- Hi, I'm Kevin Barr, head of SEI's Investment Management Unit. Stock markets are showing a level of volatility that is extremely concerning to many investors. With that in mind, I've asked Steve Dolce, Portfolio Manager for SEI's Small Cap Funds, to join me today. Thank you for joining me Steve. With today's market conditions, can you give us some clues on what's going on with our portfolios?
- Thanks for having me Kevin. When we see sell offs of this magnitude, we tend to get indiscriminate selling across the market. The SMP has dropped 20% from the peak, faster than any other market crash that we've seen. People panic, they just wanna sell everything. You've heard the phrase, "The baby gets thrown out with the bath water." That's just the indiscriminate selling. We're seeing high quality, low quality, everything in between just getting sold off. Some people just want out at all costs, which eventually sets up the opportunity for the long term. After this initial phase, the selling becomes more discernible. And lower quality names, names with new earnings, names that have financial leverage, or operational leverage, names that have much higher PE multiples, tend to get sold off more. And that's what we're seeing right now in Small Cap. The Small Cap stocks have underperformed larger caps by more than 10% here today, as of March 16th, according to the data from Russel. Almost a third of the companies in the Russel 2000 index have no earnings. Our quality positions have held up very well and has helped our relative return in Small Cap year to date. We've always told our clients that we build portfolios with a full market cycle in mind. From a long term strategic perspective, we construct portfolios with material exposure to value, momentum, and stability. Those are our Alpha sources. Tactically, we can move around these positions and last week I allocated more exposure to quality. A few of our managers are also adding to more higher quality names.
- Great. How are the portfolios positioned for the future?
- Well that's where our exposure to value and momentum come in. The value tends to out perform coming out of recessions and improving economic conditions. I mean, think about the cyclical names, industrials, financials, materials, consumer discretionary names. There's a reversion to the mean and these type of stocks tend to do well. For momentum, we have exposure, not only to price momentum, but also earnings revisions. Right now, earnings are being cut but we expect there to be a rebound eventually, and companies with better positive earnings revisions should do well.
- Steve, where do you see opportunities in the market right now?
- In terms of opportunities, we see some dramatic dislocations in the market. Our portfolios are built for the long term, but at the margin, some of our managers are seeing opportunities in oversold sectors such as financials, consumer discretionary. Within consumer discretionary, particularly at this part in the cycle, restaurants, entertainment, retail names, look particularly attractive. Within industries and within sectors, individual stock payers or trades can also present some nice opportunities. And Large Cap as well as Small Cap, we're still fully committed to value positioning, as the sub advisers we work with. Although the Russel 1000 Growth Index has been notably beating the Russel 1000 Value Index by about a thousand basis points here to date, there's substantial argument to stay the course. Spreads are more than two standard deviations wide, and this only happens fewer than 5% of the time. So very attractive levels. In terms of activity, in Large Cap we're seeing some reductions in travel related companies, and some reductions in oil stocks. The commitment to the currently, very attractively valued financial services sector, remains consistent. As does an underway to the Mega Cap growth stocks, which are believed to be expensive even after the selloff.
- Do you think this is a good time for active management?
- [Steve] I do think this is a good time for active management, particularly at this start, this part in the cycle. There are five different factors we look at, and the two most important ones are stock correlations and stock dispersions. Active management tends to do well when correlations of stocks are low, and dispersions are really wide. The Bull Market was very conducive for passive. It was a narrow market, concentrated in the FAANG stocks. Correlations were very high, dispersions were very low, and that narrow market, the FAANG stocks provided the leadership. In Small Cap, the higher beta junkier names did well, and we underperformed on a relative basis because of our quality and value exposure. But after that initial phase of indiscriminate selling, we would expect there to be more discernment for investors. And for investors to pay more attention and favor companies with good fundamentals, attractive valuations, and just overall good business models. When markets are flat to down, and Large Cap under-performs Small Cap, and Large Cap under-performs the international, those are the three other factors. This is also a tail win for active management. So we're starting to see a few of these things emerge, but we would expect more after the indiscriminate selling was over.
- How can investors put a value on the market and companies when many of the companies are now closed?
- Longer term, about 80% of the markets return is determined by the level of earnings. So company earnings drive the market. Earnings only determine about 20% of the market's return in the short term. PE multiple determines 80% of the return, and that's what we're seeing now when the markets are getting irrational.
- We've seen bear markets and corrections before. Why don't you tell us where you think we are today, and what you anticipate in the near future.
- Sure, and to put it in perspective, I'll look at the two different recessions we've had. The 2001 recession, SMP earnings were down about 27%. The market actually ended the year down 10%, as it started to look through the trough of the earnings and look through to the recovery. And the global financial crisis, earnings and SMP companies were down about 50%. They were down about 18% in 2008, and 34% in 09. Interestingly, the market, and I'll define that as the SEP 500, that was down 37% in 2008 and ended up 20% in 09, even though earnings were down. So that's the PE multiple expansion I was talking about earlier. The short term that can really determine some of the returns. Currently, Consensus still has earnings growing mid, single digits for the entire year. However, we expect that to drop into negative territory as revisions collapse. We would expect more negative revisions to follow. This is really a fluid situation, and new data points are coming out every minute it seems. The markets do not like uncertainty, they do not like the fear of the unknown. What we witnessed in China is that their equity market bottomed so far, the same day as the reported number of cases and the suspected number of cases peaked on February 3rd. They may retest this level with the rest of the world's equity markets weighing on them, but at least temporarily markets tended to settle and stabilize when the peak rates and cases have been logged.
- [Kevin] So Steve, in closing what would you say to an investor in the SEI funds?
- So these are trying times, no doubt. The volatility is high, but I would say stay the course. Strategically, the portfolios are built for a long term investment horizon. I think it's important for people to stick to their goals. This is a great opportunity, we are seeing some very attractive levels for evaluations. We have some attractive opportunities the way the portfolio's positioned with value, with momentum and stability. And so again, these are trying times, but I do think the portfolios are all weathered, provide nice diversity, and will help investors reach their goals. As long as they don't panic at the wrong time.
- Great, thanks Steve.
Glossary of Terms:
- Alpha source: Our strategies are designed to capitalize on long-term drivers of market performance through exposure to persistent sources of returns such as mean reversion, trend-following and stability. We have refined our approach to identifying these alpha sources and the factor groups we employ as proxies to measure and capture their performance.
- Momentum Alpha Source: The investment manager seeks to benefit from investor under-reaction—due to anchoring. Such groups of stocks trend in price as perceptions change directionally and serially with incoming data, leading to herding behavior by investors.
- Stability Alpha Source: The investment manager seeks to benefit from investor tendency to undervalue lower-risk, higher-stability businesses—resulting from a focus on short time horizons and overconfidence in forecasts for momentum-driven stocks. Stability-oriented stocks have the power to exceed market expectations by consistently outperforming (rather than reverting to average market returns) and through the power of stable, long-term compounding.
- Value Alpha Source: The investment manager seeks to benefit from investor overreaction—resulting from aversion to loss. Such groups of stocks revert to the mean, as fear over the perception of the investment’s risk dissipates.
- Basis point: One basis point is equal to 1/100th of 1%.
- Beta: Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
- Correction: A correction is a decline of 10% or greater in the price of a security, asset, or a financial market.
- Correlation: Correlation is a statistic that measures the degree to which two securities move in relation to each other.
- FAANG Stocks: FAANG stocks are Facebook, Amazon, Apple, Netflix and Alphabet (formerly Google).
- Price-to-Earnings Ratio: The price-to-earnings ratio is the most recent price of a security divided by the company’s annual fiscal year basis earnings per share. Price to book ratio is the most recent price of a security divided by the company’s annual fiscal year basis book value per share.
- Standard Deviation: Standard deviation is applied to the annual rate of return of an investment to measure the investment's volatility. Standard deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility.
Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company.
Investing involves risk including possible loss of principal. . Bonds and bond funds will decrease in value as interest rates rise. High yield bonds involve greater risks of default or downgrade and are more volatile than investment grade securities, due to the speculative nature of their investments.
Diversification may not protect against market risk. There can be no assurance the goals will be met.