Market Performance Analysis in the First Half of 2021: Investment Strategies and Future Outlook

It's starting to become a habit for some time now. Semester after semester the market beats my portfolio almost systematically, climbing ever higher, to the firmament. The implementation of the determining portfolio in January 2020 failed to correct this, even though it performed very well last year. It must be said that when the market is as bullish as it is now, it is difficult, if not impossible, to beat it by resorting to asset allocation.

A market that is getting carried away

During these first six months, the Swiss Performance Index has exploded by 14.7%. This is huge in such a short time, even though it was already starting from very high at the beginning of the year. During the same time, my wallet settled for just over half, or 8%. If I were a fund manager, I would probably be signing on for unemployment benefits right now.

Toutefois, comme dit l'adage, comparaison n'est pas raison. La performance relative inférieure du portefeuille déterminant par rapport au marché ne veut pas dire que la stratégie utilisée est inappropriée. En tout cas pas sur une période aussi courte. Au contraire, à regarder de plus près, cette stratégie répond parfaitement aux attentes. Elle donne également bien plus de gages de sécurité que le marché par rapport aux défis qui nous attendent. Il y a quatre éléments qui le démontrent : le mode de fonctionnement du portefeuille, la valorisation des actions et l'inflation.

How the wallet works

The determining portfolio is composed of various assets (not only stocks). I reallocate them once a month based on their valuation, momentum, volatility and a macroeconomic criterion. We are therefore very far from a buy & hold portfolio at 100% invested in stocks (like the market). My book will give you more details on the strategy followed and the scientific foundations which support it.

One of the goals of allocating multiple assets within a portfolio is to reduce its overall volatility. This allows, as described in my book, to shorten the time needed to become financially independent. The other positive point, which goes hand in hand with a reduction in volatility, is to smooth out performance and avoid negative periods that are too frequent and too large.

Along the same lines, the preference for value stocks over growth stocks also makes it possible to reduce the volatility of a portfolio, while ensuring better performance, in the long term.

The counterpart of asset allocation and the preference given to value stocks is that you have to accept being beaten by the market when it is clearly overheating. You can't chase two hares at once. If we look at the performance of this first half, annualized, that gives us 16%. That's already very good. That's what we can expect from it in the long term according to the backtests (see my work). So we are perfectly in the shot.

A large proportion of cash

Let us also note that the selection of value stocks is becoming increasingly difficult because of the market level. Thus, during this first half of the year, the portfolio averaged around 30% of cash, for want of anything better. The model certainly gave a target allocation of almost zero in cash, but I was not able to find enough stocks worthy of interest to achieve this. Achieving a performance of 16% annualized with a third of the portfolio positioned in cash is a very good result. Above all, it allows us to better prepare for a future market correction.

The valuation of shares

A positioning at 100% in shares was certainly the right strategy to follow in recent months. Obviously, we are always smarter afterwards. The question we need to ask ourselves is whether we are currently ready to invest all of our savings in shares. The valuations currently prevailing on the market are scary. Investors' expectations are totally unreasonable with regard to companies, despite the so far unconditional support of central banks.

THE Schiller PE Ratio has significantly exceeded the one that prevailed before Black Tuesday. It is not even far from the one that was in force during the 2000s, initiating a lost decade for the stock market, with two big bear markets.

Pire, le "Buffett Ratio", comparant la valorisation du marché US au PIB, n'a jamais été aussi élevé :

Inflation

If the markets have risen so much over the past ten years, it is thanks to the massive injections of liquidity by central banks, led by the Fed. Governments have supported them in this process, particularly since 2020, to counter the effects of the coronavirus. These accommodative policies have been able to persist for so long because inflation has remained very low for a long time.

However, the massive aid from central banks and governments last year seems to have been the straw that broke the camel's back. I already talked about it in last April : inflation is back, even if the markets seem to be totally ignoring it for the moment. We can clearly see it taking off in the USA since the beginning of this year in the graph below:

The sudden stoppage of the global production machine during the last year, followed by a very rapid return of demand, has revealed the fragility of the "just in time" supply model and our dependence on China. Currently, there are a huge number of products that require months of waiting before they can be delivered, in all areas of activity. The temporary accidental closure of the Suez Canal has not helped. All this puts additional pressure on prices.

Moreover, not only has inflation risen very quickly, but it has not been this high since 2000 and 2008, just before the two major bear markets.

The impact on interest rates and assets

The problem with high inflation is that it puts pressure on the big moneymen to raise interest rates. The Fed has recently announced that it was planning two rate hikes as early as 2023. However, it is likely that these hikes will come much earlier because of the rapid rise in inflation.

Des taux d'intérêts en hausse sont mauvais pour les actions de croissance et les obligations. Les entreprises qui se sont fortement endettées ces dernières années et qui survivent uniquement parce que les taux d'intérêts sont faibles sont particulièrement exposées. Les attentes déraisonnables des investisseurs vis-à-vis de certaines chimères comme Tesla risquent alors d'engendrer des réveils difficiles.  A contrario, l'attrait pour les titres de valeur augmente notablement lors des phases de hausse des taux d'intérêts. C'est le cas justement parce que ces sociétés sont faiblement endettées, bien gérées et bon marché. C'est un juste retour à la normalité des principes économiques et financiers.

Conclusion

The wait is long, but patience will eventually pay off. As the days go by, we get closer to the day of the big correction. The indicators are in bright red. The market is very high and macroeconomic conditions are unfavorable for growth stocks. It would be unwise to play the fool, buying expensive stocks hoping to sell them even more expensive. In the meantime, it is better to maintain a diversified portfolio across several types of assets and favor value stocks over growth stocks. Even if it means accepting to be beaten by the market again, at least for a while.