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Second Quarter Market Review

The final estimate of first quarter U.S. real GDP growth was –0.2%. Many of the Euro Area economies demonstrated continued improvement in the second quarter due to weaker currency, lower energy prices, and an accommodative monetary policy. Japan’s recovery remains on track, and recent data indicate that economic growth in China may be stabilizing.

Both U.S. equity and fixed income markets struggled in the second quarter of 2015. The S&P 500 Index gained only +0.3% in the quarter, while taxable bonds declined –1.7% and municipal issues declined –0.9% for the quarter. International equity markets performed slightly better, increasing +0.6% for the quarter.

In domestic and international equity portfolios, Sit Investment Associates is maintaining holdings in diversified, high-quality, growth-oriented companies. Our domestic taxable fixed income portfolios and tax-exempt portfolios continue to shorten duration in anticipation of a flattening yield curve.

The Lifeblood for Growth Portfolio Performance

Health care companies are generating above-average revenue growth from the gradually improving economy and low inflation in the U.S, along with employment gains and the Affordable Care Act that add to the number of insured people and higher medical utilization.  Internationally, the healthcare sector has experienced growth from increased medical products consumption in emerging markets and, due to a rebound in economic activity, higher medical utilization in developed markets. 

The health care sector is also benefiting from greater pipeline productivity among therapeutic and device manufacturers.  In the past few years, notable product introductions that address hepatitis C and various new oncology indications have led to higher average selling prices per course of therapy, leading to higher revenue growth among therapeutic manufacturers – a trend that is expected to continue in the foreseeable future.  Medical device manufacturers have also benefited from new product innovations that have allowed them to treat increasingly complex cardiac and orthopedic cases.  These innovations have also increased medical utilization and served to pare back industry pricing pressure.  Medical service companies benefit from rising medical utilization, but also from structural changes associated with the Affordable Care Act.  Managed care and peripheral industries are seeing increases in membership associated with the implementation of the law, while health care facilities are seeing uncompensated care fall as more people gain access to health insurance.

The three-year projected revenue growth rate for the health care sector is +6.0%, which exceeds all other S&P 500 sectors, while the sector’s three-year earnings per share growth of 11.3% is eclipsed only by the consumer discretionary and financial sectors.  The health care sector’s three-year projected growth rate exceeds expectations for the S&P 500 Index by +3.3 percentage points.  Despite this projected outperformance, the health care sector is selling just a bit higher than its 10-year relative average multiple to the S&P 500 Index on forward year earnings.

We see good value in carefully-selected biotechnology stocks, which exhibit stronger average earnings growth than the health care sector, and the market in general, driven by new product introductions.  We also like medical device stocks, which benefit from rising utilization, new product introductions and industry consolidation.  We are positive on health care services companies that help to manage the increasingly complex healthcare environment, while benefiting from secular growth trends associated with healthcare reform and an aging global population. 

Manage Risk With Asset Allocation

Asset allocation is a very important part of risk management within an investment portfolio. By investing in multiple asset classes, such as stocks, bonds, real estate, etc., that do not have closely correlated returns, investors can lower the variability of the returns that their portfolio experience over time. After an allocation method has been selected, periodically rebalancing the portfolio becomes an integral component to this process.

Through different allocation and diversification strategies, it may be possible to create portfolios with reduced risk (as measured by return variability) that can produce more consistent returns. For example, the S&P 500® Index, which is often used as a proxy for U.S. large cap stocks, fluctuated in annual returns from a low of -37.00% (2008) to a high of 26.47% (2009) for the five years ended December 31, 2012, while the Barclays U.S. Aggregate Bond Index, a proxy for the U.S. taxable bond market, only fluctuated between +4.22% (2012) and +7.84% (2011) over the same time period. During the calendar year of 2008, a portfolio comprised of holdings from both indices would have experienced a smaller decline than one made up entirely of the S&P 500 Index. In 2012, investing only in bonds (as defined by the Barclays U.S. Aggregate Bond Index) would have produced a positive return of 4.22%, but adding stocks to the equation would have increased the return on a portfolio for that year.

Asset Allocation

Read the full article "Manage Risk With Asset Allocations".

August 31, 2015

The Sit Mutual Funds are managed by Sit Investment Associates, Inc., which has been operating under the highest ethical and professional standards since it was founded in 1981 by Eugene C. Sit. We maintain an uncompromising commitment and adherence to our investment philosophy and style, while continually seeking ways to enhance our investment process.

Eugene Sit

Read about Sit Investment Associates & Sit Mutual Funds founder Eugene Sit.

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