Rotate!

The Earth rotates around the sun.  The wheel rotates allowing us to travel with ease. Baseball, football, and basketball each rely on rotation.  Records and CDs rotate to create beautiful music.[1]

The past few trading days growth sectors like technology have sold off while beaten down sectors such as retail have rallied.   The reason given for the selloff has been rotation as investors rotate between sectors.

What does rotation mean?  It means people sell high flying stocks to buy stocks offering more value.  Investors try and bounce between winners and losers hoping to sell at the top and buy at the bottom.

Rotation also means moving money between growth and value sectors.  Growth and value stocks will zig and zag throughout a market cycle.  Growth companies typically have strong revenue and earnings growth.  They pay little, if any, dividends as they plow their earnings back into the company to fund their explosive growth.  These companies tend to trade at higher valuations based on traditional benchmarks like the price to earnings ratio.  A few companies in the growth sector include Amazon, Facebook, and Nvidia.

Value companies usually have high dividends and low valuations.   These companies are mature and have been publicly traded for decades.  Companies in the value sector include Exxon, J&J, and JP Morgan.

Should you try to trade between growth and value?  Does it make sense to try and time the market so you’re either invested in growth or value?  Trying to move money between hot and cold sectors will give your portfolio lukewarm returns.  In addition, trading between sectors may increase your tax bill and lower your total return.

In 2016 the Vanguard Value Index Fund (VIVAX) returned 16.75% and the Vanguard Growth Index Fund (VIGRX) 5.99%.  The value fund outperformed the growth fund by 10.76%!  If you were chasing returns between growth and value, you would’ve sold your growth fund to buy the value fund.[2]

In 2017 the growth fund is up 26.73% and the value fund 15.27%.  The growth fund is outperforming the value fund by 11.46%!  Selling your growth fund last year to buy the value fund wouldn’t have been wise.

The two funds have rotated between outperforming and underperforming each other for many years so trying to move money between the two is foolish.  In fact, the 15-year total return for the growth fund is 9.62% and the value fund has returned 9.61%.

A $10,000 investment in these two funds in 1992 has generated similar results.  Today the value fund is worth $100,249 and the growth fund $98,048.  The difference between the two funds for the past 25 years has been $2,201 or $88 per year.

Here are few ideas to help you with your portfolio:

  • Diversify your holdings so you can take advantage of multiple sectors because you never know which one will do well. In the chart below from Dimensional Fund Advisors it shows three different companies: A, B & C.  These companies have had different price movements over time but when they are all included in your portfolio it will smooth out the long-term returns.

DFA Chart

 

  • Don’t let short-term market moves derail your long-term goals.  The stock market is constantly moving up and down so try not to sell at the bottom or buy at the top.  A buy and hold strategy allows your portfolio to participate in the long-term trend of the stock market.
  • Rebalance your accounts on an annual basis. It will force you to sell high and buy low.  This strategy will allow you to keep your asset allocation in check and reduce your risk over-time.
  • In addition to sectors, countries also move in and out of favor. In 2015 the Denmark stock market was the best performer in the world while Canada’s was last.  A year later these two countries flipped with Canada first and Denmark last.  Adding international investments to your portfolio will help reduce your risk. The chart below from Dimensional Fund Advisors highlights the performance of global markets dating back to 1997.

DFA Country

In 2018 focus on your goals and don’t worry about trying to find the hot sector.  Diversify your accounts and pay attention to your financial plan.  The stock market is in a constant state of rotation so keep your eyes fixated on the long-term horizon.

Can you hear me, Major Tom? ~ Space Odyssey, David Bowie.

Bill Parrott is the President and CEO of Parrott Wealth Management an independent, fee-only, fiduciary financial planning and investment management firm in Austin, TX.  For more information please visit www.parrottwealth.com.

December 5, 2017

Note:  Past performance is not a guarantee of future returns.  Your returns may differ than those posted in this blog.  Investments are not guaranteed.

[1] I’m dating myself but that’s okay.

[2] Morningstar Office Hypothetical tool for fund performance and ending valuations.