Market Update and Model Portfolio Reviews 12/31/2021
By Dustin Latham, CFA, CAIA, CRPC
DISCLOSURE (Click links for sources. If in print, sources available upon request). Calculations & Definitions available upon request. *Trailing returns as of 12/31/2021 and are annualized returns if over 1-Year. See “Model Disclosure” page for important disclosures and information – Total Period Measured 12/31/2016 – 12/31/2021. “Inception” refers to Inception to Date. Inception calculation assumes end of day market prices on 12/30/2016 for starting period values to calculate Inception to Date figures. Performance presented net of highest advisory fee. Views and opinions are of Alternative Capitalis, LLC and are not intended as investment advice or recommendation(s). The results do not represent actual trading and actual results may significantly differ from the theoretical results presented. Past performance is no guarantee of future results.
Be it light volume, buyers with no sellers in sight, or year end retirement plan contributions, the holiday rally in December put a cherry on another remarkable year for Domestic equities. Domestic equities finished the last month of the year up 4.48% and followed its third year in a row with double digit returns up 28.71%. Global Equities which include the Domestic equities benchmark trailed but were still up 18.18% on the year, primarily lagging due to the inclusion of Emerging Markets which were essentially flat on the year up only 1.22%. Emerging markets were largely held back by Chinese equities which were down -19.38% on the year after heading into a bear market in late July of 2021. More to follow on China and as it relates to the Model Strategies. Investment Grade Bonds* fell in December by -0.26% and finished the year down -1.54%. The Dollar finished up a strong year while gold, the so-called inflation hedge, was off on a year with inflation hitting levels not seen since the 1980’s. That said, gold tends to be negatively correlated to the value of the dollar as gold is a globally priced asset. Fears over Omicron are clearly mixed as we closed out the year. With cases surging in the Northeast, it still appears too soon to tell how health related policy decisions will hamper the start of the New Year. Home test kits are also likely not reported as effectively, and the unfortunate lagging indicator is hospitalizations and deaths. On December 30, 2021, the CDC advised against all cruise related travel, even for those fully vaccinated, again putting a strain on the cruise industry. This could also have spillover effects into the shipping industry and therefore more supply chain disruptions and the potential for additional inflation pressures. Then we balance the new CDC five-day quarantine guidance with the fastest rise in case counts since the start of the Pandemic. Policy measures and guidance have changed frequently throughout the Pandemic, one has to ponder if this is the beginning of the end of the Pandemic and the start to a new seasonal cold, or if a new super variant will emerge. The point being from a market's perspective is that we still face a 2022 with slowing (and most signs pointing to tightening) monetary and fiscal policy, with a large component driving inflation being Pandemic related supply chain disruptions. How effective is tightening monetary policy on supply chain issues due to healthcare problems? Then again, the opposite of why wait so long to tighten in the first place. We are still in expansionary monetary policy, so money supply should therefore continue to grow at a rapid pace into the first quarter of 2022 and although not a direct correlation and not technically accurate, the multiplier effect for lending reserve ratios plays a role. When in doubt, continue to print it out? Easy money has led to a surge in demand for goods and services, leading to demand for labor in a tight labor market. A faster tightening of monetary policy should at least give a breather to the surge in demand, and as we see time and time again, monetary policy is effectively limitless in what they can do, in a very short period of time.
Total Period Measured 12/31/1959 – 11/30/2021 for above illustration. The “Federal Reserve’s Core Inflation,” source U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items in U.S. City Average [CPIAUCSL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CPIAUCSL, December 28, 2021. The “CPI - Inflation,” source U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Excluding Food and Energy (Chain-Type Price Index) [PCEPILFE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/PCEPILFE, December 28, 2021.
On December 15, the Federal Reserve announced that they would double the speed of their taper, but that they could pivot if the omicron variant presents risk to the economic outlook. They also provided their summary of economic projections indicating a consensus of three interest rate hikes in 2022, while the prior projections only indicated for one interest rate hike in 2022. This caused us to exit our Banking industry exposures, and more on that to follow below. Interest rate hikes and rate hiking cycles can be interpreted in many ways for the economy and capital markets. Inflation on either the Federal Reserve’s method of measurement or headline inflation have both hit record highs not seen since the 1980’s (see chart above – not below). With the Federal Reserve’s dual mandate of price stability (inflation) and full employment, they have removed all doubt that the first mandate has been met, and now the next question becomes, “what does full employment look like?”
The “Money Supply (M2 - Seasonally Adjusted),” source Board of Governors of the Federal Reserve System (US), M2 [M2SL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/M2SL, December 31, 2021. The “Federal Reserve Balance Sheet Assets,” source Board of Governors of the Federal Reserve System (US), Assets: Total Assets: Total Assets (Less Eliminations from Consolidation): Wednesday Level [WALCL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/WALCL, December 31, 2021.
As we close out 2021, we take a look back at a handful of asset classes and regions over the past 15 years with the periodic table of returns below. We did a similar table in 2018 which was smaller but also broader from an asset class representation. Here we leave out some of those broader asset classes like Municipal bonds, Bank Loans and Commodities but also add in some of the underlying components of Commodities such as Gold and Oil and overlap in the equities space. For example, Brazilian and Chinese equities are also represented in Emerging International equities, while US Large-Cap Value and Growth roll up into US Large-Cap equities. Although not always the case, it is not uncommon to see some of the worst performing asset classes and regions in one year turn out to be the best performing in the following year and vice versa. Presenting using calendar year returns does not capture the peak to trough drops, nor trough to peaks. You can only benefit from hindsight after the fact, but some rationale could point to potential overshooting on each end of the return's spectrum. The risk for Brazil continuing to underperform in 2022 is the potential for persistently high inflation, fiscal and monetary tightening, a new president (or the same president…), all pointing to a possible recession. Most of this sounds like the case for the U.S., but naturally the differences from a country perspective vary widely. It can be argued that there is a wider skills gap in Brazil relative to the U.S. and this could also lead to an area that helps economic growth; productivity. The question is always how much of this is priced in? On the other hand, China, has created self-inflicted policy decisions with the goal of wealth redistribution or common prosperity. More on China that follows below.
December was an active month again within the Model Strategies as we initially added to our Banking Industry exposure before completely exiting it after the Federal Reserve’s last meeting of the year. We trimmed our fixed income at the start of the month as rates fell again to below our comfort level, and after the middle of the month’s Banking exposure exit, we continued to unwind more domestic exposures in our core Growth, and Technology sector. We also completely exited our Saudi Arabia exposure on December 28 which was a relatively small holding but provided one of the more favorable returns on the year. Although we continued to slightly reduce our overall equity holdings on December 28, we did add to both of our China exposures. We still see China as being misunderstood and underinvested by market participants. After the start of the New Year, we think that market participants will look at how expensive their domestic portfolio holdings look relative to other areas of the market and follow this same logic in search of value. The combined allocations to our China focus did not lead to material negative returns contribution, simply due to the timing of the allocation, but home country bias lead to strength in Domestic markets and our model strategies underperformed relative to their Domestic equity benchmark on the year.
Our Domestic sector overweight in both large cap Consumer Staples and Health Care played leading roles this month as the value rotation reemerged. Our September rotation from Consumer Discretionary to Staples has outperformed the domestic large cap index but the performance spread only narrowed, albeit dramatically relative to Consumer Discretionary, in December. Health Care services also rebounded after the Omicron scare in November, while Biotechnology was dragged down for the fourth month in a row as shares of Moderna, Inc., continued to fall from their August all-time highs. Other November allocations hit negatively from the Omicron fears such as Airlines and the United Kingdom also rebounded in December. In 2020 the clean energy space was the best performance allocation in the model strategies but the worst performance allocation in 2021, as well as for the last month of the year. Equity, style wise, domestic large cap Value underperformed its Growth counterpart for the second year in a row. As a reminder when we reference looking for value relative to equity Value style, those do not carry the same meaning. For example, you could say that Growth style stocks appear undervalued, although we are not saying that is the case right now.
We summarized our allocation decisions around the banking space above but want to dive a little deeper on our decision to exit after the Federal Reserve’s release of the Summary of Economic Projections, which included the consensus view of interest rate hikes over the next few years. We recognize that the level of the nominal Federal Funds rate plays an important role in most traditional bank’s net interest income revenues (and how that flows through to income). As we have expressed in our October 2021 month end report, “Banks do more than just lend, but the theme we continue to follow is the shape of the interest rate curve and the anticipated effects to the banking industry,” and we see this as a more important factor than a higher front end of the curve (the Federal Funds rate – raising interest rates). The impact of raising interest rates is to slow down inflation and potentially growth as well, which tends to have an impact of flattening the yield curve. So, our marginal allocation increase on December 6 to the Banking industry as a result of the yield curve flattening (and therefore more of a buying incentive – with anticipation of a re-steepening of the yield curve) was thrown off with a changed investment thesis after the surprise of more interest rate hikes from the December 15th FOMC meeting to come in 2022 (than previously expected – or projected by the FOMC).
With all of these changes in December, we now have additional dry powder (cash) for both rising interest rates and falling equities. On average across the model strategies, we have approximately 11% in cash on the sidelines. With many broad markets sitting at all time high’s and with anticipation of more interest rate volatility on the horizon, this is a comfortable place for us to close out 2021. We close out the year with all of the Model Strategies outperforming their respective Global benchmarks although lagging all but the most conservative benchmark on the Domestic side.
A note on the updated performance presentation is the removal of the two-year rolling performance figures which have been replaced with rolling three- and five-year performance figures. This was due to the model history reaching five years at the end of 2021 allowing for the history to adopt the more often seen industry convention of 1, 3, and 5 years, as example.
** Periodic Table of Returns Data Sources 12/31/2021 **
DISCLOSURE (Click links for sources. If in print, sources available upon request). Calculations & Definitions available upon request. Measured by the Barclays US Aggregate Bond Index* - Morningstar. S&P 500 Total Return Index**. See “Model Disclosure” page for important disclosures and information. Views and opinions are of Alternative Capitalis, LLC and are not intended as investment advice or recommendation(s). Total Period Measured 12/31/2016 – 12/31/2021 for performance presentation .“Inception” refers to Inception to Date. Inception calculation assumes end of day market prices on 12/30/2016 for starting period values to calculate Inception to Date figures. Performance presented net of highest advisory fee. The results do not represent actual trading and actual results may significantly differ from the theoretical results presented. Past performance is no guarantee of future results.
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Model Disclosure
Alternative Capitalis, LLC is a registered investment adviser. Information presented herein is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Model Performance Disclosure: The performance shown represents only the results of Alternative Capitalis, LLC’s model portfolios for the relevant time period and do not represent the results of actual trading of investor assets. Model portfolio performance is the result of the application of the Alternative Capitalis, LLC’s proprietary investment process. Model performance has inherent limitations. The results are theoretical and do not reflect any investor’s actual experience with owning, trading or managing an actual investment account. Thus, the performance shown does not reflect the impact that material economic and market factors had or might have had on decision making if actual investor money had been managed. Model portfolio performance is shown net of the model advisory fee of 1.25%, the highest fee charged by Alternative Capitalis, LLC. This reflects a change from Alternative Capitalis, LLC highest fee charged to a client(s) account from 1% to 1.25% annually. April 1, 2018 model performance to most recent date presented adjusts for the higher 1.25% annual fee. Model portfolio performance is shown net of the sample trading costs based on our Custodian’s, TD Ameritrade Institutional, trading costs. Performance does not reflect the deduction of other fees or expenses, including but not limited to brokerage fees, custodial fees and fees and expenses charged by mutual funds and other investment companies. Performance results shown include the reinvestment of dividends and interest on cash balances where applicable. The data used to calculate the model performance was obtained from sources deemed reliable and then organized and presented by Alternative Capitalis, LLC. The performance calculations have not been audited by any third party. Actual performance of client portfolios may differ materially due to the timing related to additional client deposits or withdrawals and the actual deployment and investment of a client portfolio, the reinvestment of dividends, the length of time various positions are held, the client’s objectives and restrictions, and fees and expenses incurred by any specific individual portfolio. The performance calculations are based on a hypothetical investment of $100,000 for both the model and benchmarks presented. Benchmarks: The performance results shown are compared to the performance of the performance of a blended ETF (exchange-traded-fund) portfolio comprised of the following two ETF’s symbols, SPY & AGG, are described below. The benchmarks used are investable ETFs and their performance calculation is inclusive of the highest fee charged to a client(s) account, 1.25% annually. This will reduce the total return of the investable benchmark by the annualized rate of 1.25%. The ETF symbol SPY (SPDR® S&P 500® ETF Trust) which seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500® Index (the "Index"). Visit https://us.spdrs.com/en/etf/spdr-sp-500-etf-SPY for more information about the ETF. The S&P 500® Index results do not reflect fees and expenses and you typically cannot invest in an index. The ETF symbol AGG (iShares Core U.S. Aggregate Bond ETF). The iShares Core U.S. Aggregate Bond ETF seeks to track the investment results of an index composed of the total U.S. investment-grade bond market. (the "Index"). Visit https://www.ishares.com/us/products/239458/ishares-core-total-us-bond-market-etf for more information about the ETF. The index composed of the total U.S. investment-grade bond market results do not reflect fees and expenses and you typically cannot invest in an index. The benchmark is blended representing a weighting of a percentage (%) to SPY and percentage (%) to AGG based on the respective model weights below. Unless otherwise indicated, the benchmarks are not rebalanced to maintain their original weighting over the period measured. Instead, they are comprised of the starting allocation and will shift given the prevailing market environment over the period measured. Return Comparison: To benchmark the results, the ETF (exchange-traded-fund) symbol SPY (SPDR® S&P 500® ETF Trust) which seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500® Index (the "Index"). The S&P 500 was chosen as it is generally well recognized as an indicator or representation of the stock market in general and includes a cross section of equity holdings. In addition, the ETF symbol AGG was chosen as a benchmark. The iShares Core U.S. Aggregate Bond ETF seeks to track the investment results of an index composed of the total U.S. investment-grade bond market. The total U.S. investment-grade bond market was chosen as it is generally well recognized as an indicator or representation of the bond market in general and includes a cross section of debt holdings. For each respective model benchmark the performance measurement weightings are as follows to SPY / AGG %: 20/80, 30/70, 40/60, 50/50, 60/40, 70/30, 80/20, 90/10 % respectively for Ultra Conservative, Conservative, Moderate, Balanced, Growth & Income, Growth, Aggressive, Ultra Aggressive. OPTIONS TRADING RISK DISCLOSURE: Options Trading – Both the purchase and writing (selling) of options contracts –involves a significant degree of risk not suitable for all investors. Investors should carefully consider the inherent risks and financial obligations associated with options trading as further detailed in the Options Clearing Corporate booklet “Characteristics and Risks of Standardized Options.” 101 Federal Street, Suite 1956A, Boston, MA 02210 is Alternative Capitalis, LLC’s client facing address. All books, records, receipts, correspondence (mailing address) and day to day operations are located at 1565 West St, Wrentham, MA 02093.
Alternative Capitalis, LLC is a registered investment adviser. Information presented herein is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. The results presented before 12/31/2016 for model performance assume that the weights initially held on that date were held at the unset of any performance presented before 12/31/2016. This assumes results based on discretionary models that are not purely quantitative or rules based. Global Benchmarks: The performance results shown are compared to the performance of the performance of a blended ETF (exchange-traded-fund) portfolio comprised of the following three ETF’s symbols, VT, BNDX & BND, are described below. The benchmarks used are investable ETFs and their performance calculation is inclusive of the highest fee charged to a client(s) account, 1.25% annually. This will reduce the total return of the investable benchmark by the annualized rate of 1.25%. Additionally, the ETF’s that lack the track record to cover the entirety of the period presented have been backfilled with index data that Alternative Capitalis, LLC deems appropriate as a proxy of the chosen ETF’s hypothetical track record. Below is the summary of backfilled data and time period:
The ETF symbol BNDX (Vanguard Total International Bond ETF). The Vanguard Total International Bond ETF attempts to track the performance of the Bloomberg Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index (USD Hedged). Visit https://investor.vanguard.com/etf/profile/BNDX for more information about the ETF. The ETF symbol VT (Vanguard Total World Stock ETF) seeks to track the performance of the FTSE Global All Cap Index, which covers both well-established and still-developing markets. Visit https://investor.vanguard.com/etf/profile/VT for more information about the ETF. The ETF symbol BND (Vanguard Total Bond Market ETF). The Vanguard Total Bond Market ETF attempts to track the performance of the Bloomberg Barclays U.S. Aggregate Float Adjusted Index and attempted to track the Bloomberg Barclays U.S. Aggregate Bond Index through December 31, 2009. Visit https://investor.vanguard.com/etf/profile/BND for more information about the ETF. The benchmark is blended representing a weighting of a percentage (%) to BND, percentage (%) to VT and percentage (%) to BNDX based on the respective model weights below. The benchmarks are rebalanced over periods that include a calendar year end date, on the calendar year end date, to their original weighting over the period measured. The Benchmarks are comprised of the starting allocation and will shift given the prevailing market environment over the period measured. Return Comparison: To benchmark the results, the ETF symbol BNDX (Vanguard Total International Bond ETF) attempts to track the performance of the Bloomberg Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index (USD Hedged). The Vanguard Total International Bond ETF was chosen as it is generally well recognized as an indicator or representation of the global bond market, ex-U.S. bonds, and tracks an investment-grade, non-USD denominated bond index, hedged against currency fluctuations for U.S. investors. The ETF symbol VT (Vanguard Total World Stock ETF) seeks to track the performance of the FTSE Global All Cap Index, which covers both well-established and still-developing markets. The Vanguard Total World Stock ETF was chosen as it is generally well recognized as an indicator or representation of the global stock market and tracks a market-cap-weighted index of global stocks covering approximately 98% of the domestic and emerging market capitalization. The ETF symbol BND (Vanguard Total Bond Market ETF) attempts to track the performance of the Bloomberg Barclays U.S. Aggregate Float Adjusted Index and attempted to track the Bloomberg Barclays U.S. Aggregate Bond Index through December 31, 2009. The Vanguard Total Bond Market ETF was chosen as it is generally well recognized as an indicator or representation of the U.S. Domestic bond market, and tracks a broad, market-value-weighted index of U.S. dollar-denominated, investment-grade, taxable, fixed-income securities with maturities of at least one year. For each respective model benchmark the performance measurement weightings are as follows to BND/VT/BNDX %: 66/20/14, 57.8/30/12.3, 49.5/40/10.5, 41.2/50/8.8, 33/60/7, 24.7/70/5.3, 16.5/80/3.5 and 8.2/90/1.8 % respectively for the Ultra Conservative, Conservative, Moderate, Balanced, Growth & Income, Growth, Aggressive and Ultra Aggressive Global Benchmarks.
The results do not represent actual trading and actual results may significantly differ from the theoretical results presented.
