June 6th just seems to be a magical day for our country… On this most recent one, American Pharoah won the final leg of horse racing’s Triple Crown, the Belmont Stakes, becoming the first horse to accomplish this fete since Affirmed in 1978. Instantly, comparisons to legendary horses of the past were made, especially to the greatest of them all, Secretariat. Are these comparisons fair? Who can say, but they sure are fun to make…
The older I get the more comparisons I seem to make, and the more I reminisce about the good old days. Knowledge of history allows us to measure our accomplishments, and apply perspective to challenges yet to be overcome. We can contemplate this individually or more broadly at a societal level.
Comparisons are central to our society, and perhaps in no arena is it more central than in politics. How does your favorite candidate compare to all the others? Which differentiating factors will determine your ultimate vote? From an investment perspective, this may be the key question – How will our economy and markets be impacted by who wins the 2016 presidential election? We will be asking these and similar questions countless times over the next year and a half.
In the meantime, market strategists are formulating all kinds of “what-if” scenarios and strategies based on potential election results. An important aspect of our investment process is developing contingent strategies for various economic scenarios. It is not only interesting to think through “what-if” scenarios, it is a critical component of prudent risk management.
Analysts and portfolio managers make comparisons as an integral part of the analytical process as they search for attractive investment opportunities. It is nearly impossible to identify value without making a comparison to some standard or historical benchmark.
How does the current economic environment measure up?
The global economy is struggling. In the U.S., we are experiencing the weakest recovery in the post-war era. Yet the stock market has recently set an all-time high. The markets have advanced for 6 ½ years, despite this stubbornly slow growth. In that respect, this recent market cycle is unlike most cycles of the past. Digging a little deeper we see several factors which make this cycle very unique. First, interest rates are at historic lows for this point in the economic cycle. Second, government regulation and involvement in the economy has reached unprecedented levels. Third, corporations have generated record levels of cash, mostly in foreign operations, where it largely remains due to high U.S. corporate tax rates.
So far in 2015, the best performing sector is Health Care. The two key drivers of this out performance are demographics and innovation. First, the world population is aging, resulting in increased spending on medical care. Second, innovation continues to be the cornerstone of the major segments of health care, especially Biotechnology and Pharmaceuticals. Importantly, the market tends to pay huge premiums for companies that can grow through innovation, therefore overcoming the drag from the slow-growth, over-regulated macro economy. The overall weight in health care in the S&P 500 is approximately 15.2%, the highest level in over 15 years. It is likely to go even higher. But how high can it go?
Back in the mid-1990s, the development and explosive growth of the Internet drove the Technology sector from 5% of the S&P 500 to nearly 30%, over a seven-year span. While the driving forces behind the growth in health care are not nearly as powerful, as the build out of the Internet, they are meaningful enough to drive the sector higher.
But how did the story end?
Toward the end of the 1990s, the overwhelming consensus was that technology stocks would move ever higher. I remember being reprimanded for paring back on a few tech stocks because they were becoming too large a percentage of the overall portfolio. Prudent risk management is never popular during a roaring bull market, but that is when it is most important.
When the technology stocks crashed in early 2000, investors searched for a new leadership theme. And when health care stocks eventually top out at the end of the current cycle, investors will do the same. Inside Willingdon we are already having spirited debates about which sector will be the next to lead. Our goal is always to balance current market momentum with potential, market-changing political and economic developments. History shows that virtually every economic sector will lead at some point. It also shows that every sector will lag for some period of time as well. These rotations are difficult to predict, but important to analyze nonetheless.
Back to the track for a final thought…
Spectacular Bid was the greatest horse not to have won the Triple Crown, waylaid by a safety pin on the morning of the final leg in 1979. The horse was the odds on favorite to win the Belmont and Triple Crown. But it was not to be. On the grand stage in sports, in our communities, or within our own lives, we celebrate success. But when we fall short, the forever wondering of what might have been haunts us, and inspires us at the same time. It’s what brings us back the next year, to try once more.
