Valuations Point Towards 2021 Risks, But Credit Trends Remain Supportive | ETF Trends

By Portfolio Manager

Market Recap

The fourth quarter of 2020 began with a turbulent and corrective market in October as investors anxiously worried about a contested election and surges in coronavirus cases as the cold weather began. The extent of investor fear was demonstrated by the VIX Market Volatility Index, which rose to over 40 in late October–a level normally associated with major bear market bottoms. The market endured only a modest 7% correction.

Market fears before a presidential election are par for the course, but to have those fears reach bear market bottom levels (and without the associated decline) indicated the potential for major market upside. More importantly for our Global Tactical investors, our credit-based risk models barely budged, and never got close to a cautionary indication.

As a result, the strategy remained fully invested during October’s anxiety. When a resolution to the election and two coronavirus vaccine approvals sparked a huge November rally, our clients were fully invested and enjoyed market gains. Markets rallied through the end of the year and as 2021 begins, we continue to be bullish on equities for the intermediate term, with a strong credit backdrop as our primary guide.

Fourth Quarter Performance Highlights

  • The portfolio currently owns two U.S. and two international equity ETFs. Their returns and weighting during the quarter were as follows: S&P 500 Index ETF (SPLG – 48% weight; up 12.2%); Small Cap ETF (IJR – 21% weight; up 31.2%); broad International Ex-U.S. ETF (IXUS – 20% weight; up 16.4%); and International Small Cap ETF (VSS – 9% weight; up 17.6%).
  • The S&P Small Cap 600 ETF (IJR), driven by a 31% gain, was the portfolio’s top contributor, despite being less than half the portfolio weight of the S&P 500 ETF (SPLG), which was the second largest contributor. The two international ETFs, despite outperforming the S&P 500, were detractors, due to their smaller portfolio weights.
  • When in risk-on mode, the portfolio allocates 70% to U.S. equity and 30% to international equity. In each region, it allocates a 70% weight to large-caps and 30% to small-caps. The resulting portfolio is very broad with a global reach, and a miniscule 0.055% aggregate expense ratio.

Positioning and Outlook

The Global Tactical portfolio enters risk-on positions when its credit-driven models favor risk-on. When the models indicate negative broad credit trends, the strategy sells its equity exposure and moves into Treasuries or cash. In 2020, the portfolio entered the year favoring equities, but reduced its positions in late February and early March as the pandemic-driven crash took hold.

On March 27th, just four days after the market bottom, our credit models turned positive and we re-entered equities, owning them until late June, when we exited after our models indicated caution. Markets immediately turned around and headed upwards, and only a month later on July 30th, we re-entered equities. Since then, we have been risk-on, owning equities as our credit-based models remain strong and have been making new highs.

Looking forward, we are watching our credit-based models for any signs of weakness in the broader financial economy, and we have seen zero signs of that yet. While we are bullish on equity prospects for 2021, contradictory indications between our indicators point towards a more volatile ride.

Valuations and investor sentiment are at extremely high levels, with the S&P 500 one year forward P/E ratio at 27. We believe this presents a risk if the economy does not fully re-open, or if earnings otherwise falter. Technicals, momentum, and breadth are strong, indicating that inevitable and overdue corrective activity should be viewed as buyable.

More than ever, though, we are mindful that all of these factors are driven by the eight-hundred-pound gorilla in the room, a determined and overwhelmingly accommodative Federal Reserve. By some indications, we are at the point in the credit and economic cycle that the Fed might want to begin to tighten, but in response to these unusual times, the Fed has declared that it is ready to let inflation run hot. That may help this bull market last longer and have more magnitude.

As always, our credit-driven models will be our primary guide in allocating risk. We are tactical and able to turn risk-off in order to avoid serious, capital-destroying bear markets, like the pandemic-driven decline we saw in March.

Global Tactical Top Contributors as of December 31, 2020

Company Name Average Weight (%) Contribution to Return (%)
Advanced Energy Industries, Inc. 2.92 1.57
Evercore Inc Class A 2.72 1.51
Virtus Investment Partners, Inc. 2.73 1.38

Global Tactical Top Detractors as of December 31, 2020

Company Name Average Weight (%) Contribution to Return (%)
SVanguard FTSE All-World ex-US Small-Cap ETF 8.84 1.53
Source: Factset. For illustrative purposes only. Past performance does not guarantee future results. The holdings identified do not represent all of the securities purchased, sold or recommended for advisory clients. In the chart above, “weight” is the average percentage weight of the holding during the period, and “contribution” is the contribution to overall performance during the period. To obtain the calculation methodology and a list showing every holding’s contribution to the overall composite during the period, contact: [email protected].

The views expressed are those of the author(s) and do not necessarily reflect the views of Clark Capital Management Group. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. There is no guarantee of the future performance of any Clark Capital investments portfolio. Material presented has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed. Nothing herein should be construed as a solicitation, recommendation or an offer to buy, sell or hold any securities, other investments or to adopt any investment strategy or strategies. For educational use only. This information is not intended to serve as investment advice. This material is not intended to be relied upon as a forecast or research. The investment or strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. Past performance does not guarantee future results.
This document may contain certain information that constitutes forward-looking statements which can be identified by the use of forward-looking terminology such as “may,” “expect,” “will,” “hope,” “forecast,” “intend,” “target,” “believe,” and/or comparable terminology (or the negative thereof). Forward looking statements cannot be guaranteed. No assurance, representation, or warranty is made by any person that any of Clark Capital’s assumptions, expectations, objectives, and/or goals will be achieved. Nothing contained in this document may be relied upon as a guarantee, promise, assurance, or representation as to the future.
The volatility (beta) of a client’s portfolio may be greater or less than its respective benchmark. It is not possible to invest in these indices.
Index returns include the reinvestment of income and dividends. The returns for these unmanaged indexes do not include any transaction costs, management fees or other costs. It is not possible to make an investment directly in any index.
Morningstar is the largest independent research organization serving more than 5.2 million individual investors, 210,000 Financial Advisors, and 1,700 institutional clients around the world.
For each separate account with at least a three-year history, Morningstar calculates a Morningstar Rating™ based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a separate account’s monthly performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of separate accounts in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. The Overall Morningstar Rating for a separate account is derived from a weighted average of the performance figures associated with its three-, five- and ten-year Morningstar Rating metrics.
© 2018 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. Not every client’s account will have these exact characteristics. The actual characteristics with respect to any particular client account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment.
Clark Capital Management Group, Inc. reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. The information provided in this report should not be considered a recommendation to purchase or sell any particular security, sector or industry. There is no assurance that any securities, sectors or industries discussed herein will be included in an account’s portfolio. Asset allocation will vary and the samples shown may not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.
Clark Capital Management Group, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Clark Capital’s advisory services and fees can be found in its Form ADV which is available upon request. CCM-508