From the most recent all-time high that the S&P 500 (IVV) achieved on January 3, 2022, the markets have struggled to maintain positive momentum. As I have recounted in my previous blog posts, the tremendous out-sized performance in 2023 of the largest mega-cap tech stocks like Apple, Microsoft, Amazon, Alphabet, and Nvidia have led to large S&P 500 gains in 2023 (see table below), but over the entire time frame the performance of the S&P 500 and these mega cap market leaders is underwhelming. High quality stocks (QUAL) based on fundamental methods over that time frame have performed a bit worse, whereas high quality stocks that pay high dividends (DVY) have performed a bit better.
Certainly, this has been a difficult time for the markets! In hindsight, there were a few things that we could have seen and acted on to help ease us through this “rough patch” of weak market performance. For example, the Fed was absolutely clear that it was entering a “tightening” cycle to raise Fed Funds rates to help fight inflation.
No guarantees, since the Fed does not control the whole yield curve, but reducing interest rate risk seemed like the right thing to do. Fed tightening has increased short rates by a total of 5 percentage points from where they were prior to the tightening cycle that began in March 2022. As can be seen by the chart below, shorter duration fixed income investments (the green, blue and gold lines) resulted in better performance than longer duration investments (black and red lines).
Shortest duration fixed income (such as NEAR, SCHO and SLQD) performed best since these investments turned over very quickly to capture the higher rates in the markets whereas longer duration investments (IEF and SCHZ) lagged. D&A acted quickly in May of last year to increase allocations to the shorter durations resulting in a net positive benefit to portfolios.
Equities, on the other hand, have been much more problematic! Aside from the partial recoveries of the mega-cap tech leaders, other equities are still struggling with weak returns. A tactical re-position out of equities into cash could have been a solution, but no one can time the market!
Certainly, a quick look at some of the tactical asset allocators like Cambria, Adaptive Alpha, and Rational Advisors have shown mixed performance; some outperformance in 2022 but varied performance so far in 2023. For example, the Adaptive Alpha Opportunities fund (AGOX) performed weakly versus the S&P 500 with a total return of -19.22% in 2022 (versus the S&P 500 of -18.16%), but is still lagging YTD in 2023 with a total return of +5.33% (versus the S&P 500 of +7.68%); a cumulative underperformance gap of 3.04%. Some tactical asset allocators have done better, but it impossible to know which ones will outperform ahead of time!
So, where do we go from here? There is a twist on an old saying that goes, “Don’t just stand there, do Nothing!” At D&A we are philosophically inclined to move slowly away from long term strategic positioning unless there is a firm reason to do so. For example, shortening fixed income duration in 2022 was the correct re-positioning that benefited client portfolios and will be reversed when market conditions indicate. Alternatively, we are not ready to move away from diversifying positions in U.S. small- and mid-cap equities, emerging market equities, or other “factor” investments that have lagged and we will continue to hold international developed markets that have recovered a bit YTD in 2023.