Rob Stein is all about the power of economic fundamentals. Building ETF portfolios that are widely used by advisors and investors alike, Stein and his team at Astor Investment Management are constantly taking the economy’s temperature and adjusting exposures accordingly. Today the firm manages nearly $2 billion in assets. Stein tells us what sectors he likes and doesn’t like for 2017, and why sector rotation is a good strategy to consider.
ETF.com: What’s your macro outlook going into 2017?
Rob Stein: We have something we call the Astor Economic Index, where we aggregate lots of economic fundamental data, and we create a reading with it. We then compare it to historical versions of that data to give us the temperature of the economy. We use that to adjust how much risk or how much stock we want in our portfolios.
It’s served us well over many years, and right now, it isn't saying a whole lot. It’s saying we're growing slightly above the recent trend—the recent trend being eight, nine years. A lot of people will tell me that 2% GDP growth is weak, and the economy is capable of doing better, but that’s the trend we’ve seen. The 3.5%, 4% GDP we aspire for hasn’t been seen in well over a decade.
Unemployment rates, GDP—these are numbers that aren't shooting the lights out, but they’re above levels we’ve seen in the last five, six, seven years. It’s certainly enough growth to support owning stocks, and having stocks be positively sloped.
We're in a low-return, low-rate environment. Risk assets aren't giving what they used to, but neither are low-risk or no-risk assets. In that context, is 1.5-2% growth good? It should support stocks. Is 5-7% equity returns good? Well, better than nothing, and better than what you're getting on risk-free assets.
I think that environment is going to stay around through much of the next year, or at least through the first couple of quarters of 2017. Now, don't get me wrong: Anything could happen tomorrow. But as the economic data looks now, there wouldn’t be anything that I think would create sustained wealth destruction or that the markets and economy wouldn't recover from. We would adjust our portfolios to handle volatility, but probably would not get defensive unless the economic data started to deteriorate.
ETF.com: So how would you implement that view, from a sector perspective?
Stein: We start by deciding how much risk assets we want to have; let's say 70%. Then we drill down into how we want to express that weighting and in what sectors. One of the things we do is look at where the growth is occurring in the economy. Of the GDP, of the output, what sectors are contributing to that the most? Same thing in employment trends: Where are the jobs being added every month going? We look to identify those sectors.
We then we look at various momentum and valuation models to come up with a portfolio weighting. Lately, the overall average of them all has outperformed any one individually. I don't think that's a consistent theme. I think there’ll be sectors that will stand out.
For example, energy. It did very poorly in 2015, and that was something that was picked up on in economic fundamentals. The energy sector was hiring fewer people than it had in the past. It was contributing less to overall economic growth than it had in the past, and it was a sector that lagged that year. Energy has bounced back some, and it’s one of the better-performing sectors now.
I would caution riding that wave much longer. It doesn't seem that the economic fundamentals of it being a leader are supportive, and we’ve actually reduced our weighting to the energy sector recently. But one of the sectors we like is the financial sector.
ETF.com: Because of the outlook of higher rates or because it should recover from a weak performance this year?
Stein: It's one of the worst-performing sectors this year. It’s uncertainty on what's going to be happening with rates, the election, and a little bit of the black eye the industry has gotten as a whole. But when I look at fundamentals, and I look from an earnings perspective, where it is from a contribution to GDP, where it is from employment trends, we see tremendous growth and upside potential in the financial sector. So, we're overweighting that sector.
ETF.com: What other sectors do you like for 2017?
Stein: Another poorly performing sector recently is health care due to uncertainty from the election and valuations that got a little long in the tooth. I see the health care sector as another place I would want to overweight in the upcoming quarters.
Basic industrials have had a good run, but the strength of the dollar, the valuation component of that, will also be a head wind for industrials, so I would reduce exposure there. The same applies to materials. The dollar and a run-up in material prices—gold particularly—have skewed that sector, and I'd be very, very cautious in materials going forward.
ETF.com: What fundamental metrics or factors do you look at to decide when it’s time to jump in and out of a sector? How do you build a sector rotation strategy?
Stein: In our sector rotation portfolio, we have a core holding of large-cap, midcap value growth—that's somewhat static. We then use sectors around it based on where we're seeing economic fundamental growth. We increase and decrease the sector allocations based on economic fundamentals.
If a sector is contributing more to the economy, we want to be in that sector. If the sector’s adding more jobs, we want to be in that sector. And then momentum is the confirming data point. You like to have all these things occurring, plus positive momentum. Or, at least if it’s negative momentum, it's waning and it’s starting to trough. Lastly, our economic fundamentals of the economy as a whole will lead us to adjust the weighting.
ETF.com: Is sector rotation a good way to tackle the equity part of a portfolio? I’ve seen research that says sector rotation strategies offer little in added returns over time. Should you invest through a sector lens?
Stein: It’s a good addition. If you only care about long-term returns, you could just leverage up the S&P 500 and close your eyes. I do caution that if you do that, you might lose all your money. The volatility in the S&P 500 might be something you’re uncomfortable with.
Additionally, there will be times like 2001 recession, when there were sectors that went up. Small-cap went up, REITs were up, financials held up OK. It was very different in the 2008 recession. So, when you make a portfolio of risk assets, having sector rotation as a component of that is very important, because the market will appreciate over time for different reasons. There will be times that a sector will be carrying the market, or a sector will be harming the market, and you’ll have this market performance that you could do better than by identifying the strong and weak sectors.
What you're seeing now is not so much deviation from that, but there are periods of time where having sector allocations really is beneficial to the risk and return of the portfolio.
ETF.com: Has sector investing changed in the last decade? Are correlations out of whack? And are different products today—such as smart-beta ETFs—impacting the way people invest in sectors?
Stein: The ETF itself has allowed you to get pure exposure to a sector in a way you couldn’t before. You'd have to buy baskets of stocks and then decide where you’d put this or that stock. Is it really fish or fowl? I don't know. Now, you have ETFs that truly mimic a sector’s indices without having to buy or pick the individual stocks. That’s to say sector investing has become a lot easier to do today.
The basic research to determine whether a sector is likely to outperform or underperform hasn't changed. Basic economic fundamentals make sense—more people working, producing more output, that's good. We all work for a profit. I'm assuming that if you're making a profit, you're going to try to do more of that. That hasn't changed.
What has changed is the profile in a low-return environment of outperforming and underperforming sectors. I don't think it’s a permanent change, but when you're in an environment where 2.5% seems like a lot greater performance that 1.9%, what constitutes a winner has changed. We need to be mindful of what the long-term objective is.
ETF.com: Is there a wrong way to implement a sector rotation strategy? How can you get it wrong?
Stein: There are wrong outcomes. There are many different ways of adjusting your sector exposure, but I’d think that if whatever you're doing constantly put you in the underperforming sector over time, you might want to look at something else.
But the risk of getting it wrong in sector selection might not be as harmful as in cash equity. The fact that there's a regression to the mean, if you will, or that a rising tide lifts all ships, it would seem to be less potentially harmful to move from a sector to another if you’re in a long-term rising stock environment than it would be to simply be in the wrong individual stocks. The risk of harming a portfolio by not being in the right individual stocks would seem higher.
ETF.com: Do you recommend sector investing globally or do you focus exclusively on the U. S.?
Stein: We have a product where we look globally at risk assets. It’s a sleeve in the portfolio, and we increase and decrease exposure based on analysis of global economies, some momentum and on how they relate to the U.S. economy. But there is a correlation between global risk assets. Maybe not day for day, or quarter for quarter, and there are some outliers, of course, for geopolitical events, but there’s a correlation between stock markets around the globe and the U.S.
ETF.com: Do you like any specific sector ETFs? Are you using sector SPDRs, or are you implementing sector strategies with smart beta funds?
Stein: We stay away from smart beta. That's what we ourselves do—we’re the smart-beta element of asset management, if you will. Unless it’s doing something we just don't look at all.
For example, we use First Trust ETFs in some things because they weight the portfolios in a way we just don't look at. But for us, we really want the ETF to perform when our fundamental analysis is performing. We also look at cost, to a degree, but it’s not a first consideration.
We need the ETF to be liquid so we can trade it, and we want to make sure it’s weighted in a way that we understand. The visibility of how the ETF is constructed is also very important.
ETF.com: REITs became its own sector this year under GICS. Is there space or even a need for other sectors to split? Could technology, for instance, be more finely tuned now that every business, in one way or another, is increasingly techy?
Stein: I think it’s going to happen more. REITs were an obvious low-hanging fruit. I think a lot of people already were separating REITs from financials. We were doing components of that when we were looking at dividend and/or REITs and/or financials.
But that’s a great point about technology: As technology becomes a very important part of every business, when does it become the business?
I’ve always said that every business ultimately becomes a marketing and distribution business. You make your doughnuts, you work on how good they taste, and they finally taste good enough where people are buying them. Now, it’s all about selling and marketing.
I'm not sure where the crossover is from a technology company. Maybe we need to look at what the core product is, but definition will be crucial to deciding what you're looking for in your exposure.
Contact Cinthia Murphy at [email protected]