Keep calm and stay focused

This past year was a difficult year for many investors.

For those of you who read last year’s update, you know that the Leveraged Value strategy focuses on small cap stocks.

Small cap stocks for the 2nd year in a row significantly underperformed large cap stocks as the Russell 2000 (Small Caps) returned -5.7% vs -0.7% for the S&P 500 (Large Caps).


Oil Collapse

The strategy began 2015 with oil as my portfolio’s 2nd largest sector. As we said at the time: “The performance of the Leveraged Value strategy vs. its benchmark will likely depend on oil prices in 2015.”

This was exactly the case. The problem, of course, is that instead of oil recovering from its 2014 collapse, the downward trajectory continued in 2015.

Tough Year

Given all of this, you won’t be surprised to know that the Leveraged Value strategy had its worst year to date, returning -9.0% vs. -5.7% for the benchmark (Russell 2000).

Frankly, I still feel very confident in the strategy’s investment process for two reasons.

First, a single oil position significantly hurt overall performance.

This position did not have a strong enough balance sheet to weather the drop in oil and as a result, we have re-evaluated the standards for what we consider “strong” balance sheets have been re-evaluated. Thus the strategy’s threshold for financial stability has been raised.

Looking Ahead

With this change, I am confident that this damage can be avoided going forward.  

Secondly, the majority of the strategy’s holdings were up in a down market. It is my opinion that this batting average indicates the process can be successful over extended periods.

To illustrate these points, my oil exposure contributed -15% while other sectors contributed 6% for a total of -9%.

Market Cycles

Although I provide these investment updates annually, I’d like to remind readers that one year is a very relatively short period of time.

My belief is that 3 years should be a minimum, 5 years is preferred, and an entire market cycle is most ideal in evaluating a manager’s returns.

With that being said, below is an updated performance history of the Leveraged Value strategy since its inception started 2 ½ years ago.

2016 Outlook

As of January 22, the S&P 500 is down 8.6% so far in 2016. As I write this sentence, the S&P 500 is down 7.5% just a few weeks into 2016.

This quick drop combined with rough end of 2015 has some investors panicking.

The best advice I can give you is to stay calm and have a long-term outlook. Now is not the time to call your financial advisor and tell him to sell your oil positions.

In the words of Warren Buffett: “Be fearful when others are greedy and greedy when others are fearful.” There is quite a bit of fear right now, specifically when it comes to oil.

Oil Outlook

Although I was wrong predicting a recovery of oil in 2015, I strongly believe that I will be proven right over the long-term.

According to the International Energy Agency, the estimated global average cost is $42/barrel. It’s very simple, the most generous figures for the most efficient oil companies estimate all-in cost at about $45 per barrel.

Furthermore, many are not profitable below $60 per barrel. In the past one and half years, worldwide rig counts dropped by more than 40%. I believe production will eventually decrease as well.

If prices remain low for an extended period of time, the weaker companies will may eventually go out of business and the stronger survivors will benefit. This strategy aims to hold companies with strong balance sheets who will survive prolonged low prices in oil.

US Stocks

I mentioned last year, “the US stock market is easily the most expensive market in the world.” This was highlighted by the high Shiller P/E Ratio of U.S. markets.

In 2015, non-US markets, represented by the Vanguard FTSE All-World Ex-US ETF, lost 7% and again underperformed U.S. markets (S&P 500).

Thus the gap has widened, and I believe international markets still provide the best  an opportunity for those with long time horizons who can stomach the ups and downs.

More specifically, the strategy will continue to avoid the biotechnology and healthcare sectors.

We have recently seen losses in these sectors after multi-year gains. I believe there is much more pain to come, especially in biotech.
Photo credit: Moyan Brenn via Flickr Creative Commons
Important Disclosures

Past performance does not guarantee future results. As with any investment strategy, there is potential for profit as well as the possibility of loss. Camelot Portfolios, LLC does not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk and investment recommendations will not always be profitable. This document does not constitute a complete description of our investment services and is for informational purposes only. It is in no way a solicitation or an offer to sell securities or investment advisory services. All investments involve risk, including foreign currency exchange rates, political risks, market risk, different methods of accounting and financial reporting, and foreign taxes.

Historical performance results for investment indices and/or categories have been provided for general comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your account holdings correspond directly to any comparative indices.  An investor may not directly invest in an index. Strategy performance results are presented net of all fees and reflect the reinvestment of dividends and capital gain.

The S&P 500 Index is presented as a general representation of the behavior of the domestic equity markets.  The Russell 2000 Index seeks to track the returns of an index composed of small-capitalization domestic equities.  The FTSE All-World ex-US ETF seeks to track the performance of a benchmark index that measures the investment return of stocks of companies located in developed and emerging markets outside of the United States.