"When the facts change, I change my mind. What do you do sir?"
-John Maynard Keynes
The first quarter of 2012 is in the books, and overall it was a very good quarter for risk assets (the riskier the better), but performance varied widely. The S&P 500 was up 12.66%, which was the best performance since the Tech bubble in 1998. Of course 2012 is very different than 1998. In 1998 risk-free Treasury Bills yielded 5%, real GDP growth was 4%, housing markets were strong, and unemployment was below 5%. 2012's rally is much different.
This years rally is led by last years losers. Bank of America (2011's worst Dow performer) was up 72% in the first quarter, while Sear's Holdings was up 108%, even though they don't expect to make money this year or next. In the S&P 500 low-quality stocks outperformed high-quality stocks by 5%. And in the Russell 1000, high-volatilty stocks outperformed low volatility stocks by 9%. Safer, higher-yielding stocks were the quarters laggards; with utilities down 3%, telecom flat, energy MLP's up 1%, and staples up just 5%. We used to call this type of rally "low quality," it is also known as a "dead cat bounce." When the fear of total collapse fades, those companies that were priced for failure have the biggest bounces.
This "low quality" rally was global in nature. Japan, one of the worst equity markets for 20 years, was up 19%, its best 1st Q since 1988. Emerging markets were up 13%, and even Greece managed to gain 7% while defaulting on their debt.
One quality asset did soar...Apple. Apple was up 48%, and accounted for nearly 20% of the appreciation in the S&P 500. It is now 4% of the S&P 500 and 11% of the NASDAQ. Even more startling, the S&P 500's year-over-year earnings growth is estimated at 7.8%, if you exclude Apple's 117% earnings growth, the overall market's growth drops to 2.7%! (It's only a matter of time before our President discovers these obscene profits and taxes the innovation out of them, its hell being successful in the USofA).
The 1st Q also saw some better economic numbers trickle out. US manufacturing is stronger, and employment is showing slight signs of improvement. Some of this may be due to the warmest winter in a hundred years, and it will be interesting to see what happens when weather is more normal. Signs of an improving economy are leading some to believe that the Fed's days of all-out liquidity and ZIRP are nearing their end. If this is the case than there will be one less massive buyer of Treasury debt, and interest rates will head higher. We started to see some signs of this in the late stages of the 1st Q. Long-term US Treasuries were down 3.5% on the quarter.
Overall most balanced investors should have had a fairly positive 1st Quarter, with their gains in equity markets offsetting their losses in the fixed income markets.
Here is a closer look at how the specific assets we invest in at Rockhaven performed:
Rockhaven Global Tactical Asset Allocation Model:
Our average client account was up about 4% on the quarter, even with a very defensive portfolio that began the year with 29.5% invested in cash and currencies.
US Equities were strong performers in the 1st quarter, the S&P 500 was up 12.66%, and the Vanguard Total Market ETF (VTI) that we use was up 12.85%. We have been at our maximum bullish weight in US Equities of 20% for the entire quarter.
International Equities were also stellar performers this quarter. Our EAFE Index ETF (EFA) was up 10.82%, and the Vanguard Emerging Markets Index (VWO) was up 13.76%. We started the year at minimal weights in these two assets of 3% and 2% respectively, but ended the quarter at our maximum allocation of 10% each.
Gold and Gold Miners were extremely volatile during the quarter, with Gold (GLD) finishing up 6.66%, and Gold Miners (GDX) falling -3.68%. Gold began the quarter at a neutral 4% weight and has ended the quarter at 4% also. Gold Miners have remained at a bearish 2% allocation the entire quarter.
US REITs, specifically the Vanguard MSCI REIT Index (VNQ), was up 10.60% for the quarter and our allocation remained at a maximum weight of 6%. International REITs, specifically the iShares FTSE-NAREIT Index (IFGL), was up 14.68%, and our allocation grew from a bearish 2% at year-end to a bullish 4% at quarter-end.
Commodities also did well during the first quarter. The broad based DB Commodity Index (DBC) was up 7.30%, and our allocation rose from a bearish 3% at year-end to a bullish 6% at quarter-end. The more narrowly focused equity agriculture index appropriately named (MOO) was up 12.04%, and again our exposure increased from a bearish 2% at year-end to a bullish 4% at quarter-end.
Fixed Income is the asset category that struggled the most, with long-term interest rates spiking up and 10-20 year US Treasuries falling -3.48% for the quarter. Our main fixed income holding, the Vanguard Long-Term Bond ETF (BLV) did slightly better and was down -2.73%. We started the year at a maximum 13% weight and ended the quarter at a neutral 9%.
Treasury Inflation Protected Bonds (TIP) managed a slight gain of 0.82%, while our allocation remained at a bullish level of 4.5% the entire quarter.
Due to their equity sensitivity, High-Yield Bonds (HYG) managed a gain of 2.63%. Our allocation increased from a neutral 3.5% at year-end to a bullish 5% at quarter-end.
Our Energy Master Limited Partnerships (AMJ) were up 1.61%, while the allocation remained at a bullish 3.5% for the entire quarter.
Our allocation to Emerging Market Bonds (ELD) was up a strong 7.50%, and our weight increased from a bearish 2% at year-end to a bullish 4% at quarter-end.
Our currency allocations were slightly positive. The Chinese Yuan (CYB) appreciated 0.63%, while the Australian Dollar (FXA) increased 2.11% for the quarter.
Our cash allocation decreased from 21.50% at year-end to 4% at quarter-end.
Here is how the portfolio looked at year-end:
And here is how it looks at quarter-end (These returns are for a 1 year period ending 3/31/12):
What is obvious from reviewing these graphs is that as riskier assets have performed better in the first quarter our allocation has shifted from a more balanced Risk-Off to a Risk-On position. We've seen a big reduction in cash and a subsequent increase in international equities.
Our goal at Rockhaven is to try and stay in harmony with the markets. We want to avoid big secular declines, and participate in big secular rallies. Our diversification helps protect us during periods of cyclical noise. We're not trying to forecast the future, we're just trying to participate and protect our assets. We'll only know after the fact whether or not this equity rally has legs, or whether the recent sell-off in bonds is the beginning of a longer-term decline. One thing you can be sure of is that we'll continue to adapt and change to survive.
Be careful out there, and keep the lights on,
Chris Wiles, CFA
412-260-7917
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This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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