For market corrections and Jack Reacher, details matter

Patient fans were rewarded earlier this year by Amazon with an eight-episode, anatomically correct retelling of the first book in Lee Child’s famed Jack Reacher series. The show details the adventures of Jack Reacher, an ex-military investigator, as he stumbles upon a crime ring in Margrave, Georgia. Reacher quickly moves from bystander to detective’s helper as the lead investigator in the small town realizes he’s in over his head. Reacher’s tagline, which gets adopted by the local police, and leads to the eventual downfall of the crime ring’s mastermind, is: “in an investigation, the details matter. “

We at Balentine have our own version of the saying: “in a market correction, the equities owned matter.” This has proven to be true in the last two market corrections; growth stocks took a very different path than the broader market in the coronavirus correction, and US value stocks are showing the same characteristics during the current market correction (Figure 1).

Figure 1. Equity Performance leading up to and during the COVID correction (left) and the 2022 correction (right)

Source: Factset, Balentine

Why the Details Matter

As with most Jack Reacher stories, there’s one detail that sticks out in his mind that he can’t quite figure out. As the investigation moves forward, this detail, which is ignored by most, nags at him until he finally connects the dots and throws the case wide open. Without first seeing this detail and then following it to its conclusion, Reacher would be no more than a B-movie detective, stumbling upon the plot only after it was too late.

Why the Equities Matter

This parallels what we see in the investing world. Many investors simply buy the broad market and ride out the corrections and bear markets. They forgo the exercise of looking at the details and clues the market is giving, happy to own a little bit of everything. This approach has merit, as it guarantees they will own some of the best performing stocks during drawdowns. The downside, however, is they own the rest of the market that is underperforming at the same time.

Balentine, on the other hand, looks for the details and clues the market is giving. This is done through utilizing a tactical allocation through our momentum investing model. This model purchased US large-cap growth stocks in the middle of 2017 and held them through May of last year. When the model then signaled that the momentum was turning towards U.S. large cap value stocks, we purchased them in May 2021.

The benefit of owning the right stocks during market corrections is that when the correction is over, the investor will have a larger asset base to grow on, which will compound through time. For example, imagine there are two investors with $100 in the market. Investor A has a tactical allocation that puts her in the right place during a correction; she loses $10. On the other hand, Investor B has the broad market and loses $20. If both investors go on to earn a 10% return over five years, Investor A would end with $144 and Investor B would only have $128. In fact, Investor B would have to earn 13% every year investor A earned 10% to catch up by year five. This is the power of being in the right place during stock market corrections.

Pitfalls

Jack Reacher is not infallible though: he displays a stubborn confidence that he can punch his way out of a situation. In his relentless effort to follow his instincts, he tends to end up in situations slightly over his head, typically leading to collateral damage and narrow escapes.

Our tactical process, which tries to mitigate the cost of static weighting to segments of the market, was in the right places during the last market corrections. The tactical nature of allocating to certain segments of equities, however, also has a cost: hit rate and taxes. Our hit rate is not 100%, and our process does not always get it right. A recent example was 2016, where we sold growth and bought value coming into the 2016 election, only to buy back growth shortly after as the FANG phenomenon gained steam.

The other cost is taxes. A tactical approach like Balentine’s will come with higher turnover and therefore typically a higher tax bill for taxable investors. There are levers we employ to reduce this tax drag including customized implementation, ensuring positions are sold at long-term gains, aggressive tax-loss harvesting when opportunities arise, and sizing the tactical portion appropriately based on client’s situation and need.

Conclusion

Whether uncovering crime rings in South Georgia or tactically allocating to equities around the globe, the details matter. Balentine’s approach has been consistent in allocating to and away from segments of the equity market based on momentum. This has been significant reason for the preservation of capital when markets are weak because in a correction, the equities you own matter.
Should you have further questions about our tactical allocation process, or any of the details related to your personal financial situation, reach out to info@balentine.com and we will connect you with a relationship manager to address your needs.