Ask the average observer how stocks are doing so far this year, and they’ll tell you in one word: Shaky.
The market doesn’t seem to want to rally like it did last year.
But it’s simply recalibrating.
More specifically, it’s moving away from “beta.”
That term describes how much a stock tends to move compared to the overall market. (For example, if the market falls 2%, does this stock fall 5%?) So it indicates a stock’s sensitivity to market fluctuations.
A high beta often means a stock is more volatile than the overall market, and vice versa.
And beta, as a factor, is down -6.3% in just three weeks. (This is judged by comparing the performance of the top 100 stocks to the bottom 100, when ranked according to their beta.)
You wouldn’t know it by seeing Nvidia (NVDA) melt up (again). It recently rose 21% from its lows on January 3. But there’s an undercurrent of other, less-notable opportunities going on outside of the Twitter favorites.
So if beta is down that much, why is the market flat?
It’s because institutional money has been piling into low volatility stocks. They have seen the exact opposite performance, up 6.2% so far this year.
This is counterbalancing the market weakness we see elsewhere
So that’s why I believe the market is recalibrating right now.
A “shaky” market denotes fear – but there’s still plenty of opportunity.
Yet as you can see from the chart below, the last time the performance gap between high beta and low volatility was this wide was at the end of 2021. That was right before the impending bear market the following year.
I’m not sure if we’ll get a 30% down move this year.
But there will be times this year when you wish your high beta exposure was as low as possible.
The pattern above is known as “alligator jaws.” I think we’re only at the beginning of it snapping shut.
And the best time to take full advantage of that is to do what the market’s doing…
Recalibrate.
How to Recalibrate Your Portfolio
The market might end up 20% by year-end as a whole (especially if Trump wins).
But the return on your portfolio could be just about at breakeven or down.
Whether you’re a retail investor or fund manager, you may be familiar with this conundrum. It has been happening throughout last year’s bull run because of the highly rotational nature of the market over the last few months.
So how should investors take advantage of this unfolding trend?
Build your own “index.”
For instance, I’m investing in an equally weighted portfolio that selects the top 15 stocks ranked for lowest volatility and highest earnings upgrades.
Here’s how I’m currently positioned:
(Note that this is just an example, not an official recommendation.)
This portfolio has an average price-to-earnings (P/E) ratio of 15.6 (much cheaper than the SPX with its P/E of 25) and a beta of 0.53 (very low).
But don’t let the low risk metrics fool you.
What should grab your attention is that the insurance sector has a big representation in this portfolio. That’s a good thing.
The insurance sector has been flat since rates rose beginning in 2022.
But it has just recently broken out of that two-year consolidation. (This makes sense if you consider that this sector doesn’t do well when short-term interest rates are higher than long-term rates.)
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But now, rates are shifting back the other way. Short-term rates are coming back below long-term rates. That’s a perfect market condition for insurance companies
Insurance companies can invest the premiums they collect to generate income. The difference between the interest they earn and the interest they pay on liabilities improves.
Asset-liability matching improves. And the list goes on.
And building your own index has other benefits.
New features at brokerages have been popping up as retail investors take investing matters into their own hands.
One new feature is “basket investing.”
It allows you to easily manage multi-leg stock baskets like the one above.
For example, here’s how Fidelity describes it:
This tool lets you harness thematic trades like the one above.
And that can help your portfolio stay multiple steps ahead of the crowd.
Regards,
Eric Shamilov
Analyst, Trading With Larry Benedict