Dear Spartan Client,
“Move not unless you see an advantage; use not your troops unless there is something to be gained; fight not unless the position is critical.”
—Sun Tzu, “The Art of War”
Over the past several months, we have consistently been asked if 2022 is unique in market history.
As systematic investment managers, we rest on data. So, we looked at the percentage and magnitude of negative days so far this year to at least get started down the path to answering this question. The table below shows the percentage of days the S&P 500 was negative for the first half of 2022 and during the prior 94 years of data.
The data shows that 2022 has been unique in terms of its downside volatility, as measured by the portion of days with performance down 1% or more. In fact, the percentage of days thus far that performed worse than -2% is more than double the historical average.
In this month’s Note, we continue to make the case for patience as we remain in lower amounts of equity exposure. Historical data suggests the likely negative cost of remaining invested in a downtrending asset outweighs the potential benefit of holding while it is in a downtrending environment. We describe our current defensive positioning and discuss how, for us, “remaining on the sidelines” with certain assets and certain portions of the portfolios equates to taking a better offensive posture over time.
Below are the asset classes utilized in our portfolios and their model-driven exposure heading into August.
Square indicates no change month-over-month. Arrows indicate increase/decrease month-over-month. Adjustments can vary across Spartan Strategies depending on each Strategy’s objectives. What’s illustrated above most closely reflects allocation adjustments for the Spartan Growth Strategy.
Disclaimer: this note is for general update purposes related to the general strategy and approach of Spartan Planning portfolios. Every client’s situation including Risk Profile, Time Horizon, Contributions, and Distributions is different from other clients. Your exposure to any given asset class will depend on your goals, risk profile, and how tactical or passive your risk profile calls for. If there have been changes to your risk profile and/or goals or if you wish to discuss them in more depth, please contact your advisor.
At a Glance: Allocation Adjustments Heading Into August, 2022
U.S. Equities: Exposure will not change from its minimum allocation, as both the intermediate- and long-term timeframes remain in downtrends.
International Equities: Exposure will not change from its minimum allocation, as both foreign developed and emerging markets remain in downtrends across both timeframes.
Real Estate: Exposure will not change from its minimum allocation, as both the intermediate- and long-term timeframes remain in downtrends.
U.S. and International Treasuries: Exposure will not change and is at its minimum allocation due to downtrends across both timeframes.
Inflation-Protected Bonds: Exposure will not change and is at its minimum due to downtrends across both timeframes.
Short-Term Fixed Income: Exposure will not change, as it is already at its max allocation due to previously taking on exposure from equities, real estate, alternatives, and longer-duration fixed income.
Alternatives: Exposure will not change and is at its minimum allocation due to downtrends across both timeframes.
Three potential macro catalysts for the recent trend changes:
- Economy Slowing: New applications for unemployment benefits reached their highest point since late last year. Initial jobless claims, a proxy for layoffs, rose to a seasonally adjusted 251,000 in the week that ended July 16, up from 244,000 the week prior, according to a report from the Labor Department. These levels are above the 2019 pre-pandemic weekly average of 218,000 when the labor market was also strong. These figures are the highest since last November.
- Housing Slowing: Mortgage rates continue to climb, with the average rate on a 30-year fixed rate up to 5.54%, as reported by mortgage-finance giant Freddie Mac. A year ago, rates were around 2.8%. The U.S. housing market has slowed significantly after two record years. Refinance activity was 80% lower and purchase activity was 19% lower than the same week last year.
- Inflation Slowing: There is more data suggesting that price pressures are easing, and June’s 9.1% increase in consumer prices could be the peak. However, even if inflation does decrease with the next report, economists expect a slow pace of decline. Gasoline prices have fallen around 10% from their mid-June high point, wheat futures prices have fallen by 37% since mid-May, and corn futures prices are down 27% from mid-June. “It’s a step in the right direction, but ultimately, even if June is the peak, we’re still looking at an environment where inflation is too hot,” says Sarah House, senior economist at Wells Fargo, who expects fourth-quarter inflation to be 7.5% to 7.8%. “So peak or not, inflation is going to remain painful through the end of the year.”
The beauty of systematic investing is that if you are doing it correctly, there is no need for angst about your next move with portfolios. All of the decision-making is resolved in the strategy-building phase, which for us was almost 10 years ago now. Once you have a robust process, you simply follow the rules and focus all your energy on execution and longer-term enhancements.
As we utilize a systematic process that takes defensive positions when equities are declining globally, like in 2022, there comes a point when you have made all the moves you can at the moment. From here, we wait until conditions change.
As we close July and enter August, that is precisely where we sit. We’re waiting and watching.
Much like the repetition of muggy summer days, mostly sitting out of the market and watching as it moves sideways or even rallies before making new lows starts to feel a little mundane. Even for a firm like ours, that prides itself on downside protection, it is much more enjoyable to watch account values increase than sit and wait in a defensive position. Avoiding losses while markets are falling mathematically has a bigger impact on your long-term rate of compounding than does outperforming to the upside, but it certainly doesn’t always feel as fun and exciting.
In times like this, we’re also reminded of the ever-present question related to trend following: If it’s so great, why doesn’t everyone do it? We think the answer is tied to how much discipline and patience it takes to always follow the data. For non-trend-followers, the allure of trying to pick a bottom (and a top) is very strong, not just because of what it can potentially do to an account value if their guess is correct but also because of how it strokes the ego. But the reality is this: often during bear markets, the better bet is to wait out counter-trend rallies. Take the bursting of the tech bubble as an example. The Nasdaq experienced a more than 70% decline from peak to trough, but it also had rallies of 40%, 28%, 41%, 50%, and 36% during this enormous market crash. Given the ultimate decline, peak to trough, it paid to largely sit on the sidelines despite these massive short-lived bear market rallies. How impossible of a task it would have been to perfectly time each of those rallies while avoiding the subsequent declines? We think this example highlights why patience is prudent even when it’s not fun.
It is also worth noting that we take heart in the fact that things can change quickly. It typically takes only 30 or so days for our more responsive rules to engage, which would soon have us participating in any burgeoning uptrends. Our longer-term rules are, of course, slower to respond, but that allows for trends to “prove themselves.”
In conclusion, we hope you are enjoying this season, and resting in the process we have created. We continue to vigilantly monitor our systems and stand ready to engage when conditions are favorable. For now, however, we wait for conditions to change.
As always, thank you for the opportunity to help guide you and your family toward a stress-free financial life.
David Childs, Ira Ross, and Eric Warren