Under Pressure

by Jason Norris, CFA Executive Vice President of Research

Under Pressure

Earlier this week we lost a music icon. While I was not a big fan of David Bowie, there are a few songs of his that I enjoy. My favorite is “Under Pressure” which he co-wrote with the band Queen in 1981. The title is very appropriate for what we are seeing in the equity markets this year. Investors globally have been reacting to concerns in China and are de-risking portfolios. While economic growth in China was the concern in August, there have been growing concerns about the amount of private debt taken on by the banking sector to finance the real estate boom the last few years in China. The Chinese government has the means to secure this private debt; however, it may only defer the debt issue. It is difficult to say how big of a problem this could be but investors aren’t waiting around to find out.

While the issues in China grab the headlines, the U.S. economy continues to execute well. Consumer spending will grow roughly 3 percent in 2015 and 2016, which a nice, steady rate. There were over 2.5 million jobs created in 2015 and wages continue to improve. Consumer confidence is at a seven-month high. Recent earnings reports this week have emphasized the strength of the U.S. and European economies. However, these reports also highlighted continued weakness in the emerging markets. We do not believe we are on the verge of recession and thus are maintaining our current asset allocation in this environment.

With weakness today, stocks are down 10 percent from the November high. This is the second 10 percent decline we have seen in the last year. While not enjoyable, these selloffs are common. In the last 25 years, there have been twenty 10 percent selloffs, and we have experienced three recessions. While equities are under pressure, the U.S. economy is not.

To Index or Not to Index

Over the last two years there have been a growing number of headlines highlighting the benefits of passive over active investment management. The catalyst for these calls has been the strong relative performance indexing has delivered. In 2015, only 24 percent of active managers beat their benchmark; slightly better than the 17 percent that beat their benchmarks in 2014. While there will be short periods of time where passive beats active, looking at long-term invest horizons, passive trails. The chart below shows rolling 10-year periods comparing active and passive in the large cap space. As you can see, roughly 75 percent of active institutional large cap managers beat the S&P 500.

Jason Chart
Jason Chart

Sources: Strategas, Wilshires

The chart shows that passive performance has improved recently. However, there is not one ten-year period in the last 20 years that owning the S&P 500 index would have done better than the average active large cap investment manager. Finally, the periods that passive is the worse is when markets are volatile and negative.

Our Takeaways for the Week:

  • Major selloffs occur regularly. However, we believe that the U.S. economy is still on sound footing
  • While there can be short-term periods of strong passive management, longer-term, active management consistently outperforms