanding of risk. It’s important to impress upon clients that they can’t have return without investment risk, and that risk is actually a more predictable variable in a portfolio than return over time. Putting risk first in portfolio design can provide a more stable foundation as clients pursue their goals. Conducting periodic risk “audits” can help determine whether they are taking on too much or too little risk along the way.
A study on New Year’s resolutions found that one of the top ten promises Americans make each year is to help others reach their dreams. Advisors who follow through on helping their clients better understand risk can put a check mark next to that pledge for themselves.
Performance Update
After a relatively calm November, December delivered a wallop to the markets. Trade concerns with China, interest rate hikes, and weakening corporate earnings were just some of the factors that led to the dramatic volatility and downside movements in equities for the month. Just to put things into perspective, consider the following:
  • The S&P 500 had it’s worst December since 1931, and the Nasdaq its worst on record
  • The S&P 500 experienced 10 days of change in excess of 1% - up or down. Historically, the average month experiences just 3 such days
  • Mutual funds invested in equity and bonds lost a record $152 billion for the month

The numbers were not pretty, with all the three major US equity indexes losing more than 8% for the month, and Small Caps (Russell 2000) faring even worse, losing 11.9%. December’s carnage drove the major equity indexes into bear market territory. Even as the markets have bounced back the last few weeks, they remain well below their September highs.

For the year, major equity indexes experienced negative returns for the first time since 2008. The S&P 500 ended the year down 4.4%, Small Caps (IWM) and Mid Caps (IJH) fared much worse, falling 11.1% and 11.2% respectively. Of the 11 S&P 500 equity sectors, just 3 finished the year in the green – Healthcare, Utilities and Consumer Discretionary. Five lost more than 10% with Energy losing the most at 18.1%.

As we’ve indicated in previous updates, many of our strategies shifted to a defensive posture during the 4th quarter - some as early as October. While some of our strategies did not necessarily move to cash, they did move to more defensive-oriented holdings such as Utilities, Real Estate and Healthcare. These moves helped mitigate losses in the Asset Allocation and Sector Rotation styles. Several of our Tactical approaches also moved defensive throughout the month. Cipher, TUG1 and TUG2 have the ability to go short which all did at some point during the month.

Q3 Strategy Focus

Enhanced / Strategic Allocation Sector

Managers employing Sector Rotation investing had a challenging December, 4th Quarter, and 2018. The market-leading sectors earlier in the year – chiefly Technology and Healthcare – suffered large losses in the latter part of the year. Many Sector Rotation managers were slow to act on these market changes and suffered significant losses. In many cases, their strategies are considered to be “actively” managed, but some only reevaluate the holdings every 3 months.
While Strategic Allocation (SA) had outperformed Enhanced Allocation (EA) leading into October, EA turned in a better 4th quarter showing. This is due to EA having the ability to shift defensive, which is where it has been since October 25. The defensive positions in EA, largely short-term bonds, weathered the volatility storm of December and led to strong relative performance for the time periods shown. With the next EA trade scheduled for January 24th, we expect the strategy to remain out of equities for at least the next trade cycle.

By contrast, Strategic Allocation (SA) does NOT rotate completely defensive all at once. Rather, it remains in the strongest positions whether they be sector equities, bonds, or even money markets. SA has maintained some equity exposure throughput the entire time period. These equities, however, have included some defensive sectors such as Utilities, Consumer Staples and Healthcare. More recently, SA began to shift a bit more aggressive. Our last trade (January 7) saw buys into the Technology and Leisure sectors.

Q3 Housekeeping Items

We recently introduced strategy allocation reports for some of our most popular strategies. Below you will find links to the latest updates.

Enhanced Allocation
Strategic Allocation

As always, if there’s anything we can do for you don’t hesitate to call.

All the best,

Bruce Greig, CFA, CAIA


Advisor Use Only. The Advisor Insight Newsletter may provide general investment information from sources deemed reliable but is in no way a solicitation to buy or sell any security. Past performance is not indicative of future results. Data is provided for informational purposes only and should not be construed as investment or tax advice. Performance data is based on monthly balances and reflective of model accounts held at Trust Company of America. Performance on other platforms may vary based on a number of factors including available fund universe and trade cut off times. Any “gross of fees” performance data is for Investment Adviser Representative use only and cannot be used with investors. In such a case, performance does not reflect the deduction of advisory fees and a client’s return will be reduced by the advisory fee and any other expenses incurred on the account. “Gross of fees” performance does not reflect the impact that fees have on the compounding effect of returns. Details on Q3’s fees are outlined in our ADV Part 2 brochure, which is available upon request. There is no assurance that objectives will be realized. There is risk of loss with all of Q3 Asset Management's investment strategies. Any reference to or use of the term 'registered investment advisor' does not imply that Q3 Asset Management or any person associated with Q3 Asset Management has achieved a certain level of skill or training. For additional information please see Q3 Asset Management Corporation's ADV, which is available upon request.

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