Consider Size and Country of Domicile When Investing in Quality Companies
Sources: Sources for data in tables: Equity Market and Fixed Income returns are from JP Morgan as of 4/24/2020. Rates and Economic Calendar Data from Bloomberg as of 4/24/2020. International developed markets measured by the MSCI EAFE Index, emerging markets measured by the MSCI EM Index. Sector performance is measured using GICS methodology.
Global equity markets fell for the week as significant supply/demand imbalances in the oil market, as well as the announcement of some disappointing antiviral COVID-19 trial results, weighed on investor sentiment. In the U.S., the S&P 500 Index meandered to a level of 2,837, representing a loss of 1.30%, while the Russell Midcap Index gave back 1.26% last week. Meanwhile, the Russell 2000 Index, a measure of the Nation’s smallest publicly traded firms, returned 0.33% over the week. Negative performance wasn’t limited to just U.S. equities, as developed and emerging markets moved 2.01% and 2.39% lower, respectively. Finally, the yield on the 10-year U.S. Treasury continued to slide lower, finishing the week at 0.60%.
With this said, it is important to remember that overall, the month of April has treated investors relatively well thus far, coming off a difficult February and even harsher March. As of April 24, 2020, the S&P 500 Index has increased by 9.88% on a total return basis thus far during the month of April.
We’ve spent a good deal of time discussing our preference in this environment for U.S. Large Cap Quality stocks, defining quality companies as those that exhibit stable and robust balance sheets absent of excessive leverage, a consistent track record of increased and growing profitability, and a skillful and experienced management team. Most of the conversation thus far has centered on the importance of quality overall, but two underlying considerations are critical as well: country of domicile and market capitalization. In other words, targeting only quality companies might not produce the desired result unless those quality companies are also categorized as Large Cap, or having a market cap above $8 billion, and domiciled (and often incorporated) in the United States.
Why consider U.S. domiciled companies?
Investors learned in the aftermath of the Great Financial Crisis of 2008/2009 that those countries that provided coordinated and sizeable monetary and fiscal aid subsequently went on to produce the best performance over the following decade. For instance, the S&P 500 Index, which represents U.S. large-cap stocks, has returned 187% over the last ten years, compared to 33% by the MSCI EAFE Index, which represents developed international equities. Now, consider the fiscal packages put together by sovereign nations and trading regions around the world to deal with the current COVID related crisis. The stimulus package created by the U.S. should likely pack a much more powerful punch than what’s currently being proposed, or has been put in place, by any other nation or region. The sheer size and scope of the relief packages created by the U.S. relative to all other countries gives us confidence in the belief that a recovery roadmap similar to the last decade in which the U.S. outperforms all others is plausible.
Why consider Large Cap over Small Cap?
Smaller sized companies have historically produced higher long-term returns than their larger counterparts. However, they also tend to be more volatile and thus liable to see more significant price swings. One of the primary causes of the increased volatility innate to smaller companies is debt. The consequence of debt for a corporation is akin to the consequence of leverage for an investor in that both positive and negative results are enhanced. That can spell trouble in a highly unusual and uncertain economic environment, especially for smaller companies that have historically operated with higher levels of debt than their larger counterparts. This trend has become even more pronounced over the last five years, leading us to believe that some of these companies may continue to struggle in this environment.
It is for these reasons that we believe U.S. Large Cap Quality stocks are worthy of consideration for growth-oriented investors. With that said, we continue to encourage investors to stay disciplined and work with experienced financial professionals to help manage their portfolios through various market cycles within an appropriately diversified framework that is consistent with their objectives, timeframe, and tolerance for risk.
Best wishes for continued health and safety to all.
Disclosure: Past performance does not guarantee future results. We have taken this information from sources that we believe to be reliable and accurate. Hennion and Walsh cannot guarantee the accuracy of said information and cannot be held liable. You cannot invest directly in an index. Diversification can help mitigate the risk and volatility in your portfolio but does not ensure a profit or guarantee against loss. Hennion & Walsh Asset Management currently has allocations within its managed money program and Hennion & Walsh currently has allocations within certain SmartTrust® Unit Investment Trusts (UITs) consistent with several of the portfolio management ideas for consideration cited above.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.
There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions. Distributions from REIT investments are taxed at the owner’s tax bracket.
The prices of small company and mid-cap stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.
Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.
Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.
Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than the original cost upon redemption or maturity. Bond Prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.
MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.
MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.
Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.
ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.
ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.
Investors cannot directly purchase any index.
LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.
The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.
The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate.