Strategic Allocation Models & Market Update

Strategic Allocation Models & Market Update

April 25, 2022
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Before I get too deep into my message, I want to apologize in advance for the technical nature of what I am trying to explain. Please don’t hesitate to reach out to us with any questions or clarifications you might have.

 

2022 thus far has been a very difficult year for both the equity and fixed income (bond) markets.  We understand your frustrations with overall portfolio performances; however, we build our diversified model portfolios to mitigate the effects of market downturns while capturing as much of market gains as possible over the long term.  You might have noticed a recent email we sent out alerting you that we are making changes to models based on a lot of research and due diligence.  This is to position your portfolios to take advantage of where we believe markets, and more specifically asset classes will be going.  We are facing a whole host of exogenous factors that are affecting every asset class and region of the world.  We have a Federal Reserve who, by all accounts has gotten behind the curve and is aggressively raising interest rates, an inverted yield curve, a possible recession on the horizon, a war in Europe, oil prices at extreme levels, a lock down in China further complicating supply chains, a pandemic that is still lingering; oh by the way the purchasing power of cash is losing 8.5% a year due to 40 year highs in inflation.  Our goal is to position our clients to ride out this volatility with as much downside mitigation as possible on a risk adjusted basis.  The consensus view of the analysts I speak with (Fidelity, T Rowe Price, Columbia Threadneedle, Pimco, and Guggenheim) is this volatility will ease over the next 6-12 months as supply chain bottlenecks and inflation start to moderate.  We do not try to outthink the markets, chase yield, returns or the next hot stock or fund out there.  The reason we don't do this is because it typically does not work.  By moving in and out of positions, going to cash or otherwise trying to time the volatility could mean missing strong up days in particular asset classes or markets as a whole.  Missing up days in the markets is every bit as bad as participating in the down days, this is a historical fact.

 

We did not made the move to our updated model portfolios sooner because all of our models, with the exception of our most conservative, were all positive for the month of March.  April has historically been a very positive month for equities as well; however, 2022 is turning out to buck that trend.  Therefore, we feel now is the right time to update and transition our models to best weather this storm and position our clients for what we think will give the most downside risk mitigation, while still participating in market gains going forward based on the exogenous factors I listed above.  We are constantly researching and talking to analysts to make sure we are doing our best; however, we are not traders! We will not be moving in and out of holdings trying to time the market or picking hot securities, we employ a strategic asset allocation model making adjustments as economic factors change over time.

 

Our diversified models are based on using securities within the portfolio that have low or negative correlation to one another; however, in the environment we’re in right now there are precious few areas to hedge.  Rising interest rates means that fixed income funds are losing money; therefore we favor shorter duration and higher yielding sectors through an overweight to floating rate credit and high yield bond markets because they are significantly less interest rate sensitive.  Growth stocks have lead the S&P 500 and NASDAQ for quite a while but rising interest rates and a tightening money supply have hit high valuation stocks (growth) very hard.  While valuations are off recent peaks, we are shifting our weighting to more value oriented securities based on moderating growth and earnings outlook amid an active Fed and lingering inflation concerns.  We will still maintain an equal weighting to large cap growth and large cap value in an effort to take advantage of moves in both asset classes.  However, due in large part to the factors I mentioned above, we have shifted our small/mid cap holdings entirely to value.  Domestic equities have also been leaders for quite some time and when we started the vetting process on our models our intention was to add a greater weighting to international both developed and emerging markets.  Taking into account the Russian invasion of Ukraine earlier this year and actions by Central Banks around the world ending their asset purchases and aggressively raising interest rates to curb inflation, we have moderated a bit on how much international holdings we have in our models.  We have still added to our international position in this update but not as much as originally intended.  Emerging markets is an asset class we will be monitoring very closely in the coming months for opportunities to add to our position. 

In our more aggressive models, we have added a sleeve of commodities to take advantage of inflated prices in the marketplace.  This is a more tactical sleeve with a much shorter time horizon than the rest of the portfolio.  As supply chains around the world start to loosen and demand tightens due to higher costs, this position will likely be replaced.

 

The last thing I want to touch on is actively managed mutual funds versus passively managed index funds.  Although we have the ability to hold both of these securities in our models, we have chosen at this time to be fully invested in actively managed funds.  The reason for this is simple, for active managers to be successful they need volatility in the markets to provide buying opportunities for skilled portfolio managers.  As I have described previously, volatility is what we have in large quantities therefore making this market what is commonly referred to as a “Stock Pickers Market”.  We are relying on skilled active fund managers to deliver Alpha to your portfolios.  If this dynamic changes, we will shift our focus from active to passive by asset class based on where we are in the business cycle.

 

I hope this sheds some light on what is going on in the markets and what we are doing to help you maneuver through the chaos.  Please don’t hesitate to reach out to our office for any questions you may have.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Asset allocation does not ensure a profit or protect against a loss.