It’s checkers not chess.

At RBA, we strictly focus on macro fundamentals, and the data during 2016 seemed to be clearly suggesting investors were too defensively positioned. A focus on defensive income rather than on growth ultimately curtailed many investors’ 2016 performance.

There is an old saying that “It’s chess, not checkers”, which implies that things are more complicated than one might expect. However, right now we view the markets as being more checkers than chess. The stock and bond markets’ performances are currently based on a rather simple construct: when in the past has Washington, DC ever proposed significant fiscal stimulus when the economy was NOT in recession? Answer: never. Adding significant fiscal stimulus to a healthy, albeit not robust, economy is virtually unprecedented.

Many have ascribed the markets’ performances solely to a post-election surprise, but the performance trends seen after the election actually began in the first quarter of 2016. The markets have been forecasting an improving global economy for 10 months, and not simply for 10 weeks. The post-election acceleration in the stock market’s performance, however, strongly supports our point. Why wouldn’t the stock market like (and the bond market dislike) this unprecedented situation?

It’s checkers, not chess.

Focus on low quality and cyclicality

2016’s sector and size performance clearly suggested that corporate profits would improve more than investors expected. Chart 1 shows 2016 sector performance, and cyclical sectors dominated 2016’s returns. Four of the top five performing sectors during the year (Energy, Financials, Industrials, and Materials) are cyclical sectors. Charts 2-4 show second, third, and fourth quarter sector returns. The rotation toward cyclical shares began long before Election Day. Although Energy was the only cyclical sector to dominate performance during the second quarter, the cyclical leadership clearly broadened during the third quarter.

Similarly, Chart 5 shows 2016 total returns by style and size. More cyclical indices (i.e., small value) significantly outperformed more defensive ones (i.e., large growth).

2016 S&P 500® Sector Performance

2nd Qtr 2016 S&P 500® Sector Performance

3rd Qtr 2016 S&P 500® Sector Performance

4th Qtr 2016 S&P 500® Sector Performance

Source: Bloomberg Finance L.P.


Source: Richard Bernstein Advisors LLC, Bloomberg Finance L.P.