Just as it seemed active managers would struggle to ever beat the S&P 500 after getting trounced in 2021 as stock indexes soared, 2022 is clearly a year where active sector management is at a super-sized premium.
The latest SPIVA report, offering research to measure actively managed funds against their relevant index benchmarks worldwide, is typical. Just 17% of U.S. large-cap stock pickers beat the S&P 500 over the past 10 years through 2021, and that number drops to 6% over 20 years.
What is most notable is that those asset managers that do beat the S&P do so more from a stylistic standpoint than from pure stock picking. According to Citadel hedge fund billionaire Ken Griffin, “The average hedge fund lives for about three years. So, several hundred shut down a year and the world goes on.”
History would place Peter Lynch as the most revered fund manager. Lynch racked up a return of 29% a year at the helm of Fidelity’s Magellan Fund from 1977 to 1990, including dividends. He outpaced the S&P 500, the fund’s benchmark, by more than 13% a year during that time. His success in the then-$18-billion Magellan Fund resulted more from his paired strategies of quality and value that worked marvelously at that time, and less on sheer bottom-up growth stock picking across all sectors.
It has been surmised that Lynch’s quality/value approach would have only performed in line with the S&P during the 13 years preceding 1977 and would have sorely underperformed the S&P in the past decade, where higher-beta growth stocks and especially technology stocks led the market to record highs. By Lynch’s formula, he would not have owned FAANG stocks — Meta Platforms Inc. (NASDAQ: META), formerly Facebook; Amazon (NASDAQ: AMZN); Apple (NASDAQ: AAPL); Netflix (NASDAQ: NFLX); and Alphabet (NASDAQ: GOOG), formerly Google — and other huge growth stocks with rich price-to-earnings (P/E) ratios.
For the most part, Lynch owned many more companies that traded outside the S&P 500 than within it. He used a combination of all-cap, high-quality, deep-value discipline in a portfolio of equally weighted stocks that numbered as many as 1,400. This approach drove the stellar returns that made him a Wall Street legend. His style was perfect for the time.
In today’s investing landscape, there is widespread multiple contraction underway, with last week’s dismal market performance taking another bite out of P/E ratios. With all the major averages closing below their respective 50-day moving averages, investors have entered what Altimeter Capital founder Brad Gerstner dubbed “peak uncertainty,” which I found to be spot-on as a way to describe the current market.
Bank of America’s global fund manager survey for September showed fund managers’ average cash balance has risen to 6.1% in September — the highest since October 2001, after the 9/11 shock. The BofA survey said, “Record low share of FMS investors taking higher risk than normal. Investor risk appetite is on a par with the low of March 2020 when Covid broke out.” Looking at the top 10 holdings in today’s Magellan Fund, it is loaded with big-cap tech — not a single major integrated energy company, liquefied natural gas (LNG) provider, pipeline operator, oil and gas exploration and production (E&P) or agriculture stock as a top holding.
This is very interesting in that selling of stocks climaxed shortly after 9/11 in September 2001, while a market bottom related to the COVID-19 crisis was seen in late March 2020. So, once again, the market is facing another period of high anxiety — this time based on inflation, aggressive Fed policy, fears of an earnings collapse and global recession risks. How much of this uncertainty is already priced in is the big unknown quantity.
Is it now “darkest before the dawn?” That’s too hard to say. The June lows for the market look like they will be tested. Businesses may dash to raise cash and hide out in the dollar that is right back up to its recent high. With that said, there are sectors and stocks in their own stealth bull markets that are very noteworthy and demonstrate what style of investing is working against a primary downtrend for the broad market. So far, 2022 is a year defined by very strong returns for certain commodities — with energy a big winner.
Shares of the Energy Select Sector SPDR (XLE) have rallied 41% year to date, not including dividends, and have soared throughout the year. Most of the major energy companies reduced capital expenditure (capex) spending and have focused on returning value to shareholders in the form of buybacks and paying out incredible dividend income this year.
The energy pipeline, storage and transfer infrastructure sector has also been a bastion of solid year-to-date performance. Shares of the Alerian MLP ETF (AMLP) are higher by 17% year-to-date, not including dividends, that sport a current yield of 7.4%.
Even utilities have performed admirably this year, as investors seeking the reliability of attractive income and relative safety of the sector at a time when recession fears are on the rise. Shares of the Utilities Select Sector SPDR ETF (XLU) have returned 6.4% year to date, not including dividends.
Additionally, solar stocks have charged higher of late in response to the firehose of planned spending and future tax credits in the sector as outlined in the Inflation Reduction Act. Shares of Invesco Solar ETF (TAN) have broken out of a range, trading sharply higher against a very difficult tape.
The agriculture sector is also delivering strong returns for stocks of the top companies producing nitrogen and phosphate fertilizers, seeds and crop production nutrients. And the performances of the top lithium mining companies in the world have been incredibly impressive, rounding out what has been a fantastic year for the commodity-style investing strategy, when most other sectors and styles are in bear market territory.
These six areas of the market remain very constructive, both fundamentally and technically. Having the willingness to greatly reduce exposure or to rotate out of sectors under distribution and move into sectors benefiting from accumulation when macroeconomic conditions dictate to do so is rewarding those who are taking action.
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