For investors, the recent past has been a tough time to be conservative – or has it? If one is chasing performance, seeking to always outperform the market, then this strategy has, indeed, been going through a cold spell. But if one is goal oriented, and if one’s goal calls for an emphasis on staying generally in the same ballpark as the market but with less volatile swings either way, then this approach remains appealing.

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Trump Rally?

It’s no secret that after a brief (very brief, so brief it can be hard to even remember) falloff once it became apparent that Donald Trump would win become President of the United States, the market has been on a tear. Explanations are as widespread as political analyses, and as widespread as forecasts of a Clinton landslide. Quality of assessment aside, the logic of a Trump rally, if that’s what we’ve been seeing, deal with the potential impact of rising interest rates on financial firms (which have led the rally) and expectations that his nationalistic populist pro-business (interesting juxtaposition of ideas) will help the economy and, presumably, generate enough profit growth to more than offset the impact of rising interest rates.

Early January Effect?

Remember the January effect? That’s when year-1 laggards rally in the first month of Year-2 and when Year-1 leaders languish in January of Year-2. Like most things in the market that become extremely well known, investors anticipate it. So nowadays, we can’t really be sure the January effect will actually take place during January. A case can be made that the tax adjustments said to motivate the January effect have been causing and/or contributing to the rally we’ve been seeing. That may explain why especially hard hit groups, such as value and small cap stocks, have been strong.

Darned If I Know!

As with pre-election forecasting, the most accurate analyses may be the ones offered by those who shrug their shoulders, roll their eyes, and give up trying to predict. I’m in that camp; my automated “signature” in the Portfolio123 Forums says “Want to know what's going to happen in the next year? No problem; I'll tell you 366 days from now.” Actually, I adapted that from a scene from the 1970-something movie “Oh God!” when the title character is asked if he can predict the future. The late George Burns, playing the role of the divinity says something to the effect of “Yes, I can predict the future, as soon as it becomes the past.”

A Strategy for Those Who Hate to Predict

I’m guessing the cinematic deity would appreciate the Smart Alpha Low Volatility Select – S&P 500 portfolio (available for free both for divine and human beings on portfolio123.com). It leaves the predicting and performance-chasing to others who are wiser, or at least those who believe they are. There’s a price to pay for that: Sometimes, when the market gets hot, you have to sit in the back and occasionally endure the taunts of those who scratched and clawed their way to front row seats.

Figure 1

That’s so at least until the ushers come around to look at tickets, as they inevitably do. (I know. Often when I was young, I tried to parley my $1.50 General Admission ticket to Yankee Stadium to a flied level box seat at field level at Yankee Stadium and managed to squeeze out a few innings now and then, but not an entire game.)

This is a low-volatility strategy not by happenstance (while historical Betas are considered, they are not projected naively into the future) but by design. It emphasizes companies whose business structures and/or balance sheets make it more likely than not that their profit streams will be more stable than we see at most companies. While in the short term, anything can happen, over time, more stable profit streams are likely to translate to more stable equity returns. So don’t expect exposure across all market segments. Expect, instead, an emphasis on so-called defensive sectors and large cap stocks (large size makes for decreased influence of fixed costs and better internal diversification).

Figure 2

Don’t expect low valuation. Goodness no! If one is risk averse, the last thing one should do is chase low P/E. Trying to diminish risk by reducing P/E is like trying to fireproof a space by pouring kerosene all over it.

Without getting mathematical here (I do it elsewhere, such as here), the formulation for a “correct” P/E, the same formula that tells up P/E can rise as growth rises, tells us that all else being equal, P/E must rise as risk falls. Risk protection is a benefit for which one must pay. That’s so in life (see, e.g., fire insurance, auto insurance, errors and omissions insurance, health insurance) and it’s so in the market, whether one pays premiums to own risk-reducing derivatives or higher P/Es to own shares of higher-quality companies (this strategy opts for the latter).

The Stocks

This low-turnover portfolio is refreshed every three months. The most recent trades are:

• Sell Cintas (CTAS), International Flavors and Fragrances (IFF) and TJX (TJX).
• Buy O’Reilly Automotive (ORLY), United Parcel Services (UPS)

Table 1 lists the current portfolio:

Table 1

* Days held is measured from its inception, on 1/2/99 as a simulation. The portfolio went live on 9/1/15, which is the period depicted above in Figure 1.