Commentary Archive 2016

Commentary Archive 2016 background

Commentary Archive 2016

Disclosure

Performance results are based on estimates. Although the information contained in the commentary sections have been obtained from sources we believe to be reliable, the accuracy and completeness of such information and the opinions expressed herein cannot be guaranteed. Past performance is not necessarily indicative of future results. Different types of investments involve varying degrees of risk.

FOURTH QUARTER 2016

Hanseatic Market Commentary

Year in Review

The year 2016 was a year of surprises, confounding conventional wisdom at every turn. The year commenced with one of the worst starts ever as stocks dropped 10% during the first five weeks in response to the collapse in oil prices. But by the end of the first quarter, the market had erased all the early carnage and climbed into positive territory. Then came the election surprises, both the Brexit vote in June and the Trump election ran counter to conventional wisdom as did the resilience of the equity markets following these events. Against this chaotic and unpredictable backdrop, US Equities closed the year with healthy gains.

In 2016, the U.S. economy navigated some difficult challenges including legitimate concerns that the decline in the energy and manufacturing sectors could tip the economy into recession. The Fed was forced to retreat significantly from the path of tightening interest rates and normalizing monetary policy. Things seemed to change when the financial markets (except the British Pound) stabilized following the Brexit vote. The U.S. Treasury bond prices peaked as the market began to discount the prospect of a more restrictive monetary policy than previously forecast. Since then, bond investors have increasingly built in expectations of higher inflation, stronger economic growth, and potentially a faster pace of interest rate increases.

The strong post-election rally has been attributed to the rising business and investor confidence tied to the pro-business policy agenda of the incoming administration which includes tax reform, regulatory relief and infrastructure spending. One could argue, however, that economic and stock fundamental improvement had already begun prior to the election. For instance, the Citigroup Economic Surprise Index which measures how economic data releases compare to the consensus expectations bottomed in October 2016. Also, aggregate S&P500 earnings also turned positive in October following a one-year earnings recession. The market itself had been trending positively since the February 2016 bottom although it corrected about 4% for the S&P500 and 7% for the Russell 2000 over the several week period leading up to the election. The point is that things were notably more constructive from an economic, earnings, and market trend standpoint compared to the 12 months prior.

Factor Shift from Growth to Value

One of the most significant thematic changes that took place in 2016 has been the leadership in value stocks relative to growth. Relative to the Russell 1000 Growth index for instance, its Russell 1000 Value counterpart peaked in July 2006 and bottomed in December 2015. Thus except for a 14-month hiatus in 2013-14, value stocks have been in a bear market relative to growth stocks for 9 ½ years. Most of the previous underperformance of the value component of the market over the 2006-2015 period can be tied to bank stocks which topped in late 2006 and the energy sector which peaked in mid-2008. Now financials are the top performing sector, banks in particular. Several positive forces have the potential to support the banking segment of the market including higher interest rates, improved economic growth and regulatory relief. Our internal analysis of bank stocks in general concludes that there are good odds that the current leadership can persist.

Looking Forward – Bull versus Bear

Going into 2017, the bullish case rests mainly on earnings growth. Potential sources of earnings growth include organic growth of the type that was beginning to manifest pre-election. Earnings growth sources related to the election include a cut in the corporate tax rate and offshore tax repatriation. Incremental earnings increases from a tax cut depend on the new rate as well as other details. Some Wall Street strategists have estimated a tax earning effect around +10%. The benefit for some form of a tax repatriation holiday would come in the form of dividends, buybacks, domestic debt reduction, and capital spending. The effects would be positive certainly, but there are way too many variables and assumptions necessary for a reasonable estimate.

The primary bear case for the market is that valuations are stretched by virtually all measures, although as discussed in the 2016 second quarter commentary, relative valuations paint a different picture. For instance, the current trailing P/E ratio for S&P500 is about 20.6 which translates to an earnings yield of 4.9%, in contrast to the 10-year Treasury note yield at 2.5%. Beyond the persistent overvaluation issue is the degree to which the tax cuts, regulatory overhaul, and fiscal spending proposals will actually be passed by congress. That is, to what extent will reality match the hopes and promises? Is the market priced for perfection? A valid concern in our view. Markets typically climb a wall of worry, but this currently seems in short supply.

Conclusion

In conclusion, the U.S. stock market remains in a secular bull market, the second longest in market history. While long from a calendar standpoint, the market is remarkably absent the excesses in sentiment and relative valuation that have historically characterized market tops. Also, the market has only recently emerged from a 2+ year consolidation period that was in effect a cyclical bear market from a time perspective. What also seems likely from our work is that new and more focused and enduring leadership has emerged in the form of the cyclical and financial market sectors.

PROCESS COMMENTARY AND REVIEW

Year

Hanseatic’s investment process is designed to recognize and adapt to emerging sector, group, and/or individual stock sustained price leadership, particularly following periods of weakness or consolidations. Years of sustained leadership like 2013 reflect this well. However, the market can improve like it did in 2016 and still pose challenges to the strategy. The first quarter of the year involved volatility that persisted from 2015 and a sharp downturn followed by a rally of high beta stocks. The second quarter followed by moving sideways and with some measureable volatility. Third quarter offered strength in technology and biotech which turned out to be short lived. Fourth quarter into 2017 is showing signs of life, and with it, our process which is positioned well for new and persistent leadership.

Quarter

The portfolios in Q4 saw a leadership shift from technology, utilities, real estate, consumer staples, and consumer discretionary (particularly retailers), to financials (particularly banks), materials, industrials, and energy. As long as this leadership persists, our process is poised to capture it, regardless of the earlier mentioned shift to value-based themes as evidenced by our fairly quick adaptation to financials. Further, the portfolios held individual stocks that were doing very well in terms of price leadership which later declined due to the post-election rotation and earnings guidance headlines. Overall, the earnings season was challenging on several portfolio positions. As always and particularly during these periods, we look to stay true to our investment process and remain positioned to capture future leadership.

HANSEATIC QUARTERLY COMPOSITE PERFORMANCE AND ATTRIBUTION

LARGE CAP INSTITUTIONAL EQUITY

The Large Cap Institutional Equity composite return was -0.43%, the Russell 1000 Growth benchmark return was 1.01%. The composite’s fourth quarter lag was derived from relative underperformance in eight of eleven sectors. Technology was the most notable sector contributing 0.87% to the relative performance. Energy and Utilities contributed a combined 0.09%. Industrials, Staples, Consumer Discretionary, Materials, and Real Estate detracted 0.56%, 0.54%, 0.48%, 0.35%, and 0.26% respectively from the relative gain. Healthcare, Financials, and Telecom detracted a combined 0.21% from relative performance. The portfolio is overweight Industrials, Financials, and Energy and underweight Consumer Discretionary, Staples, and Healthcare.

ALL CAP GROWTH EQUITY

The All Cap Growth Equity composite return was -0.42%, the Russell 3000 Growth benchmark return was 1.20%. The composite’s fourth quarter underperformance was derived from relative underperformance in eight of eleven sectors. Technology was the most notable sector contributing 1.32% to relative performance. Materials and Energy contributed a combined 0.37% to relative performance. Consumer Discretionary, Healthcare, and Industrials detracted 0.91%, 0.87%, and 0.82% respectively from relative performance. Financials, Staples, Real Estate, Utilities, and Telecom combined detracted 0.73% from relative performance. Underexposure to Consumer Discretionary, Industrials and Financials were the main drivers behind the lag coupled with corrections in select Healthcare stocks. The portfolio is overweight Financials and Industrials and underweight Staples and Consumer Discretionary.

ALL CAP GROWTH CONCENTRATED EQUITY

The All Cap Growth Concentrated Equity composite return was 3.33%, the Russell 3000 Growth benchmark return was 1.20%. The composite’s fourth quarter outperformance was derived from relative outperformance in three of eleven sectors. Technology, Utilities, and Energy were the most notable contributing 4.96%, 0.63%, and, 0.54% sequentially to relative performance. Staples, Healthcare, Materials, Industrials, and Financials detracted 1.55%, 1.03%, 0.94%, 0.21%, and 0.13% respectively from relative performance. Telecom and Real Estate detracted a combined 0.09% and underexposure to Telecom contributed a modest 0.06% relatively. The portfolio is overweight Energy, Financials, Utilities, and Industrials and underweight Healthcare, Staples, and Consumer Discretionary.

MID CAP EQUITY

The Mid Cap Equity composite return was -0.95%, the Russell Midcap Growth benchmark return was 0.46%. The composite’s fourth quarter underperformance was derived from relative underperformance in eight of eleven sectors. Technology, Utilities, and Consumer Discretionary were the most notable contributing 1.02%, 0.14%, and 0.12% sequentially to relative performance. Underperformance in Staples, Materials, and Real Estate detracted 1.04%, 0.75%, and 0.46% respectively from relative performance. Financials, Energy, Healthcare, Industrials, and Telecom detracted a combined 0.50%. The portfolio is overweight Financials, Industrials, Energy, and Materials and is underweight Consumer Discretionary, Healthcare, and Staples.

SMID EQUITY

The SMID Cap Equity composite return was 1.29%, the Russell 2500 Growth benchmark return was 2.60%. The composite’s fourth quarter underperformance was derived from relative underperformance in nine of eleven sectors. Energy and Technology were the most notable contributing 0.94% and 0.62% respectively to relative performance. Industrials, Consumer Discretionary, Materials, and Financials detracted 0.95%, 0.77%, 0.45%, and 0.36% respectively from relative performance. Underexposure to Industrials, Consumer Discretionary, and Financials were the main detractors. The portfolio is overweight Energy and Tech and is underweight Consumer Discretionary, Real Estate, Healthcare, and Staples.

SMALL CAP EQUITY

The Small Cap Equity composite return was 0.79%, the Russell 2000 Growth benchmark return was 3.57%. The Small Cap Equity composite’s fourth quarter underperformance was derived from relative underperformance in eight of eleven sectors. Energy, Tech, and Staples were the most notable contributing 0.49%, 0.17%, and 0.01% respectively to relative performance. Consumer Discretionary, Materials, Healthcare, Financials, and Real Estate detracted 0.73%, 0.66%, 0.65%, 0.52%, and 0.38% sequentially from relative performance. Utilities, Industrials, and Telecom detracted a combined 0.47%. The portfolio is overweight Tech and Energy and is underweight Real Estate and Healthcare.

AMERICAS EQUITY

The Americas Equity composite return was -0.02%, the MSCI All Cap Americas Index return was 2.85%. The composite’s fourth quarter underperformance was derived from relative underperformance in nine of eleven sectors. Tech was the most notable sector contributing 2.27% to relative performance. Energy contributed a modest 0.30% to the relative performance. Healthcare and underexposure to Financials were the two most notable sectors detracting 1.94% and 1.44% sequentially from relative performance. Consumer Discretionary, Materials, Staples, Industrials, Utilities, Telecom, and Real Estate detracted 0.55%, 0.39%, 0.37%, 0.36%, 0.19%, 0.13%, and 0.10% respectively from relative performance. At the sector level, the portfolio is overweight Tech, Industrials, Materials, and Financials and underweight Staples, Consumer Discretionary, Telecom, and Real Estate. The portfolio is underweight developed U.S. and Canada by 13%, and overweight emerging markets by 11%.

LATIN AMERICA EQUITY

The Latin America Equity composite return was 2.43%, the Russell Latin America benchmark return was -1.68%. The composite’s fourth quarter outperformance was derived from consistent performance across six of eleven sectors. Most notable were Financials, Materials, Utilities, Energy, Industrials, and Consumer Discretionary contributing 1.64%, 1.15%, 0.55%, 0.49%, 0.35%, and 0.08% sequentially to performance. Tech, Staples, Real Estate and Telecom detracted 0.96%, 0.71%, 0.21%, and 0.16% respectively from performance. Healthcare had no exposure and was flat. The portfolio is overweight Industrials, Utilities, Real Estate, and Materials and is underweight Financials, Staples, Telecom, Consumer Discretionary, and Energy.

GROWTH & INCOME EQUITY

The Growth & Income Equity composite return was 3.89%, the S&P 500 Total Return benchmark return was 3.82%. The composite’s fourth quarter outperformance was derived from relative outperformance in six of eleven sectors. Notable were Technology, Energy, Healthcare, and Materials contributing 0.89%, 0.77%, 0.51%, and 0.34% respectively to relative performance. Utilities and Industrials contributed a combined 0.10% to relative performance. Real Estate and Financials were notable detracting 1.17% and 0.59% respectively from relative performance. Consumer Discretionary, Staples, and Telecom detracted a combined 1.00% from relative performance. The portfolio is overweight Materials, Financials, Utilities, and Industrials and is underweight Staples and Telecom.

THIRD QUARTER 2016

  • The Large Cap Institutional Equity composite gained 5.40%, outperforming the Russell 1000 Growth benchmark by 0.82%.
  • The All Cap Growth Equity composite gained 7.26%, outperforming the Russell 3000 Growth benchmark by 2.34%.
  • The All Cap Growth Concentrated Equity composite gained 8.92%, outperforming the Russell 3000 Growth benchmark by 4.00%.
  • The Mid Cap Equity composite gained 4.01%, underperforming the Russell Midcap Growth benchmark by 0.58%.
  • The SMID Cap Equity composite gained 5.68%, underperforming the Russell 2500 Growth benchmark by 1.30%.
  • The Small Cap Equity composite gained 6.18%, underperforming the Russell 2000 Growth benchmark by 3.04%.
  • The Americas Equity composite gained 4.53%, outperforming the MSCI All Cap Americas Index by 0.93%.
  • The Latin America Equity composite gained 11.08%, outperforming the Russell Latin America benchmark by 5.24%.
  • The Growth & Income Equity composite gained 0.65%, underperforming the S&P 500 Total Return benchmark by 3.20%.

Hanseatic Market Commentary

U.S. stocks performed well in the third quarter with the average S&P 500 stock gaining about 4%. The average mid-cap stock also gained 4%, but the average small cap stock was up a resounding 8.5%. Technology, Financials, Energy, and Industrials were the greatest contributors to Q3 returns while Utilities, Consumer Staples, and Real Estate considerably lagged.

The most notable sector development has been the robust performance of Technology stocks over the past quarter. Its absolute and relative leadership spans all cap ranges and is broad based from an industry group standpoint. The Natural Resources stocks that made positive reversals from a 20-month cyclical bear market in February have largely gone sideways the past few months, but in general still exhibit a positive profile. The yield-friendly stocks in the Staples, Utilities, and Real Estate sectors have performed well overall in 2016, but have corrected over the last couple months. Healthcare is mixed with medical device makers and select small cap biotech stocks doing well. However, larger biotech and pharmaceuticals are in cyclical bear markets. The broadly diversified Consumer Discretionary sector is also quite mixed. The strong performance of E-commerce and housing-related stocks has been more than offset by the decline in department stores and other brick-and-mortar retailers. Finally, the low interest rate environment has been challenging for banks and performance of bank stocks and the financial sector in general reflects that reality.

While there are several risk factors that warrant attention in the current market environment, the most important, in our view, is valuation. Most traditional valuation measures caution that stocks are somewhere between moderately priced to extremely expensive. These metrics include the price/earnings and price/sales ratios for the market indices as well as the 10-year P/E/Schiller CAPE measures. The consensus view seems to be that because of the high valuations the market is vulnerable to a sharp correction or necessarily subject to minimal or even negative annual returns in the years ahead. That the market is expensive seems to be a rational deduction given that valuation measures are high relative to their historic norms. But that conclusion is less convincing if two other important factors are taken into account, namely low inflation and low sovereign bond yields. An important indicator of the market’s risk-return profile is the Earnings Yield-Indicator(EYI)* which measures the rate of earnings growth relative to the 10-year Treasury yield. Historically, stocks have done well even in a rising interest rate environment, which is clearly a current risk, if earnings growth exceeded the 10-year Treasury yield. Although the current S&P 500 P/E on trailing earnings is elevated at 24.45, the current 10-year yield is near a record low at 1.74% compared to an earnings yield of 4.01%. Earnings growth has been negative the last couple years due in large part to weak energy prices and a strong dollar. These variables should be less of a drag going forward.

Another concern is the age of the bull market which at seven and one-half years is historically long. But neither equity bull markets nor economic expansions die of old age but rather end with excess. For the stock market, the excesses take the form of extreme bullish sentiment, leverage, debt, or extreme valuations. In the current market environment, enthusiasm and confidence for owning stocks is muted at best - more like apathy. This is not consistent with market peaks historically.

There is an additional thesis for our relative optimism about the equity market in the months ahead. Consider that over the 18-month period from June 30, 2014 to January 2016 the returns were:

  • S&P 500 +1.3%
  • S&P 500 (Equal Weighted) -5.64%
  • S&P 400 -8.2%
  • Russell 2000 -13.3%
None of these indices came very close to the nominal 20% decline that is conventional standard for a bear market. But we think that “bear markets” are a function of time as well as price decline. That is to say that extended periods of no return serve in some degree the same purpose as a bear market which in general is to expunge the excesses of the prior bull market, and create a more favorable climate for forward returns. In 2014, the primary excesses were the near-parabolic advances in Energy and Biotech stocks. These were corrected and more. But beyond these corrections, the 18-month period of stagnant returns was in effect a bear market in time which may serve as a foundation for an extension of the secular bull market. Also of note is that this was the longest sideways period in the S&P 500 since 1950.

*Earnings growth less Treasury bond yield

Hanseatic Quarterly Composite Commentary

Large Cap Institutional Equity

The Large Cap Institutional Equity composite’s third quarter outperformance was derived from relative outperformance in five of eleven sectors. Staples, Healthcare, and Industrials were the most notable sectors contributing 0.92%, 0.62%, and 0.55% sequentially to the relative performance. Energy and Real Estate contributed a combined 0.09%. Technology, although the strongest absolute performer during the quarter at 3.05%, detracted 0.80% from the relative gain as the benchmark returned 3.85% in Tech. Consumer Discretionary and Utilities detracted 0.27% and 0.26% respectively from the relative gain. Materials, Financials, and Telecom detracted a combined 0.23% from relative performance. The portfolio is overweight Industrials, Utilities, Energy and Real Estate and underweight Consumer Discretionary, Healthcare, and Staples.

All Cap Growth Equity

The All Cap Growth Equity composite’s third quarter outperformance was derived from relative outperformance in eight of eleven sectors. Healthcare, Industrials, and Staples were the three most notable sectors contributing 1.96%, 0.29%, and 0.26% sequentially to relative performance. Materials contributed 0.13% to relative performance. Consumer Discretionary, Financials, Telecom and Energy contributed a combined 0.23% to relative performance. Real Estate, Utilities, and Tech detracted a combined 0.57% from relative performance. Tech, even modestly lagging the benchmark by a relative 0.01%, returned 3.74% during the quarter and was the strongest absolute performer. The portfolio is overweight Utilities, Healthcare, and Energy and underweight Staples and Consumer Discretionary.

All Cap Growth Concentrated Equity

The All Cap Growth Concentrated Equity composite’s third quarter outperformance was derived from relative outperformance in seven of eleven sectors. Technology, Staples, Energy and Consumer Discretionary were the most notable contributing 1.42%, 1.12%, 1.06%, and 0.94% sequentially to relative performance. Healthcare and Utilities contributed a combined 0.95% to relative performance. Real Estate, Materials, and Financials detracted 0.87%, 0.41%, and 0.25% respectively from relative performance. Industrials detracted a modest 0.03% and underexposure to Telecom contributed a modest 0.06% relatively. The portfolio is overweight Energy, Real Estate, Utilities, and Materials and underweight Tech, Healthcare, Consumer Discretionary, and Financials.

Mid Cap Equity

The Mid Cap Equity composite’s third quarter underperformance was derived from relative underperformance in six of eleven sectors. Notable was the relative underperformance in Technology detracting 1.03% from relative performance. Materials, Financials, Healthcare, and Utilities detracted 0.35%, 0.30%, 0.29%, and 0.21% sequentially. Underexposure to Telecom detracted a modest 0.04% from relative performance. Staples, Energy, Consumer Discretionary, Industrials, and Real Estate contributed 0.63%, 0.31%, 0.17%, 0.16%, and 0.13% sequentially to relative performance. The portfolio is overweight Energy, Utilities, and Materials and is underweight Consumer Discretionary, Healthcare, and Financials.

SMID Equity

The SMID Equity composite’s third quarter underperformance was derived from relative underperformance in eight of eleven sectors. Real Estate, Telecom, Healthcare, Consumer Discretionary, Utilities, Industrials, Staples, and Financials all detracted from relative performance on a range of 0.22% (Financials) to 0.63% (Real Estate). Energy, Tech, and Materials contributed 0.88%, 0.44%, and 0.31% respectively to relative outperformance. The portfolio performed well on an absolute basis with 6 of 11 sectors performing positively. The portfolio is overweight Tech, Energy, and Utilities and is underweight Consumer Discretionary, Financials, Industrials, and Healthcare.

Small Cap Equity

The Small Cap Equity composite’s third quarter underperformance was derived from relative underperformance in nine of eleven sectors. Tech and Materials modestly outperformed contributing a combined 0.32% to relative performance. Of the remaining nine sectors, Healthcare was the biggest laggard at 0.71%, but adding an absolute 2.33% to performance, not enough to compete with a benchmark sector return of 3.04% during the quarter. On the other end of the spectrum Energy only modestly lagged the benchmark by 0.06% relatively. The remaining seven sectors fell somewhere in between and detracted 2.62% from relative performance. The portfolio performed well on an absolute basis with 6 of 11 sectors performing positively. The portfolio is overweight Tech, Staples, and Utilities and is underweight Consumer Discretionary, Healthcare, and Financials.

Americas Equity

The Americas Equity composite’s third quarter outperformance was derived from relative outperformance in seven of eleven sectors. Healthcare was the most notable sector contributing 1.16% to relative performance. Staples, Tech, Energy, Telecom and Industrials all contributed to the relative performance adding 0.47%, 0.39%, 0.16%, 0.10%, and 0.04% sequentially. Financials, Real Estate, Materials and Consumer Discretionary detracted 0.52%, 0.40%, 0.34%, and 0.13% sequentially from relative performance. At the sector level, the portfolio is overweight Industrials, Utilities, Tech, and Healthcare and underweight Financials, Consumer Discretionary, Staples, and Telecom. The portfolio is underweight developed U.S. and Canada by 9%, and overweight emerging markets by 8%.

Latin America Equity

The Latin America Equity composite’s third quarter outperformance was derived from strong performance across ten of eleven sectors. Most notable were Financials, Materials, Energy, Utilities, Industrials, and Tech contributing 3.23%, 1.66%, 1.24%, 1.22%, 1.22%, and 1.20% to performance. Staples, Consumer Discretionary, Telecom and Real Estate combined added 1.32% to performance. Healthcare had no exposure and was flat. The portfolio is overweight Utilities, Industrials, and Tech and is underweight Staples, Financials, and Consumer Discretionary.

Growth & Income Equity

The Growth & Income Equity composite’s third quarter underperformance was derived from relative underperformance in eight of eleven sectors. Energy and Materials contributed 0.55% and 0.31% respectively to relative performance. Telecom was flat. Tech and Real Estate were notable detracting 1.19% and 0.81% respectively from relative performance. Financials, Utilities, Industrials, Staples, Consumer Discretionary, and Healthcare detracted a combined 2.25% and all relatively lagged benchmark sectors ranging from 0.57% (Financials) to 0.18% (Healthcare). The portfolio is overweight Real Estate, Materials, Utilities, and Industrials and is underweight Healthcare, Financials, and Consumer Discretionary.

SECOND QUARTER 2016

  • The Large Cap Institutional Equity composite gained 1.34%, outperforming the Russell 1000 Growth benchmark by 0.73%.
  • The All Cap Growth Equity composite gained 2.60%, outperforming the Russell 3000 Growth benchmark by 1.80%.
  • The Mid Cap Equity composite gained 2.63%, outperforming the Russell Midcap Growth benchmark by 1.07%.
  • The SMID Cap Equity composite gained 2.20%, underperforming the Russell 2500 Growth benchmark by 0.50%.
  • The Small Cap Equity composite gained 3.55%, outperforming the Russell 2000 Growth benchmark by 0.31%.
  • The Americas Equity composite gained 3.31%, outperforming the MSCI All Cap Americas Index by 1.16%.
  • The Latin America Equity composite gained 8.43%, outperforming the Russell Latin America benchmark by 1.98%.
  • The Growth & Income Equity composite gained 5.02%, outperforming the S&P 500 Total Return benchmark by 2.56%.

Hanseatic Market Commentary

In the current investment climate, there are two notable features, both outliers from a market history standpoint. The first is the protracted trading range environment in the U.S. equity market. As of the end of the second quarter, the S&P 500 had not made a new high since May 21, 2015, but more significantly the index was only 1.4% higher than its November, 2014 close. There have been bouts of high volatility, notably in late 2015 and early this year, but no decline of sufficient magnitude to threaten the secular bull market. Post-1950 there have been five bull markets that experienced one-year periods that failed to make a new high. Following each of these one-year droughts (1954, 1961, 1979, 1985, and 1995) the market made significant gains prior to the final bull market peaks. But what is unique about the current environment is both the 18-month duration of the sideways environment, and how narrow and choppy it has been. The consequence of the prolonged trading range has been the near absence of thematic market leadership. The primary engines of the bull market, Consumer Discretionary and Healthcare, both peaked on an absolute basis in early-2015. No market sector or industry group has filled the void save for the sporadic advances in Consumer Staples and Utilities, and in recent months, Energy.

The second notable feature is the ongoing plunge in interest rates and global bond yields. The U.S. government bond yield of ~1.4% is by far the highest government yield in the world among those nations with positive yields; the equivalent yields in Germany, Japan and Switzerland are negative. The spread between the 10-year U.S. Treasury bond and the two-year note is now less than 80 bps, the lowest since November 2007. A flattening yield curve has been conventionally viewed as a warning sign that economic growth may be slowing because of tightening monetary policy. But the current period of flattening yield curves may more reflect the global thirst for income in an increasingly low yield world. In any case, the current yield relationships pose significant headwinds for banks and other financial intermediaries.

While we have expressed cautious optimism about the market for some time, we believe current conditions warrant a more upbeat outlook. While conventional valuation measures have stocks as being somewhat expensive, we believe higher valuations are supported by the low interest rate/inflation environment. In any case, valuations are considerably more modest than those registered at bull market peaks. Also, one of the positive consequences of the market's long and frustrating consolidation from a contrarian standpoint is that bullish sentiment as measured by AAII data peaked in late 2014 and has trended lower ever since. By some measures, using the same data, individual investors are more pessimistic than any time since 2005. The wall of worry that sustains bull markets remains intact in our view. Considered from another standpoint, the market is simply absent excesses typically observed in high risk market environments. Finally, even as the market is making new highs, there is room for considerable improvement in much of the market space including the Healthcare, Financial, and Consumer Discretionary sectors.

Hanseatic Quarterly Composite Commentary

Large Cap Institutional Equity

The Large Cap Institutional Equity composite's second quarter outperformance was derived from relative outperformance in six of ten sectors. Industrials, Financials, Utilities, Materials, and Healthcare were the most notable sectors contributing 0.68%, 0.56%, 0.48%, 0.46%, and 0.32% respectively to the relative performance. Underexposure to Technology contributed a relative gain of 0.06%. Telecom, Consumer Discretionary, Energy, and Staples detracted 0.18%, 0.40%, 0.56% and 0.70% sequentially from relative performance. The portfolio is overweight Materials, Financials, Industrials, and Utilities and underweight Consumer Discretionary, Technology, and Staples.

All Cap Growth Equity

The All Cap Growth Equity composite's second quarter outperformance was derived from relative outperformance in five of ten sectors. Industrials, Utilities, Healthcare and Financials were the four most notable sectors contributing 1.10%, 0.56%, 0.40%, and 0.39% sequentially to relative performance. Materials modestly contributed 0.07% to relative performance. Staples, Energy, Telecom, and Materials also detracted a combined 1.38% from performance. Healthcare, Utilities and Financials contributed to relative performance by 0.45%, 0.41%, and 0.15% respectively. The portfolio is overweight Utilities, Financials, and Energy and underweight Healthcare and Consumer Discretionary.

Mid Cap Equity

The Mid Cap Equity composite's second quarter outperformance was derived from relative outperformance in seven of ten sectors. Notable was the relative outperformance in Industrials, Consumer Discretionary, and Utilities adding 0.64%, 0.52%, and 0.42% sequentially. Materials, Financials, Staples and Healthcare contributed a combined 0.74% to relative performance. Energy, Technology, and Telecom detracted 0.72%, 0.48%, and 0.05% respectively from relative performance. The portfolio is overweight Utilities, Energy, and Materials and is underweight Consumer Discretionary, Financials, Technology and Industrials. At the end of the quarter the portfolio had ~21% in cash.

SMID Equity

The SMID Equity composite's second quarter underperformance was derived from relative underperformance in six of ten sectors. Notable was the relative underperformance in Consumer Discretionary detracting 1.30%. Technology, Energy, Healthcare, Materials and Staples detracted a combined 1.00% from relative performance. One stock to note in the SMID portfolio, Francesca's Holdings Corporation (FRAN), announced the resignation of its CEO along with disappointing preliminary fiscal first-quarter results on May 17, 2016. Combined with poor earning, it was an "unexpected" CEO departure, which rarely resonates positively with investors. The stock lost almost 30% on May 17, 2016, and detracted 0.50% from the quarterly return. The stock was purchased January 12, 2016, at ~17 and sold May 25, 2016, at ~$10 after the news. Financials, Telecom, Utilities and Industrials contributed 0.74%, 0.55%, 0.46%, and 0.04% respectively to relative outperformance. The portfolio is overweight Utilities and is underweight Consumer Discretionary and Industrials.

Small Cap Equity

The Small Cap Equity composite's second quarter outperformance was derived from relative outperformance in five of ten sectors. Financials, Telecom, Industrials, Staples, and Utilities added 0.60%, 0.54%, 0.25%, 0.17%, and 0.16% respectively. Consumer Discretionary and underexposure to Energy detracted 0.63% and 0.44% from relative performance. Healthcare and Materials detracted a combined 0.32%. The portfolio is overweight Utilities and is underweight Consumer Discretionary and Healthcare.

Americas Equity

The Americas Equity composite's second quarter outperformance was derived from relative outperformance in six of ten sectors. Utilities, Financials, Industrials and Materials were the four most notable sectors contributing 0.70%, 0.63%, 0.47%, and 0.21% respectively to relative performance. Healthcare and underexposure to Technology contributed a modest 0.06% and 0.09%. Energy, Staples, Consumer Discretionary, and Telecom detracted 0.41%, 0.28%, 0.26% and 0.14% sequentially from relative performance. The portfolio is overweight Industrials, Utilities, and Materials and underweight Financials.

Latin America Equity

The Latin America Equity composite's second quarter outperformance was derived from strong performance across seven of ten sectors. Most notable were Financials, Utilities, and Energy. The three sectors contributed 2.38%, 1.84%, and 1.83% to performance. Staples, Technology, Materials, and Consumer Discretionary combined added 3.42% to performance. Industrials and Telecom detracted from the performance by 0.61% and 0.43% sequentially. The portfolio is overweight Energy, Industrials and Technology and is underweight Staples, Financials, and Consumer Discretionary.

Growth & Income Equity

The Growth & Income Equity composite's second quarter outperformance was derived from relative outperformance in six of ten sectors. Financials, Utilities, Materials, underexposure to Technology, and Staples contributed 1.48%, 1.19%, 0.58%, 0.51%, 0.46% and 0.35% respectively to relative performance. Energy (underexposure), Healthcare, Telecom and Consumer Discretionary detracted 1.16%, 0.65%, 0.11%, and 0.08% respectively from relative performance. The portfolio is overweight Utilities and Materials and is underweight Technology and Healthcare. At the end of the quarter the portfolio had ~15% in cash.

FIRST QUARTER 2016

  • The Large Cap Institutional Equity composite lost 2.40%, underperforming the Russell 1000 Growth benchmark by 3.14%.
  • The All Cap Growth Equity composite lost 4.07%, underperforming the Russell 3000 Growth benchmark by 4.41%.
  • The Americas Equity composite lost 2.46%, underperforming the MSCI All Cap Americas Index by 3.71%.
  • The Mid Cap Equity composite lost 3.19%, underperforming the Russell Midcap Growth benchmark by 3.77%.
  • The SMID Cap Equity composite lost 3.16%, underperforming the Russell 2500 Growth benchmark by 0.50%.
  • The Small Cap Equity composite lost 4.80%, underperforming the Russell 2000 Growth benchmark by 0.12%.
  • The Latin America Equity composite gained 3.41%, underperforming the Russell Latin America benchmark by 15.32%.

The extreme volatility that began in late summer 2015 has now persisted into the first quarter 2016. During the past seven bull market years, there have been a total of nine periods of extreme volatility as measured by the VIX. Six of these have occurred in last eighteen months and three of the nine since December 2015. This level of volatility is difficult for our process.

In the first quarter 2016, the stock market turned sharply down, and we sold a number of stocks. Many of these stocks continued to decline. The stocks that rallied during this period were not buy candidates. These stocks tended to be those in cyclical/secular market declines including energy, materials, and consumer discretionary while our process looks for sustainable trends. Further, our Defensive Index signaled risk-off during the quarter so the portfolio was positioned more defensively away from high beta type stocks.

Currently, given that our Defensive Index is still in a buy signal, and the two strongest major sectors are Utilities and Consumer Staples, our market orientation remains moderately risk-off. This may change in the weeks ahead with some recent improvement in underperforming sectors.

Hanseatic Market Commentary

The modest advance in equity market indices masked the wild ride investors endured through the first quarter. In the first half of the quarter, already depressed oil prices plunged another 30%, fueling fears of both global and domestic recession. Stock prices dropped sharply in just six weeks; about 12% in the S&P 500 and 16% in the Russell 2000 small cap index. The markets essentially bought the narrative that rapidly deteriorating global economic conditions rather than excess supply and panic selling precipitated the energy price decline.

On February 11, 2016, crude bottomed, likely on rumors of Saudi Arabia's production freeze agreement that was announced a few days later. Oil rallied from $26 a barrel to just over $40 in late March before falling back to $35 recently. The surge in crude prices reflected the recognition that, as with all commodity declines, market forces will reduce excess supply over time. Along with the sharp rise in oil, risk assets across the board rallied including stocks. The stock recovery focused on cyclical and lower quality stocks but was strong enough and sufficiently broad to reverse all of the previous decline and the quarter ended slightly positive for most equity benchmarks save small cap measures which were modestly negative.

Recent macro data on the economy continues to point to positive, albeit sluggish, growth. Economic growth since the recession has consistently been anchored by consistent improvement in the labor market. Positive job market news continued in March, with improvement in both the unemployment and participation rates as well as hourly earnings. Other tailwinds for the economy include consumer income growth, low mortgage rates, and low energy prices. Manufacturing may also be ramping up with considerable improvement in the latest ISM Manufacturing Index readings. The important takeaway from this, for both the economy and the capital markets, is that the onset of recession in the months ahead is unlikely.

So far into 2016, oil prices and the Fed have been the most important factors affecting both domestic and international stock markets. Despite extremely low unemployment, higher inflation numbers and a rebounding industrial sector, the Fed focused on the downside risks posed by weakness in the global economy and concluded that a cautious approach to raising rates would be prudent. The Fed seems to believe that it is compelled by circumstances to go beyond its domestic mandate, and for now act as the world's central bank. In any case, the Feds surprisingly dovish posture over recent weeks has been positive for domestic stocks, but also, via a weakened US dollar, a plus for energy, metals, and stock markets in the developing world.

A month ago marked the seventh anniversary of US stock markets making their bear market lows and the beginning of the secular bull market. While the bull market technically continues, beneath the market surface the sector and industry group environment is quite messy. For starters, the S&P 500 has not made a new high since May, 2015. Two of the ten market sectors, Energy and Materials remain in bear markets despite recent rallies. By our standards, the Financial sector is also in bear market territory. The Healthcare sector overall remains in a positive uptrend, but important components in the form of Pharmaceuticals and Biotech are now in bear markets by our measures. On the positive side, Consumer Staples, Utilities, and Telecom are in bull markets and are currently the strongest market sectors, while Industrials have made the most recent improvement.

The CRB Commodities Index (19 different commodities) has now been in a bear market for five years, losing over 50% of its value over that period. Observing the CRB data back to 1988, the current decline is the longest bear market over the past 28 years and about the same magnitude of correction as during the 2008 bear market. Lower risk bottoming structures are developing in our CRB index model and we also observe improvement in individual Materials sector stocks. There is a similar picture developing with crude oil. There has been a number of false alarm rallies over the course of the steep crude oil decline the past two years. The supply-demand equation for oil is complex and a return to oil below $30 cannot be ruled out. What we can say is that the model probabilities for a more favorable risk/return environment for crude oil and related stocks have much improved over the last several weeks.

Looking forward we are generally optimistic about the stock market. There are obstacles of course, and they include elevated valuations and the virtual certainty of higher interest rates down the road. We believe the positives in the current market environment outweigh the potential headwinds. First, with the notable exception of small cap stocks, the secular bull market remains intact. That reality in combination with low interest rates, favorable monetary policies, a positively sloped yield curve, and a low probability of recession are together a baseline case for at least cautious optimism. Also important, in our view, is the lack of excess anywhere across the economic spectrum. There are no excesses in spending, consumer or business, and nothing in the way of "booms" such as energy prices or housing as in years past. The same applies to stock market sentiment. The enthusiasm quotient for stocks is rather low by our observation, much less exuberance. So, modest optimism.

Hanseatic Quarterly Composite Commentary

Large Cap Institutional Equity

The Large Cap Institutional Equity composite's first quarter underperformance was derived from relative underperformance in seven of ten sectors. Technology and Consumer Discretionary were the two most notable sectors detracting 1.48% and 1.09% respectively from the relative performance. Industrials, Staples, Telecom, Financials, and Energy also detracted with a combined relative loss of 1.69%. Healthcare, Utilities, and Materials contributed 0.78%, 0.25%, and 0.02% respectively to relative performance. The portfolio is overweight Industrials, Utilities, and Financials and underweight Healthcare.

All Cap Growth Equity

The All Cap Growth Equity composite's first quarter underperformance was derived from relative underperformance in seven of ten sectors. Technology, Consumer Discretionary, and Industrials were the three most notable sectors detracting 1.59%, 1.22%, and 1.21% respectively from relative performance. Staples, Energy, Telecom, and Materials also detracted a combined 1.38% from performance. Healthcare, Utilities and Financials contributed to relative performance by 0.45%, 0.41%, and 0.15% respectively. The portfolio is overweight Utilities, Financials, and Energy and underweight Healthcare and Consumer Discretionary.

Americas Equity

The Americas Equity composite's first quarter underperformance was derived from relative underperformance in eight of ten sectors. Technology, Industrials, and Energy were the three most notable sectors detracting 2.16%, 0.94%, and 0.48% respectively from relative performance. Telecom, Healthcare, Utilities, Consumer Discretionary, and Materials detracted a combined 1.05% from relative performance. Consumer Staples and Financials contributed to performance by 0.50% and 0.35% respectively. The portfolio is overweight Staples, Consumer Discretionary, and Industrials and underweight Healthcare, Financials, and Energy.

Mid Cap Equity

The Mid Cap Equity composite's first quarter underperformance was derived from relative underperformance in six of ten sectors. Notable was the relative underperformance in Consumer Discretionary, Industrials, Technology, Financials, Healthcare, and Energy detracting 1.15%, 1.10%, 1.06%, 0.58%, 0.58%, and 0.43% respectively. Utilities, Consumer Staples, Materials, and Telecom contributed 0.52%, 0.40%, 0.14% and 0.02% respectively to relative performance. The portfolio is overweight Utilities and Consumer Staples and is underweight Consumer Discretionary, Industrials and Healthcare. At the end of the quarter the portfolio had ~25% in cash.

SMID Equity

The SMID Equity composite's first quarter underperformance was derived from relative underperformance in five of ten sectors. Notable was the relative underperformance in Industrials and Energy detracting 1.36% and 0.44% respectively. Materials, Technology, and Consumer Discretionary detracted a combined 0.72% from relative performance. Healthcare, Telecom, Utilities, and Financials contributed adding 1.49%, 0.32%, 0.18%, and 0.06% to relative outperformance. Consumer Staples were flat. The portfolio is overweight Utilities and is underweight Healthcare and Consumer Discretionary. At the end of the quarter the portfolio had ~17% in cash.

Small Cap Equity

The Small Cap Equity composite's first quarter underperformance was derived from relative underperformance in six of ten sectors. Most notable was the relative underperformance in Industrials, Technology, Energy, and Financials detracting 0.57%, 0.52%, 0.52%, and 0.49% respectively. Consumer Discretionary and Materials combined detracted 0.50% from relative performance. Healthcare, Utilities, and Consumer Staples contributed during the month adding 2.33%, 0.11%, and 0.04% respectively. The portfolio is overweight Utilities and is underweight Healthcare, Technology, Consumer Discretionary, and Industrials. At the end of the quarter the portfolio had ~29% in cash.

Latin America Equity

The Latin America Equity composite's first quarter underperformance was derived from maintaining a large cash position. Latin America rallied sharply during the first quarter similar to the "V bottom" of 2009. Cash was prudently put to work during the quarter as new stocks met the minimum buy criteria and were added to the portfolio. Seven of ten sectors performed positively during the quarter. Most notable were Financials, Utilities, and Staples. The three sectors contributed 1.10%, 0.89%, and 0.85% to performance. Energy, Industrials, Telecom, and Consumer Discretionary combined added 1.77% to performance. Materials and Technology detracted from the performance by 0.66% and 0.55% respectively. The portfolio is overweight Industrials and Utilities and is underweight Staples and Materials. At the end of the quarter the portfolio had ~19% in cash, down from 37% last quarter.