2019 Mid-year Equity Scorecard

We look at where we were right and wrong in the first half of 2019 and look to what to expect for the rest of the year.

As is our custom, it’s time to put on the big boy pants of accountability to discuss where we were right and as importantly, where we’ve been wrong so far this year.

Where We Were Right

Our trade ideas for the Gravitational 15 portfolio have skewed the odds of success in your favor as we’ve clipped 71% winners in our closed trades so far this year and 80% winners over the last 24 closed trades.

In addition to our trade ideas, our macro themes have focused you in the U.S. markets with the best risk-return profiles on the long side. 

Our U.S. Shift Work call to be long utilities (+12.7%), REITs (+17.2%) and Treasuries (+9.3%) has gotten us paid, with minimal year-to-date drawdowns of -3.4%, -5.1%, and -3.5%, respectively.

You’re probably thinking, “Everything has gone up this year, getting longs right in this environment is a given.” To that, I channel my inner Lee Corso, “Not so fast, my friend!”

Most investors forget that not all returns are created equal, from a risk perspective. We aren’t trying to generate returns based on the beta, or the embedded risk in the market, alone. Anyone can ride the beta wave up; the problem is you’re forced to ride it on the way down as well!

In contrast, we focus on generating the best absolute, risk-adjusted, returns the prevailing Fundamental Gravity environment will allow.

For instance, both biotech (+13.2%) and utilities (+12.7%) have delivered approximately the same return so far this year. However, on the path to providing those fantastic double-digit returns, biotech stocks experienced a -13.1% drawdown, while utilities experienced a -3.5% peak-to-trough decline. The $64,000 question is: which +13% return would you rather have?

One look at the reward-to-risk (R-2-R) profiles of our long calls and you’ll notice that the R-2-R profiles are more than three-to-one, meaning you’ve only had to experience a dollar’s worth of drawdown to earn $3.

We’ve been riding and dying with utilities, REITs, and Treasuries since last September and there is no reason to change horses now. The fact that U.S. growth will continue to slow ensures that the Fundamental Gravity environment will remain bullish for these asset classes as we traverse the second half of the year.

Where We Were Wrong

Hindsight is a wonderful thing, isn’t it? Hindsight tells us that U.S. equities (the S&P 500) just experienced the 10th best first six months of a calendar year, ever!

Despite the Winter and Fall FG environments in Q1 and Q2, financials (+15.9%) and basic materials (+15.8%) have followed the broader market higher and posted double-digit gains. Our short call on retailers has worked out a bit better, with a +3.4% year to date gain and a 13.0% drawdown in the first six months, at least the reward has been skewed to the downside, nearly 4-to-1.

Despite the uber-bullish price action so far, our timing for short trades in the Gravitational 15 portfolio has been better than bad with a 67%-win rate on the 12 closed trades this year.

I’m not one to stubbornly stick with a call for ego. We are in this business to get more calls right than wrong and to make sure we get the correct calls really right and the wrong calls only slightly wrong.

We’ve stuck with these bearish biases because the data has backed our play, even if the price action has not. Our U.S. Shift Work-driven call is to remain bearish on financials, basic materials, and small caps as well as being short retailers via Retail-iation. The Winter Fundamental Gravity environment is being confirmed with every data point released, and the coming earnings recession will have the last bearish laugh.

Financial markets may have disconnected from the underlying Fundamental Gravity environment for the first four months of the year, but there has been a subtle re-alignment over the last eight weeks. This re-alignment adds to our conviction to maintain a short bias for these markets and to consider any meaningful rally a short selling opportunity.

That Was Then; This Is Now

There is no question that U.S. equity markets have ripped this year, but what most investors don’t realize is that over the last six months, it’s been a tale of two markets.

From Jan. 2 through April 28 the return profiles for our bearish markets (and the S&P 500) look like this:

• S&P 500: 18.0% gain, with a 2.4% drawdown (7.5-to-1 in favor of the bull)
• Financials: 17.2% gain, with a 6.2% drawdown (2.7-to-1)
• Basic Materials: 13.6% gain, with a 3.2% pullback (4.3-to-1)
• Small Caps: 17.9% gain, with a 5.2% drawdown (3.4-to-1)
• Small Cap Value: 15.2% gain, with a max decline of -6.6% (2.3-to-1)
• Retailers: 10.2% gain, with a 5.7% pullback (1.8-to-1)

The reward-to-risk profiles were heavily skewed in favor of the bulls.

However, the return profiles since May 1 have completely flipped:

• S&P 500: 0.9% gain, with a 6.6% max decline (0.13-to-1)
• Financials: -0.20% gain, with a 7.3% drawdown (all downside)
• Basic Materials: 4.3% gain, with a 6.9% pullback (1.6-to-1)
• Small Caps: -0.5% gain, with a 9.3% drawdown (all downside)
• Small Cap Value: -1.9% gain, with a max decline of 9.5% (all downside)
• Retailers: 5.6% loss, with a -12.6% correction (all downside)

And while these markets have realigned with the bearish prevailing Fundamental Gravity for the last two months, our three longs have all printed brand-new all-time highs.

The bottom line is that we’re back to getting paid on both sides of the U.S. Shift Work macro theme. Our longs have gained an additional 4.13% (on average), and our bearish markets have once again headed south with an average return of -0.78%. A two-month relative outperformance of 491 basis points is good enough to hang a hedge fund shingle, charge 2 and 20, and outperform 80% of the competition.

The Bottom Line

Capturing economic and financial market data and contextualizing it is something the Old Institution and its followers find very difficult to do. It takes a disciplined, time-tested approach to measure the slopes and extremes in economic and financial market data across several hundred markets in all four major asset classes across 27 economies globally. Beyond that, it takes a unique skill set to contextualize all of that data to formulate accurate market calls (our macro themes) and then to trade those calls in a risk-conscious manner profitably.

As I’m fond of saying, the game is always played in front of us and never behind. The first half of 2019 is in the books, and it’s time for me to get back to the global macro grind because the second half of the 2019 investing game is on.

Enjoy this latest monthly edition of Gravitational Edge!

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