Fixed Income Barbell Strategy
A barbell investment strategy is a popular fixed-income portfolio investment strategy that seeks to create a balanced portfolio by removing the probability of large blowup events in an investment portfolio. The concept is to only invest in the two extremes (i.e., high risk and low-risk assets) while at the same time avoiding the middle of the risk assets. The barbell strategy is most useful when interest rates are rising. The objective is to increase risk-adjusted returns on your investment portfolio by investing in the long-and short-duration bonds and avoiding intermediate-duration bonds. When interest rates rise, the short-term maturities are rolled over, as they can receive a higher interest rate. In turn, this will lead to the value appreciating. The primary objective of the fixed income barbell strategy is to minimize the hidden risks of the middle assets by avoiding the intermediate-term duration and take control of your investment strategy by investing only in the long-and short-duration bonds.
Equity Barbell Strategy
Applying a barbell strategy to stocks is more complex since an effective execution involves holding multiple groups of stocks and sectors in an investment portfolio. However, just like a physical barbell, where the balance of the weights is concentrated on the two opposing sides of the barbell, an equity barbell portfolio is structured to heavily weigh the two extreme sides of your equity risk profiles. Remember risk is a relative term. Each investor has different risk profiles based on various time horizons and different risk tolerance levels. For a stock barbell strategy, one side of the equity barbell consists of the lower-risk (lower beta) and lower return equities, and the other side on higher-risk (higher beta) and higher return equities. Many investors have been running an equity barbell portfolio of stay-at-home stocks, structural growth names, and reopening or economically sensitive recovery stocks.
However, do we need to adjust the equity barbell strategy to reflect changing investment themes and trends?
The timeline of the pandemic and the leading sectors that dominated the marketplace during the respective periods are as follows:
Height of Pandemic March/April 2020 – Healthcare and Technology Outperforms
A prior 4/07/20 Blog entitled - It is all Relative – two (2) S&P 500 sectors dominated the top hundred SCTR ranked list. Half of the top hundred ranked large-cap names were thirty (30) Healthcare and twenty (20) Technology stocks. A deeper dive in the list also showed five (5) of the top ten (10) ranked SCTR was Technology names, and two (2) were Healthcare names.
At the height of the COVID-19 pandemic, during March/April 2020, it was again reasonable to expect investors to focus on the Healthcare sector (aging demographic trend) and specifically on the Biotechnology industry (vaccines). Also, during periods of market uncertainties, investors favor defensive-minded sectors that provide income.
It was also reasonable to expect investors favored many Technology names during the sheltered-in-place environment because of the structural growth themes involving the wireless 5G technology, social media, e-commerce, AI, and cloud computing. Many investors turn to Technology stocks and specifically mega-cap Technology names since they have greater visibility and can grow faster than the economy. Second, Technology is also one of the largest market-cap-weighted S&P sectors within the S&P 500 Index (SPX). It is also over 40% of the NASDAQ NDX 100 Index (NDX) by market-cap. Due to the sizeable market-cap weighting in the Technology sector, professional money managers turned to many of these blue-chip Technology names during market uncertainties.
July 2020 timeframe – Technology and Healthcare Continues to Dominate
On 7/1/20, another technical review of the top 100 large-cap names ranked by SCTR showed Technology and Healthcare stocks continuing to dominate the list. There were 26 Technology stocks and 22 Healthcare stocks occupying the top-100 list. However, investors started to turn to economically sensitive sectors as 11 Consumer Discretionary stocks and another 9 Industrials showed up on the top 100 list. Below the surface, improving relative strengths from cyclical sensitive industries hint of investors anticipating the start of an economic recovery or the worst of the COVID-19 pandemic is behind us. It is interesting to point out that market breadth visibly expanded during this timeframe. The winners were more evenly balanced than at any other period in the past year. For instance, within the top 20 SCTR list, there were 7 Technology, 5 Healthcare, 4 Consumer Discretionary, and 4 Telecommunication Services stocks.
Year-end 2020 – Consumer Discretionary, Industrials, Technology, and Financials Lead
Toward year-end (11/23/20), we compiled another top 100 SCTR list. The promising results on the vaccine front gave investors further hope for a sustained economic recovery. Investors continue to rotate into the reopening stocks and away from the stay-at-home plays. A current review of the top 100 large-cap list ranked by SCTR scores further confirms investors are indeed moving into the reopening stocks in anticipation of an impending vaccine-driven rally. A deeper dive in the top 100 SCTR list shows economically sensitive sectors now dominating the list. For instance, the largest concentration of stocks comes from Consumer Discretionary (26 names), Industrials (21), Technology (16), and Financials (9).
Nearly a year ago, it felt like almost everyone was buying FAANGs and technology-based stay-at-home stories. Growth stocks outperformed value stocks by the largest discrepancy in decades in the biggest dichotomy since the dot-com era of 1999-2000.
While some were expecting that everything will return to normal tomorrow, the COVID-19 pandemic has forever changed the way we live, work, interact, spend, and invest. The pandemic has likely accelerated some of the technology trends that would have happened anyway. It has also created widely overbought levels in many of these growth-related names. The structural stay-at-home theme that began in earnest last year is probably far from over. The secular growth story strongly suggests investors still need to be positioned in the Technology sector, longer-term. Despite the underperformance over the past few months, on 11/23/20, 16 technology names remain in the top 100 list as ranked by SCTR scores. However, the epic rally from the Mar 2020 bottom has created overbought conditions in the marketplace including some of the secular growth trends.
Start of 2021 – Consumer Discretionary, Financials, Energy, Technology, and Industrials
On 2/23/21, a new SCTR study on the top 100 technical ranked names displayed an accelerating trend toward more reopening names (Consumer Discretionary and Industrials). However, it also shows two new themes emerging - investors pricing in a sustainable recovery in interest rates (Financials) and higher inflationary pressures (Energy). Within the top 100 SCTR list, two S&P sectors dominate half of the list – Consumer Discretionary (28 stocks) and Financials (25 Financials). Consumer Discretionary is a classic play on the reopening theme. Financials will excel in a higher interest rate environment. Financials could also be a shift by investors rebalancing their portfolios from growth toward value stocks. Energy (12), Technology (11), and Industrials (10) account for another 33 names. The shift toward the reopening theme is most evident in the top 20 SCTR list as 8 stocks are Consumer Discretionary names, and 4 stocks each come from the Energy and the economically sensitive portion of the Communication Services (i.e., Entertainment and Publishing). Note that there was no Technology name in the top 20 SCTR list, suggesting the structural growth sector may still be undergoing consolidations. Until the overbought conditions have been fully alleviated the Technology-driven stocks may remain volatile.
Time to Modify the Equity Barbell Strategy?
So, the pertinent question then becomes, should investors rebalance their portfolios and adjust their equity barbell strategy to incorporate the emerging two new themes – higher interest rates and higher inflation/commodity prices. Adding the stronger Financial and Energy/Materials names into an equity portfolio will allow investors to participate in rising interest rates while hedging against higher inflationary/rising commodities prices.
Should one leg of the equity barbell strategy consist of the structural growth, stay-at-home stocks, and the reopening/economic recovery stocks (i.e., Technology, Consumer Discretionary, and Industrials)? Should the other leg of the barbell now consist of rising interest rates and rising inflation/commodities trends (i.e., Financials, Energy, and Materials)?