Contents of this month’s post include:
- Market Update of the current economic regime
- Monthly Portfolio Update for July 2022 with a fresh set of charts
July is well behind us, and now that most of the rate hikes in the US up to about 3.75-4.00% are expected and priced in, the All Seasons Portfolio got a bit of a revenge this past month with some positive performance.
Speaking of interest rates, in case you missed it, I recently published a longer Insights article about interest rate risk, and specifically how it broadly affects most asset classes (correlations go to one) and how that macroeconomic factor explains changes in asset prices during the first half of 2022. This is a valuable lesson to bear in mind also in the future (if you are reading this article later). Check it out via the link above when you find the time!
Let us continue with taking a closer look at how this all affects the markets and the macroeconomic regime we are currently in.
July 2022 Market Update
First, the usual reminder regarding the All Seasons four-square matrix of macro factors, as more or less all market moves can be traced back to essentially two forces: inflation and economic growth, and especially positive and negative changes in expectations of these.
That gives rise to four possible market regimes, as a combination of the two factors can be summarized by a matrix of four squares with inflation and economic growth on on axis each. The four possible regimes are this inflationary stagnation, inflationary boom, deflationary bust, and disinflationary boom.
This will serve as a backdrop for for the below summary of what market regime we are currently in, which might help us explain changes in asset prices.
In what market regime are we now? The US inflation rate for July was just published as 8.5%, down from 9.1% in June, and below market expectations of 8.7%. It could be that inflation has peaked, as theorised by several market commentators and macro traders, and that the main fear on a forward-looking basis is weak growth. This would again decrease the correlation between stocks and bonds, which has been rather high during the first six months of this year.
The below charts only read until June (the latest month when we have had data available for both inflation AND economic growth), and thus do not show this just yet. (I am a bit late with publishing this post, which I usually do before the inflation print is published).
While we will be looking more closely at inflation in a bit, let’s just for now focus more on the golden lines in the chart pair below, as growth is really slowing down. Note that this chart shows the rolling 3-month real growth rate (i.e. adjusted for inflation). At least to me, two consecutive quarters of negative growth still is the definition of recession, so it doesn’t look so good now, does it?
Right: 5Y Breakeven rates and US PMI
(click to enlarge)
It is also interesting to see what the chart on the right is telling us. Here, inflation expectations have been coming down for quite some time already from topping in April 2022, even though (headline) inflation prints have kept rising. Usually, there is a strong correlation between backward-looking inflation and the breakeven rate (as opposed to the breakeven rate and future realized inflation), why it is notable that this relationship has broken. However, the trend in the 5Y breakeven rate has more closely been following the core inflation rate, which has also been in a similar trend of retracing downwards. Perhaps the market has gotten the inflation expectations right this time, but I suppose we will only know that for sure much later.
Now, check below the headline inflation rates for US and the Euro zone. It appears that from history, Europe lags the US by about three months, so we might still see higher inflation here n Europe for a bit longer, before it turns down. However, we have other forces in play here as well with electricity and natural gas prices still going through the roof across Europe, with the worst still ahead for winter when the demand is higher.
With regard to core inflation, as you see below, this is coming down in the US for the last few months already, but still rising in Europe. It is early to claim that the inflationary cycle would already be over. Remember that in the 1970s, we saw several such consecutive cycles before the inflation rate came under control a decade later.
As for forward-looking indicators, I add here below some data from ICE on various inflation indicies and how these have developed through this year. It shows how the market now expects inflation to come down going forward.
See especially the black line of the 1-year inflation swap, which shows that already in 12 months, the inflation should (according to the market) come back to the long-term goal of 2%. I view this as highly unlikely, and note therefore that there remains ample room for surprises to the upside. Allocation to inflation hedging alts remains a wise decision in this market.
The next chart from FRED shows the 5-year breakeven rate (nominal 5-year bond minus the inflation-linked bond with the same maturity). This follows the same pattern as the ICE chart above, where the expectations of higher inflation in the future peaked in March, and has now come down toward same levels as one year ago. This corresponds with the notion that inflation expectations is highly correlated with the then prevailing changes in past actual inflation.
Now, we are waiting for the next FOMC meeting in September when it will be revealed if the Fed announces a third consecutive 75bps rate hike, or if they too start becoming contempt with the apparent slowing inflation. With the minutes from the 26-27 July meeting (released on 17 August 2022), the Fed communicated its intent to continue hiking rates, but that the pace may slow down during the autumn. This of course soothed equity and bond markets that recovered following the release, but let us see if this can carry over to the rest of the year.
With the next two usual charts, we depict the trend in historical inflation and growth, as well as forward-looking expectations. Each data points are measuring the difference between the latest number and average of the previous 12 data points, where the larger dots being the latest numbers (the yellow diamond being the last measure).
The inflation trend remains at similar levels as a month ago, meaning that inflation is rising at the same rate. When the yellow diamond starts moving downwards, that indicates that at least the strength of the inflation trends is slowing, but we are not quite there yet.
The difference against the month-over-month trend visible in the charts from Trading Economics further up that is worth highlighting is that my data here below show changes and trends over a longer horizon of the last print versus the average of the previous year. We are more interested in actual trends, and therefore want to filter out noise that may arise from monthly changes. It is important to zoom out to get the bigger picture.
We thus see that the trend in economic growth remains slow and that a recession appears imminent (as I have been saying here for several months). If you are not already investing with an All Seasons Portfolio inspired strategy with alternative asset classes to stocks and bonds, now is a good time to start to cover your bets.
As for inflation, the trend remains as strong as it has been for the last 12 months, hovering around 2.5 percentage points above its rolling 12-month average. Hence, even though the inflation rate in the US has slowed month-over-month, the trend in increasing inflation persists.
However, for the forward-looking indicators, the PMI confirms the story of recession fears, but for inflation, as mentioned further above, the market is expecting that inflation has peaked. Really?
Right: MoM change in %- of US 5Y Breakevens vs. PMI to the right (calculated as difference of datapoint for month n minus previous 12m average)
Yellow diamond marks the latest datapoint, with the previous in order of size.
In other words, I would claim that we are facing the inflationary bust quadrant, and should prepare our portfolios accordingly. I stick with my general strategy, as I (as always) remain agnostic.
Interpreting all charts above, we now have a good understanding of the current environment. Let’s therefore continue to look at my All Seasons Portfolio to see whether theory translates to reality.
If you are looking for getting started with your own All Seasons Portfolio and need some inspiration, check out my post on How to get started with the All Seasons Portfolio strategy. While stocks have been a great investment the last decade, there are no guarantees that this trend will last, as their continued success depends on several factors. Instead, consider diversifying your portfolio to include other asset classes, and benefit from the rebalancing period over the long-term, as described in this article.
July 2022 Portfolio Update
As mentioned in the introduction to this post, July gave us some welcomed revenge after a disappointing first half of 2022.
Whilst not portfolio is immune to drawdowns, I would have expected my All Seasons Portfolio trading on eToro to have done a bit better so far (-15% per 31 July), but it is about at par with the stock market (just 1 percentage point ahead of the S&P 500). The change in future expected cash rates (on top of which assets will have to return a risk premium) has impacted most asset classes.
However, looking ahead, as stocks remain expensive (it is just the cash rate that has been neutralized, not the expected yield) with CAPE ratios still on historically high levels, and bonds yields remain low (2.75% is what many economists claim is the neutral rate in an environment with 2% inflation, not 9% inflation), there is still challenges to any portfolio holding just these two assets.
I have just finished reading The Allocator’s Edge by Phil Huber, and then started Investing Amid Low Expected Returns by Antti Ilmanen (will share my notes on these in separate posts), and the common theme in these two recent publications is that where we are currently in the cycle, is not a favourable time for stocks or bonds for the next decade.
Allocation to alternative asset classes is thus more important than ever (sorry for those who had adopted commodities in their portfolios in the disappointing 2010s), and this is one key reason my conviction to the All Seasons Portfolio remains higher than ever, despite the weak performance so far this year.
If we start with my eToro portfolio, which is an All Seasons Portfolio that is levered 1.34x times, July gave us a positive return of about 5%.
Notably, there were positive returns across most line items. Stocks and Long-Term Treasury Bonds were the main contributors, as you will see from the charts here below.
The black sheep of the month included carbon credits, gold, and VIX. The last of these declined this month again as the volatility index has remained subdued during the recent bull market in stocks (bear market rally?). However, as the allocation to carbon credits and VIX is rather small, the impact of their return contribution to the whole portfolio was negligible.
Cryptocurrencies saw also a great spike this month as investors were again inclined to take more risk. And as you see from the above chart, the portfolio is rather stable despite its components being quite volatility from time to time this year.
I also executed a rebalancing of my eToro portfolio on the last day of June. The only assets with deviations remain long-term treasury bonds (underweight) and TIPS (overweight) due to current inflationary environment, but that the balance between these two have been partially brought closer this month.
Additionally, I have decided to tighten the rebalancing span from previously being 20% of the aimed allocation down to 10%. This means that if stocks go from making up 30% to 33%, this triggers a rebalancing, instead of 36% in the past. My reasoning behind this is that during higher volatilities between assets, we could capture more of a rebalancing premium by rebalancing more frequently in markets that move up and down a lot, instead of waiting until it hits the marks on broader spans. I am yet to do backtesting on this thesis though, but am trying it out for now.
If you are already on eToro, make sure to follow me there too, as I from time to time share brief updates there directly about that particular portfolio. The updates I share on this blog will however remain deeper and more insightful. Otherwise, make sure to click the banner below and create an account, (and support the upkeep of this blog financially at the same time by using the affiliate link!).
Follow me there by finding user Allseasonsport. And feel free to copy my portfolio there with a small amount of your portfolio if you want a more hands-off approach to risk parity investing. I do all my trading there in a systematic and rule-based manner, and already have 13 copiers (excluding friends and family) at the time of writing. I very much like this copy investing functionality, as it makes it easier to follow other people’s strategies, while the investors like myself that are copied have skin in the game as all trades are done with my own money.
As for my DEGIRO All Seasons Portfolio, July was too a very good month.
The total portfolio return amounted to an impressive 7.2% with broad rallies in both nominal and real bonds as the main contributors, with help from equities and Bitcoin. You will see more details in the table near the bottom of this post, as well as in the charts below.
As for portfolio allocation, I am near my aimed weights, but remain overweight in TIPS vs. LT Treasury Bonds in this inflationary environment, as you will see from the below charts.
Over the last 12 months, this All Seasons Portfolio is again almost flat after the July rally, which is far better than the S&P 500 has returned. My portfolio is also much more stable with a standard deviation of just 10% annualized, which is why I have in the past months started using margin on this account (the numbers presented are excl. margin, but reported on a gross level). My current leverage is 1.4x, with an interest rate of 3% (which is still less than my expected long-term annual return).
Here follows a chart of how each asset class performed over the month. Here it becomes evident how IL Bonds and Treasury Bonds have been the main contributors of the positive returns this month, while VIX is the asset that has performed most poorly.
Zooming out to a 3-month chart of each ETF, nominal bond ETFs (3TYL and DBXG [both US bonds]) have performed well lately, and with Bitcoin dragging quite a bit behind. Luckily, I only have a small tactical allocation to Bitcoin as an allocation to the future, IF that develops into a distinct asset class.
Lastly, as usual, here is the table of my ETFs and the changes laid out in table form.
| ETF | Name | Asset Class | 2022-06-30 | 2022-07-31 | Change (Hold) | Change (ETF) |
|---|---|---|---|---|---|---|
| UIMB | UBS LFS Bloomberg TIPS 10+ UCI ETF(USD)Ad | TIPS | €888.03 | €979.11 | 10.26% | 10.26% |
| FRC4 | UBS LFS-Blmbrg Eur InflLnk10+ UCIT ETF(EUR)Ad | TIPS | €594.58 | €646.97 | 8.81% | 8.81% |
| DTLE | iShares $ Treasury Bond 20+yr UCITS ETF EUR H D | LT Treasury Bonds | €633.36 | €663.00 | 4.68% | 4.68% |
| DBXG | Xtrackers II Eurozone Gov Bond 25+ UCITS ETF 1C | LT Treasury Bonds | €601.38 | €685.94 | 14.06% | 14.06% |
| 3TYL | Wisdomtree Us Treasuries 10Y 3X Daily Le | LT Treasury Bonds | €263.55 | €303.87 | 15.30% | 15.30% |
| M9SA | Market Access Rogers Int Com Index UCITS ETF | Commodities | €568.98 | €572.04 | 0.54% | 0.54% |
| 4GLD | Xetra-Gold | Gold | €497.94 | €497.47 | -0.10% | -0.10% |
| JPGL | JPM Global Equity Multi-Factor UCITS ETF - USD acc | Stocks | €1,964.02 | €2,097.84 | 6.81% | 6.81% |
| VOOL | Lyxor S&P 500 VIX Futures Enhcd Roll UCITS ETF A | VIX | €100.80 | €93.60 | -7.14% | -7.14% |
| Currency:BTCUSD | Bitcoin XBT | Crypto | €96.18 | €116.29 | 20.90% | 20.90% |
| Cash Position | €0.00 | €0.00 | ||||
| Total | €6,208.83 | €6,656.12 | 7.20% |
By the way, this could also be a good time to mention that I have recently started a Wikifolio profile, where I also will be managing an All Seasons Portfolio. Wikifolio.com is, similar to eToro, a social trading platform but where you can track portfolio via regular brokers (currently brokers with activity in Germany, Austria and Switzerland such as 1882direkt) by investing in certificates listed on Börse Stuttgart (one of Germany’s major stock markets) and issued by Wikifolio’s partner Lang & Schwarz. I have already launched an Optimal Commodity Strategy that you can make a reservation for by registering and searching for my profile RiskParityNick.
Thank you yet again for following my blog about risk parity investing and the All Seasons Portfolio. If you haven’t done so already, make sure to subscribe to the newsletter via the form in the page footer, and to drop any comments you may have on the content with the comment section or via email to nicholas@allseasonsportfolio.eu. The greatest value I have received from upkeeping this blog is the fantastic conversations with great people, such as yourselves, about ideas on investing and strategies. Thanks for that!
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We’ll catch up soon for the next update!
Nicholas Ahonen
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