2019 YEAR END: HINDSIGHT SHOULD NOT BE YOUR 2020

Hindsight should never be the reason for adjusting an investment portfolio. Period. Positive or negative performance of the past has come and gone; it cannot be changed. However, analyzing historical data can help understand and manage risk going forward. In this commentary, we explain why the risk of equity markets are higher than normal going forward.

Positive momentum may be at risk of stalling out. The gauge of market breadth is at its highest level since early 2018. This type of cyclical peak in momentum, as indicated in the chart below by previous similar peaks in 2018, 2017 and 2016, has historically been followed by heightened volatility.

Compounding the need for caution is the fact that investors overall have been exiting equity fund vehicles. Almost $200 billion left equity mutual funds and ETFs (exchange-traded funds), despite the market rally in 2019. This is a strange phenomenon given supply and demand typically dictates prices rise with fund inflows, and fall with fund outflows. So if all the flows are going out, how can prices be rising? Perhaps investors are leaving diversified equity funds to favor individual stocks, such as mega-cap technology names, and in turn, causing the index to become more concentrated as shown…

Sources: Bloomberg, Redwood. For illustration purposes only. An investor can not invest directly in an index.