CTWM Investment Committee: Portfolio UpdateSubmitted by Connecticut Wealth Management, LLC on June 6th, 2018
When you last heard from us in mid-February, we were amidst a period of heightened stock market volatility, and it was at that time that we noted how the economic indicators we study still suggested that solid market fundamentals would prevail in the near term. The results of the first quarter earnings season, which just wrapped up last month, continue to make that case. The S&P 500 Index, which represents the 500 largest US companies, grew earnings 26% year over year, the best in eight years. The percentage of companies who beat earnings estimates was approximately 78%, which is outsized by historical standards. Estimates for the next four quarters rose during reporting season, a somewhat rare yet positive development. By just about any measure, it was an incredible show of strength by US companies.
Despite these optimistic earnings releases, the market’s reaction was somewhat muted. As a result of this subdued response, and continuing with the theme we initiated last year, we believe the time is right to further trim areas of the portfolio that have performed incredibly well and have driven returns over the last several years, in order to reallocate to areas that may be poised for outpaced growth going forward. Specifically, the Investment Committee has voted to reduce our US large cap stock allocation, lock in these additional gains, and reallocate the proceeds to US small cap stocks and emerging market stocks.
When we wrote in January regarding potential beneficiaries of corporate tax reform, we noted that small cap stocks were likely to represent a significant part of this camp. This notion has proven true as the Russell 2000 Index has outperformed the S&P 500 this year. While you have benefited from your current small cap exposure, we believe this growth is sustainable, that tax reform will continue to be a tailwind, and that a slight increase to our allocation is warranted. Further, small cap stocks are more insulated from potential trade war risks since a smaller portion of their revenues are derived from overseas. We recognize that small cap stocks have historically been a more volatile asset class, so while we believe prospects for growth are compelling, we are only advocating a small increase as to control risk in your portfolio.
The key theme behind increasing our emerging market allocation is the prospect for faster economic growth. Emerging market stocks have historically done well when economic growth has accelerated relative to growth in developed economies. The expectations for the growth differential continues to widen due to advantageous demographics and commodity gains. While a recent strong US dollar and trade policy concerns have put some pressure on the asset class, we believe most of the largest emerging economies are in a good position to weather dollar gains and negotiate favorable trade agreements. In fact, this recent weakness has created an even better buying opportunity from a valuation perspective.
As always, if you have any questions, please do not hesitate to reach out to us.