A close college friend is getting married in May, and I traveled to New Orleans this weekend for his bachelor party. As the only investor in a group otherwise made up of much smarter doctors, writers, and musicians, I was asked how investors think about picking stocks for a portfolio. We were on Frenchman Street, listening to some great music, so I used jazz as a metaphor (pardon me if this echoes Baldwin's 'Shadow and Act' too much). For the more classically-inclined, an orchestra is the same idea. A jazz band is made up of a collection of different instruments and players. Sometimes they play together, and hit a harmony that can blow the doors off. However, at the same time, each is playing his or her own piece, with individual riffs and improvisations. The beauty of jazz is in that improvisation, that the same band is likely to play the same piece differently tomorrow to respond best to each audience. So it is with investing - A good diversified portfolio reflects the balancing act between the harmonies (the market risk) of the portfolio and the improvisations of individual stocks (the idiosyncratic risk), and the need to adjust it in a way that best responds to the market as a whole.
The small cap market, as defined by the Russell 2000 Index, was flat overall during the week in highly volatile trading (first time the Russell 2000 Index had three 100bp moves in a row since the election). Donald Trump spoke to a session of Congress on Tuesday and while investors reacted positively on Wednesday in response to his more measured tone and policy endorsement initially, a lack of policy specifics and significantly increased expectations for a March rate hike (up from 50% to 80% likelihood, driven by stronger customer and producer confidence) supported relative strength in large cap stocks (Russell 1000 Index) versus small cap stocks (Russell 2000 Index), up this week by 65 basis points. Among small caps, however, Growth significantly outperformed, with the Russell 2000 Growth Index beating the Russell 2000 Value Index by around 100bps, but almost 2/3 of this was driven by the Growth index's healthcare exposure.
Within the Index, Health Care (+3.1%) was the strongest performer as biotechs and pharma ran on Trump's statements suggesting regulation will be softened. Materials (+1.2%) and Industrials (+0.3%) were also up, as economically-sensitive and inflation-driven sectors were also buoyed by the speech. On the downside, Telecommunication Services (-2.4%) and Energy (-2.0%) were the weakest.
Earnings season continues, and with almost 80% of the Russell 2000 out so far, companies are reporting decent Q4 results, with around 60% beating Wall Street revenue estimates and around 65% beating on the profit line. Looking forward, however, estimates for next quarter remain weak, with over half of Q1 estimates going down due to guidance or other factors. Given high valuations, it is important to consider how reduced growth expectations will affect performance.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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