In this episode of Markets in Focus

Value came roaring back in late 2020 after years of growth dominance. But the next strategic play for investors might not be at either style extreme. Steve Singleton, Head of Risk for Carillon Tower Advisers, joins Matt Orton, CFA, Director and Portfolio Specialist, to discuss tactics.

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Transcript

Matt Orton:
In our last episode, we discussed some of the significant contrasts of 2020 notably in the small cap space and what that might mean going forward. But the meaningful contrasts weren't limited to just small cap equities. We saw a massive performance differential between growth and value indices across market capitalizations for most of last year, but a sharp reversal towards the end of the year has led value to stage an equally strong comeback that's continuing today.

This is Markets in Focus from Carillon Tower Advisers. I'm your host, Matt Orton. Join me and my colleagues as we discuss the latest trends and developments driving the markets, visit us at marketsinfocuspodcast.com for additional episodes and insights.

I'm lucky to be joined by Steve Singleton, Head of Risk at Carillon Tower Advisers, and developer of a proprietary risk analytics platform that helps us among other things understand and contextualize factor performance in the market. Steve, thanks for being here today.

Steve Singleton:
Yeah. Thanks, Matt. Glad to be here.

Matt Orton:
Great to have you. And I think it would make sense to go back a few months and dig a little bit deeper into the reversals we saw in November with respect to growth and value, particularly after the positive vaccine news was announced. So Steve, maybe you can set the stage for our listeners for what we saw happened.

Steve Singleton:
Sure, Matt, I think what happened in 2020 overall was quite historic. We entered 2020, essentially, already in what we would consider an elongated recovery cycle from the great recession of 2008. At the time, there were thoughts that perhaps we were going to take a pause, but then we were introduced to COVID-19 in January. That dramatically changed everything as interest rates plunged to historic lows, setting the stage for equities to really prosper in sort of a growth at any price type of environment. And so, longer duration equities which are, essentially, growth names did extraordinarily well and widened the gap between growth performance and value performance to some 3,500 basis points through the first three quarters of the year.

But then that changed as a discussion around vaccine development and deployment looked extraordinarily positive that we might be able to see something by year end, by Q1 of this year, and that essentially started the cyclical trade where we began to look at those beaten down value names, the stuff that would reopen in an environment where we saw vaccines that were successfully deployed being the driver. And so, that sort of what we began to see in November, and we saw into the end of the quarter and actually extending now through Q1.

Matt Orton:
One thing you said was interesting that the beaten down deep value names, because we definitely noticed a lot of, I'd say, the names that did the worst, starting to do the best in the fourth quarter. So maybe you can comment a little bit on, what I would say, deep value names initially driving that sort of value recovery. And then, are we starting to see some normalization from this right now?

Steve Singleton:
Yes. The deep value names are very deep value cyclical sectors that do well in a normal economy. So this is stuff like travel related, airlines, and cruise lines and some of the smaller sectors with mom and pop shops, these are areas that during the first nine months of 2020 found it very difficult to gain any footing as COVID, essentially, shut the economy down. And so, they had a very powerful snap back at the prospect that we would see vaccines deployed in such a way that we would be able to reopen the economy.

Matt Orton:
And do you think the out-performance of some of those names was a headwind or a tailwind for active managers?

Steve Singleton:
It was actually a tailwind for those managers that are actually a little more cyclically focused, and a bit of a headwind for those managers that tend to have portfolios that are structured with longer duration, very growth-like equities. You saw the latter group there underperform a bit in Q4 while the former group actually caught some footing and did quite well.

Matt Orton:
Yeah, I think it's particularly interesting when you look at active manager performance from the fourth quarter. One area that I think was hurt a little bit or especially hard came in the small cap space because in addition to this growth versus value change that we saw take place, we've also seen size reverse pretty sharply. We've seen a massive rally in small caps and micro-caps with momentum having a reversal. Maybe you can give some color around these factors that have been at play.

Steve Singleton:
No, absolutely. That's exactly it. It wasn't just growth versus value, size was big as well. As we were in the first nine months, the growth trade had a larger size component to it because it looked like some of the bigger technology names that could drive a sort of stay at home theme and that essentially alienated the smaller names. So again, we could see reopening on the horizon, the smaller names snapped back with a very, very powerful surge. And so, you saw the very smallest areas of it really pushed hard and lead that surge in through Q4 and now into Q1.

Matt Orton:
And so, I think the natural question then is, especially in your seat as someone who looks at risk for active managers, what sort of precautions can active managers take to protect their portfolios from these powerful surges that you described? Do you think there's any lessons that we can take from what's transpired over the past few months?

Steve Singleton:
Yeah, well, I think the difficulty that a transition, a very pronounced transition like we've seen in both style and size, which historically are the two most powerful factors that explain most of the market performance outside of beta to your respective benchmark, you actually need to essentially adhere to it on the size, with respect to size. That is if you're way up market cap stream, in a situation like that, you're going to probably underperform. There's just really no way to get yourself into the smaller areas. If you are leaned more way, one way towards growth, perhaps over value, it's probably a signal that you want to be a bit more diversified and even bifurcated to a certain extent where you own some of those names that perhaps you wouldn't own, or in this sector areas that you wouldn't own, just so you balance out the portfolio a little bit more and give it a more of a core feel rather than one style feel.

On the size piece, what's interesting there is that when you get these types of size moves, small size moves, right? Liquidity tends to put a finite end to the timeframe where that can actually run its course and hurt you. So typically we see, and in a case like what we have now, where micro-caps are moved really strongly, it only lasts three to six months because you can only get so much liquidity down into micro-cap. You can withstand some of that in that case. But the value versus growth thing is best mitigated through balance.

Matt Orton:
When you talk about balance, we're not talking about making wholesale changes to names in a portfolio, we're talking about making marginal changes making some slight weight changes, correct?

Steve Singleton:
Correct. That's the way that we think about it is we tend to use the concept of factors and factor tilting to lean us towards the exposure that we want.

Matt Orton:
Great. So I think maybe let's transition now from having talked about style and size and move into another I think important factor, which is momentum. And another theme that we have seen play out since the positive vaccine news has been that some of the biggest winners from last year have been struggling or still struggling and have been under increasing pressure with rising interest rates as well. And then you have sectors like energy and financials that have been on a tear with this reopening trade, like cruise companies and airlines. Do you foresee a normalization of this bifurcation and what are some ways that active managers can avoid being overexposed to these types of reversals?

Steve Singleton:
So with respect to normalization, I think we're seeing that begin actually right now where the stocks that the sectors and groups that did not do as well over the last six months are now beginning to do well again. Those are large cap in particular, it's technology in particular, it's the old growth trade. And it's sort of coming back while the cyclical trade takes a bit of a break here. And interestingly enough, it takes a bit of a break as interest rates are sort of taking a bit of a break here.

Matt Orton:
What are some steps that active managers can take to avoid being overexposed to these sorts of reversals that we've seen play out over the past couple of months?

Steve Singleton:
It's a really tough time. There's just tons of factor noise, if you will, that have gone on over the past several months. And really, it's a time for managers to be as balanced and diversified as possible. It's really a time for them to try to push the error or the gain into stock selection, but to be extremely balanced across factors and sectors.

Matt Orton:
In addition to this bifurcation you've seen, another trend that I've noticed playing out recently is that lower volatility stocks, the ones that tend to be more defensive, pay higher dividends and thus are more sensitive to increases in interest rates had been bouncing off of multi-decade lows with respect to the broader market. Do you think that this is just a short-term bounce or is there any reason to believe that low vol could start to perform better going forward?

Steve Singleton:
I think low vol and its connection really to yield and the yield factor will continue to be a play, a safe haven for this year. But again, it's not a place that I would go play, right? I would still consider it in a larger, broader context and themes. Yes, you will do fine if you've got dividend yielding stocks this year. Yes, you will do fine if you've got lower volatility names that are probably higher quality. Yes, you will do well if you've got that. But again, thinking about it in the larger context of a balanced diversified portfolio.

Matt Orton:
And so then, putting all of these together, how would you look at asset allocation from the perspective of an investor who's trying to play across all of the style boxes and is maybe concerned about some of the factor whiplash that we've been experiencing lately.

Steve Singleton:
Probably, more than any year in the last several, this is a year to be as balanced. Core should be a great, comfortable place to be and inequities. And that way you naturally bifurcate yourself across many of the themes that you've brought up.

Matt Orton:
When you're thinking about that from a portfolio management standpoint, what are some ways that you might recommend to help nudge yourself in that direction or say, you may have had a heavy exposure to growth or size or value or whatever it might be? Now, how can you kind of force yourself or think about making those changes?

Steve Singleton:
Typically, the factor that works best in a time like this is quality and it's actually really started picking up since the middle of last month. It was good for the quarter, but particularly strong since the middle of last month. What quality does is quality reaches across value and growth and reaches up into tiers of larger cap and down into tiers of smaller cap. Because again, what are we saying? We're looking for good balance sheets. We're looking for visibility in moats a year or two out rather than five to 10 years out. We want the balance sheet to be strong enough to support that, that is not too much debt, but enough to essentially help generate us a nice stable ROE. That's a diversifier in and of itself. It's a place where I think that managers are going to find themselves some nice performance.

Matt Orton:
And so, kind of putting this all together then, when you look across the market, what do you see as the key headwinds and tailwinds going forward and what scenarios might cause these to materialize?

Steve Singleton:
Let's start with headwinds first. I mean, obviously the bigger headwinds are that stimulus fails to stimulate due to perhaps not getting enough shots in arms in time to battle the variants that are in place right now. And thus, we can't open the economy, reopen it the way that we want to. So we're not going to see the GDP growth that we want to. So now, we don't have the GDP growth in place and we don't have anything else in place. That becomes a headwind going forward. Another potential headwind going forward is that all of the stimulus in place tends to actually look more inflationary than we're expecting right now. The thought is certainly coming from FED Chair, Powell, is that this is a transitory inflationary vision that we've seen, but if it becomes actually more permanent, that becomes a massive headwind to equities as well. Tailwinds are very simple. Everything works, right? Vaccines work, stimulus works. Growth is real. GDP growth is real. That's a very strong scenario for equities to move up into the low double digits again this year.

Matt Orton:
Kind of just building on that, if everything works, what about that big I word, inflation? What happens if we do manage to actually see tangible inflation that's not transitory? What happens if it's significantly more than we expect and it lasts?

Steve Singleton:
If that's the case, we will see corrective activity that will mute returns for 2021. 2021 could be a flat-ish year, perhaps even negative, if that happens.

Matt Orton:
I guess back to what you said before, that's another reason possibly to lean into quality like you described, right?

Steve Singleton:
Absolutely. Absolutely. And we think that quality is essentially equities' best safe haven for 2021.

Matt Orton:
Perfect. I think that is a great note to end on. I just want to thank everyone for staying tuned. And until next time, take care.

Thanks for listening to Markets in Focus from Carillon Tower Advisers. Please find additional episodes and market insight at marketsinfocuspodcast.com. You can also subscribe to our podcast on Apple podcasts, Spotify, or your favorite podcast app. Until next time, I'm Matt Orton.