September 21 2022

Are You Winning Son?

Hey markets, what’s up? Well, nothing is up. The year 2022 continues to see catastrophic performance of long positions, including the 60-40 portfolio that is suffering from the high correlation between equity and bonds in this year’s drawdown. Some long-only positions outperform though, mostly commodities and Utilities. Long-short strategies are doing well, as further divergence appears in high beta and low beta stocks.

The mantra is more than ever “Don’t fight the Fed”, and anything that stands in its hiking path is killed. The Fed no longer provides a “market put” as it did since the dawn of massive QE measures, but is resolutely “short call”. An ebullient market has become synonym of an over-heated economy along with inflation. As soon as the market jumps back, the Fed has an incentive to slam it down. Unexpectedly, the Fed has hiked interest rates by 75bps on Wednesday, with a stronger hawkish stance to boot. It stands ready to sacrifice employment, real estate, and consumption on the altar of inflation. It unfortunately forces other central banks onto the same path, at the very moment when global economy slows down.

Rumour has it that investors are tempted to tip-toe back into fixed income. As per Erin Browne, portfolio manager for multi-asset strategies at Pimco, “We now see real value in several segments of the fixed income market, including investment grade bonds, mortgages and securitized products.” As a benchmark, yields on mortgage-backed securities are at ~4.5%, back to 2008 level, rising from 2% at the beginning of the year, and mortgage rates are closing on 7%. While I agree that there is absolute value in a 3% to 4.5% coupon, it is not exactly a panacea placed against an 8% inflation, but is probably a good place to start selectively adding for the longer term.

The perspective of further rate hike in the next 6 months, combined with a sombre economic outlook had the rate curve inverted, with longer yields lower than shorter ones. This is more often than not indicative of an imminent recession. Guess what, it’s coming.

In such a trend, short duration and high-quality assets are your best friends. As the short-term yields hang around 4%, we think that short-term duration in government and investment grade become relatively attractive again, as we edge closer to 4.5%, which we see as close to peak on short-term yields. We remain cautious on longer duration and credit though. On equities, the dominoes have not all fallen yet, and we are of the view that the deteriorating economic background will play out in lower corporate earnings and sagging employment. We are neutral on US equities and still negative elsewhere. We foresee the USD strength to abate in the coming 6 months. As it does, gold should probably bounce back. Commodities will remain well bid in our opinion. Crypto has behaved like an extreme risk asset, and we believe that institutional adoption will drive the next leg up.

Very few investors are winning in this drastic tightening cycle. The idea is to hold tight onto positions, and be ready to fight another day.

About –

360 Advisory LLC is a Boston-based RIA managing investments, including crypto