2016 – Another Year Thematic Investing Beats the S&P 500
08 Jan

2016 – Another Year Thematic Investing Beats the S&P 500

Looking back 2016 was quite the year with Greek debt relief, the EU’s tax crackdown, the sale of Yahoo (YHOO 41.99 0.00 0.00%) and rumored takeover of Twitter (Twitter, Inc. 16.96 0.00 0.00%), the unexpected Brexit vote and the ensuing British Pound Sterling’s plunge to multi-decade lows, the Italian referendum followed by Prime Minister Renzi’s resignation, the troubled Monte dei Paschi (BMDPY) bailout, Russian hacking, OPEC’s deal to cut output, and one of the most vicious presidential campaigns culminating in Donald Trump’s election, followed by the Fed’s lone rate hike in 2016 and a corresponding surge in the US dollar. We think we would be hard-pressed to find many that predicted all of those happenings this time last year.

We also think there were few and far between that thought back in January 2016 that the S&P 500, the preferred metric among fund managers, would have climbed 9.5% by the end of 2016. Let’s remember, after the first several weeks of 2016 that index was down just over 8.7%. That makes the rebound and climb higher over the balance of 2016 that much more impressive if you bought the market.

The problem is, despite all the mutual funds and ETFs that are out there, very few investors actually “buy the market.” Buying the market can, at times, deliver rewards as we saw in 2016. According to Openfolio, the average investor in 2016 didn’t “buy the market” and instead had a gain of roughly 5%, due in part to having their portfolio too concentrated in stocks that didn’t perform. Let’s face it, if you didn’t own shares of Goldman Sachs in the back half of 2016, odds are you didn’t beat the Dow Jones Industrial Average.

Lest we let the year’s heady gains of cloud our judgment, for every 2016 — where buying an ETF that mimicked the performance of the S&P 500 or the Dow worked well by year’s end — there tends to be a year like 2015 when the S&P 500 fell nearly 1%. While we tend to hear about the great bull market that transpired during the late 1980s and 1990s, we also have to remember that if you were an investor that, “bought the market” in early 2000, it would have taken you until July 2007 to recoup your losses. Then came the Great Recession, which meant if you held “the market,” it meant meaningful positive returns would have eluded you until after March 2013.

As we like to say perspective is everything. That same perspective also reminds us that the world is a very different place than it was in the last part of the 20th Century. Consider that back then there was no such thing as the smartphone, the Internet, Amazon, streaming content, online shopping, mobile payments, and texting only caught on toward the end of the 1990s. Back then we also saw a labor force growing versus the relatively stagnant levels since the financial crisis.

We live in a very different world today compared to a few decades ago, which makes comparisons more like apples to oranges than apples to apples. There continue to be many transformative elements at play today and we are only now starting to see the impact of some, like mobile commerce and artificial intelligence, as well as augmented and virtual reality, that will likely see that transformation continue. That’s before we contemplate what will happen once President-elect Trump becomes President Trump. While we are optimistic about the pending policy changes and what they could mean for businesses and stock prices, they have yet to be fully spelled out, which makes it hard to assess their potential impact.

As we say at Tematica Research, only by thinking differently than the herd can you truly outperform the market. We believe that traditional sector investing is dead, and investors need to position themselves to capture the shifting landscapes that are resulting in pronounced tailwinds and headwinds. That thinking led to our creation of the Thematic Index, which reflects our 17 investment themes across more than 150 stocks.

 

So how did the Thematic Index perform in 2016?

Once again it outperformed the S&P 500 in 2016, marking the sixth consecutive year it has done so. Some of our stronger performing thematics in 2016 included Tooling & Re-Tooling, Economic Acceleration/Deceleration, and Scarce Resources.

Were all of our 17 themes strong performers in 2016? Of course not, but the overall performance speaks to having a balance thematic portfolio rather than favoring any one particular theme.

Before accounting for dividends, eight of our investment themes outperformed the market by a wide margin, one was essentially in line with the S&P 500 and eight underperformed with two of those under performing themes down slightly for the year. There were a number of high fliers across our 17 investment themes, including Grand Canyon Education (LOPE 57.61 0.00 0.00%), iRobot (IRBT 58.46 0.00 0.00%), IDEXX Laboratories (IDXX 120.01 0.00 0.00%) and Mueller Water Products (MWA 12.87 0.00 0.00%), Parker-Hannifin (PH 143.62 0.00 0.00%), Wynn Resorts (WYNN 92.34 0.00 0.00%), and ZELTIQ Aesthetics (ZLTQ 41.13 0.00 0.00%) to name just over a handful. The index was also dealt a helping hand from M&A activity during the year, which led to hefty gains in Lifelock, LinkedIn, and ARM Holdings.

It wasn’t all peaches and cream, as the Thematic Index felt the weight associated with drops in Stonemore Partners, Corrections Corp. of America (CXW 27.72 +0.01 0.04%), Nuance Communications (NUAN 15.57 0.00 0.00%) and Under Armour (UAA 30.14 0.00 0.00%).  We’ll reassess those under-performing positions to see if either the thematic drivers that first landed them in the Thematic Index are intact or has the business has shifted such that they are no longer in the thematic slipstream. During the December quarter, we exited Corrections Corp. of America and Shake Shack (SHAK 35.15 0.00 0.00%), replacing them with OSI Systems (OSIS 72.12 0.00 0.00%) and Insulet Corp (PODD 43.50 0.00 0.00%).

We’ll continue to make refinements and needed adjustments to the Thematic Index as dictated by the shifting and intersecting landscapes of economics, demographics, psychographics, technology and other key factors to identify the companies best positioned to ride the thematic transformation and avoid those companies that either can’t or won’t adjust their business model. In our view, those latter companies are poised to hit a headwind that will not only impact their business, but their stock price as well. When it comes to investing minimizing the number of underperforming positions can be as important as identifying the winners if you’re looking to beat the market. When it comes to investing minimizing the number of underperforming positions can be as important as identifying the winners if you’re looking to beat the market.

 

About the Author

Chris Versace, Chief Investment Officer
I'm the Chief Investment Officer of Tematica Research and editor of Tematica Investing newsletter. All of that capitalizes on my near 20 years in the investment industry, nearly all of it breaking down industries and recommending stocks. In that time, I've been ranked an All Star Analyst by Zacks Investment Research and my efforts in analyzing industries, companies and equities have been recognized by both Institutional Investor and Thomson Reuters’ StarMine Monitor. In my travels, I've covered cyclicals, tech and more, which gives me a different vantage point, one that uses not only an ecosystem or food chain perspective, but one that also examines demographics, economics, psychographics and more when formulating my investment views. The question I most often get is "Are you related to…."

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