Market Update and Model Portfolio Reviews 12/31/2022
By Dustin Latham, CFA, CAIA, CRPC
January 3, 2023
DISCLOSURE (Click links for sources. If in print, sources available upon request). Calculations & Definitions available upon request. *Trailing returns as of 12/31/2022 and are annualized returns if over 1-Year. See “Model Disclosure” page for important disclosures and information – Total Period Measured 12/31/2016 – 12/31/2022. “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.
‘Twasn’t the year for most equities and bonds, unless you were long the Energy Sector in 2022. Domestic equites reached their 2022 (calendar year) bear market lows on October 12 as they pressed through the earlier lows set on June 12. The Pandemic darlings, in many respects, cratered in 2022 (in part a continuation of 2021) while inflation quickly shifted to the big issue as pandemic nerves mostly rolled off the mind. Interest rates rose over 4.00% in parts of the Treasury Yield curve, which is a lot when the starting point was below 1% in some parts. The rise in rates was off the back of the Federal Reserve’s policy rate increasing by 4.25% to a range of 4.25-4.50%. The 60/40 stock/bond portfolio suffered its demise over the year, and then recovered…. Or at least returned to reality after a decade of chatter of the eventual funeral and rebirth of the beloved risk/reward allocation. Large cap domestic equities suffered their worst yearly decline since 2008, but without the similar dive from peak to trough during the financial crisis. Value was the style box to wear in 2022 (down -5.22%), with the largest outperformance relative to Growth (down -29.41%) since the dot com bubble. At the sector level the Communications Sector (down -39.89%) underperformed the Energy Sector (up 65.72%) by over 100% (not a typo, that is one hundred percent). Hats off to the courageous who went long Energy, with all those gains and more realized in the first half of 2022 for the Energy Sector, while giving back part of their gain in the second half of the year. The Utilities Sector was the only other large cap domestic sector to eek out a gain in 2022. The end consumer saw larger increases in their electricity bill relative to any other calendar year over year end since 1980 (assuming 2022 ended in November compared to December in prior years) but this is under 3% of the consumers spending budget (on average) and maybe more attention should be focused to the larger part of the basket; housing. After a wild two years of construction prices rising, 2022 appears to have found a peak as demand tapered off with rising interest rates on mortgages. Most commodity prices rolled over by the mid to third quarter of the year, as the services inflation remains elevated and a key measure to watch into 2023 and year end 2022. 2022 was the year that consumers ability to save was eroded by inflation. The consumer savings rate fell to near an all time low in October to 2.2% only to recover to 2.4% in November. Prior to the pandemic the prior 10-year personal savings rate averaged 7.5%. A challenging situation for many households as we look to see the Unemployment rate rise in 2023 from the economy slowing, after appearing to bottom at 3.5% in September, the most recent reading of 3.7% for November, and the last report for 2022 due on January 6, 2023.
Global Equities finished December on theme with the year, down -3.72%, and down -18.24% on the year. Domestic equities in similar fashion closed the month down -5.76% and ended the year down -18.11%. The domestic equity price index essentially closed on (in) bear market territory down -19.95% from the January 3, 2022, high. Emerging Markets steadied in December down -1.07% relative to the big up month in November and closed out the year down -17.75%. The Treasury yield curve (interest rates) moved higher in December. With yields moving inversely to price, prices were generally lower for most fixed income securities on the month. Domestic Investment Grade Bonds finished December down -0.41% and down -12.03% for 2022. The Federal reserve raised interest rates by a half of one percent, a step down in the pace of interest rate hiking but left the door open for continued hikes in the meetings ahead (next rate decision on February 1, 2023). The December 14th meeting stalled the bear market rally in equities as the keen reminder of the pause/wait approach saturated the likelihood of a challenging 2023. As mentioned last month, we were more surprised at the runup in equities than the recent selloff that followed the meeting, “We believe that this recent equity rally will fade and investors that believed we were entering into a new bull market will be shaken out of their convictions helping to move markets lower.” Ideally with this narrative playing out we will utilize our cash and cash equivalents to start adding additional risk as prices are falling. There is a lot of self-proclaimed dry powder (cash) around the industry (including ourselves) with no shortage of clashing views of what the rock bottom is for the next equity market recovery to take hold of. With so much sentiment on the same page of a recession in 2023, maybe the majority could wind up in the minority of returns. Respecting both the laws of gravity in investing (prices tend to fall faster than they recover) and difficulties of timing the bottom in markets, we are continuing to use down days to add to risk and or duration (fixed income) to dollar cost cash back into the market.
Selected Region & Asset Class Returns
Keeping in style with year end 2021, we repeat in 2022 with selected returns over the past 16 years. Value should do okay next year, but the worst beaten down Growth names should be poised for a rebound with anticipation of any pause and/or rollover in interest rates. We do not see a US-China war over Taiwan anytime soon, as lessons from the Russian invasion of Ukraine have laid the breadth of groundwork for crippling economic sanctions as a starting point. This would be mutually assured economic destruction for the U.S. and China although, on balance, we did not see the benefit of the original Russian invasion; it was not our base case at the start 2022. Russia’s economy was in a different place before the start of the war, albeit more of a fly on the windshield in relative economic size to China. China’s economy has had three very challenging years, virtually all its own doing. China played hard lock down and then about-faced on their Covid zero policy, like their crackdown and following reversal on mega cap companies from 2021 into 2022. In the face of making U.S. investments in Chinese equities worthless, we took a constructive approach to a messy environment, including the accelerated risk of some U.S. listed Chinese companies facing delisting. Chinese equities went zero to sixty in short order on the news, but the underlying economy is following a slower acceleration with countries like the U.S. recently requiring Covid testing for travelers arriving from China. China’s reopening did pressure commodity prices higher giving markets a restlessness over inflation coming in check. China is the largest consumer of commodities and the zero-Covid era has been a bit of a blessing and a curse for inflation and commodities. More signs of U.S.-China tensions over Taiwan easing, in our view, should help drive Chinese equities higher in 2023 after the significant rally and pause observed through December of 2022.
See, “**Periodic Table of Returns Data Sources 12/31/2022**” at end of report for more information about the data sources.
The model strategies were down on the month but outperformed all their respective benchmarks. The primary reason for outperformance was our level of cash sidelined facing possibilities of rising rates and falling risk assets. After a monster month in November, our Chinese exposures took a pause while the good news for the space continued to pour in. This month we continued to add to individual company names on the equity side including Intuit, Inc. (INTU), and PayPal Holdings, Inc. (PYPL) on December 22, and then Tesla, Inc. (TSLA) on December 28. Finally, we added to Amazon.com, Inc. (AMZN) and Generac Holdings Inc. (GNRC) on the last the last trading day of the year (December 30). On the year these names are down anywhere from 40 to 80% which, in and of itself, is not a reason to buy, but in our view, these names are offering reasonable valuations relative to their historically lofty metrics. Be it a Value rotation slamming these names, additional year end tax loss harvesting, momentum to the downside trade, or fund flows, they all appear to fall into the oversold camp. These are not large individual positions, and absent any material changes to fundamentals, we’ll continue to look to price (falling) to attempt to add more to these positions if the opportunity presents itself. We also added to the Consumer Discretionary (in addition to the individual TSLA holding) and Technology Sectors on December 22. The blended cash levels across the models stands at just over 23% with Equity still holding more in cash and cash equivalents at just over 26% and bonds/fixed income at approximately 20% for cash weightings. We are still positioned Risk-Off but are being mindful that not all names will bottom at once and recognize the risk to the additional capitulation (further selling pressure) for those respective names that were added in the back half of December.
We ended 2021 with an average of 11% cash at the model strategy level, compared to the most recent year end 2022 level of cash on average at just over 23%. The 2021 foresight, in hindsight, wasn’t all too bad at year end, “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.” In 2022 we did a reasonable job on the macro calls and when to use cash as a last resort over individual position selection (when the only viable option appeared to be cash except going short). On balance, we were mixed on our individual company, sector and geographic region calls. Some of our 2021 losers turned into winners in the first part of 2022 such as being long Brazilian equities, and Copper Miner Exposures, but we suffered from our Chinese equity allocations (badly), and what turned into a painfully early call into Meta (Facebook) on May 20. Target Corp. was roughly in line with equities from that period when added, while Walmart Inc. was the bread winner (pun intended). We went long the Japanese Yen to Dollar (added as a fixed income alternative), which took a different road than much of fixed income, but through reallocation (rebalancing) outperformed our bond benchmark going back to the allocation date on May 20, 2022. Our biggest detractor on the year was our long duration Treasury Coupon Strip exposure. As yields rose across the yield curve (Treasury yield over years to maturity), the longer maturity, lower starting yields took the biggest hit.
We See the Light at the End of the Tunnel, But is it Really Just a Freight Train?
Looking into 2023 we all see light at the end of the tunnel from 2022, although there’s good reason to believe that light might be a freight train. History has many comparisons that we can compare to 2022. Growth names were clobbered, but not so bad as during the dot com bubble. Fears over an unforeseen contagion, like the financial crisis from mortgages defaulting, such as the still relatively non broader market events from the FTX Crypto Exchange fiasco. There is a period of time that reminds us of today and that was during the bear market from 1973 to 1974. In 1973 the domestic equity market was off by -17.37% (2022 off by -19.44%) while in 1974 markets continued their gradual slide to end that year down another -29.72%. There’s been four instances out of 21 initial down years on the index back to the Great Depression, that have had a following yearly loss, all which were greater than the first year over year decline. The period of comparison (1973-74) had similar characteristics to today’s economic climate. Inflation was running near historic highs in 2022 as was the case in 1973 and 1974. Inflation spiked at the start of 1973 and peaked in October of 1974 during a recession (a stagflationary period). As we saw the effects of commodity prices including oil from the Russian war in Ukraine, so too was the effect of the oil crisis in 1973. There was a binge of Fiscal stimulus in the early 1970’s just like the early 2020s. Although there were price and wage caps in the 1970’s, now too is the concern of services and wages inflation becoming engrained and factoring into future business and investment planning (leading to disinvestment).
Over the past century and throughout history, periods of persistent inflation have ultimately led anywhere from struggling to cratering economies. The Federal Reserve, however, can turn on a dime, even in unscheduled fashion, to aid the economy back to its feet. The Federal Reserve was behind the inflation curve to start 2022 and markets appear to be betting that they will be forced to lower rates in the back end of 2023, even though the Fed’s call is to raise and hold through year end 2023. We can’t blame the market for doubting the Federal Reserves projections. After all, in September of 2021, the Federal Reserve was only forecasting an interest rate hike of 0.25% for 2022 versus the actual 4.25%. We do think the light at the end of the tunnel is a freight train. However, rather than a violent economic collision, we see the train stopping in time to avoid the big bang, but still inconveniently blocking the tunnel exit for a few quarters. The time it will take to reverse that economic engine will most likely come at the gradual expense to growth as we simultaneously stall out inflation, with the first quarter of 2023 possibly looking more like the first three negative quarters of 2022 for equity markets.
DISCLOSURE (Click links for sources. If in print, sources available upon request). Calculations & Definitions available upon request. Investment Grade Bonds measured by the S&P U.S. Aggregate Bond Index. S&P 500 Total Return Index**. *Trailing returns as of 12/31/2022 and are annualized returns if over 1-Year. See “Model Disclosure” page for important disclosures and information – Total Period Measured 12/31/2016 – 12/31/2022. “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.
Disclosure WARRANTIES & DISCLAIMERS
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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.