Contents of this month’s post include:
- Market Update of the current economic regime
- Monthly Portfolio Update for June 2022 with a fresh set of charts
The half-time whistle has sounded for 2022, and it is one of the worst first halves in a very long time for the stock market – not since 1970 has this US stock index declined more than 20% in the first six months of a year. Coincidently, that was also a time of rapidly rising inflation and rising rates to combat it, which echoes in this market decline, albeit there are many structural differences between the two compared years.
A decline of more than 20% also famously (or infamously) is the mark for when investors consider a bear market to officially have begun. While stocks have recovered slightly in the first part of July to get back on the right side of that limit, it is still clear that this current market environment is not fitting stocks at all.
As predicted a month ago in the May 2022 monthly update, the Fed’s chairman Powell has increased the steering rate by 75bps to 1.50%, and as non-farm payrolls came in stronger than expected for June (372k added jobs vs. expected 268k), there is room for further sharp hikes from the the US central bank as the hikes so far have not adversely impacted the employment rate, why further hikes would be possible without hurting the economy as much as first feared. It is likely that the Fed is chasing a recession as it is currently only focusing on inflation as stated by J. Power after the June meeting, why rising rates can be expected into a recession.
The commentary on the latest Macro Voices episode with an interview of Jeff Snider (7 July 2022), is however that from looking at the eurodollar curve, the market expects some additional hikes into the autumn and end of 2022, before the Fed lifts its foot from the throttle and perhaps starts easing again into 2023/2024. This possibility is something to bear in mind while allocating assets ahead, but much uncertainty remains.
Let us continue with taking a closer look at how this all affects the markets and the macroeconomic regime we are currently in.
June 2022 Market Update
As a reminder, 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.
That will serve as a backdrop for the next section which will cover a brief summary on the current market regime and where we might be heading.
In what market regime are we now? Translating the above chart into real life, I will be showing a similar chart with only the matrix, and plotting the development of historic inflation and economic growth to show the current regime. I’ll also be doing the same exercise with forward-looking indicators, showing market expectations.
We are currently seeing persistently high inflation and falling economic growth – a recipe of stagflation – and rising rates have added to the backdrop for the month of June 2022.
Inflation in the US rose to 8.6% (May figure reported in June), up from 8.3% the prior month, pushing the Fed to raise rates further by 75bps to 1.75%. In Europe, the inflation rate surprised on the upside, also at 8.6%, up from 8.1%, with the ECB expected to hike rates for the first time in July by 25bps from zero. Notably Germany posted a trade deficit for the first time since unification in 1991 mainly due to increased manufacturing input costs. Economic growth is weak across the board, with the Q1 GDP growth rate in the US being confirmed at -1.6% (vs. preliminary number of -1.5%), with rolling 3M growth remaining negative until June. It is not a rosy picture that is being painted, and the environment has been challenging for most assets this past month.
From the charts below, the existing trends remain intact for both inflation and economic growth. The May 2022 inflation (published mid-June) continued strong at 8.6% and remains elevated despite base effects from last summer.
While the official GDP growth rate for Q2 will not become available until 28 July, and then only with preliminary numbers, we already have available monthly GDP numbers available until May for now (June number will be published later in July), and it sure looks like we are heading toward a technical recession with another quarter of negative GDP growth, on top of the Q1 -1.6% print. While it is just a ‘technical’ recession, we could very well be entering a propert recession ahead with elevated food and energy prices.
On 13 July, the June 2022 inflation print becomes published as well, with 8.8% YoY headline inflation expected, versus the last print of 8.6% mentioned above. While the trend is still rising, notably the core inflation rate is in a clear downward sloping trend with declining rate ever since topping in March at 6.5%, and an expected print of 5.8% for June.
Considering that the core inflation is falling while headline inflation is rising, it indicates that much of the rise in headline inflation is driven by food and energy prices (as the core number excludes these two items). These two components are already causing real issues around the world with protests due to rising costs of living already in countries like Sri Lanka, Ghana, Albania, Libya, and Peru, to name a few. Especially poorer countries are set to struggle, and it is likely we have just seen the beginning of a larger crisis from this coming winter and cold season.
While the 5Y inflation expectations are coming down a bit to 2.7%, they remain over the Fed’s target of 2%, still indicating that inflation will persist for longer. Also PMI – a forward looking metric on growth expectations – is steadily trending downwards.
The next two charts 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.
As for growth expectations, this declining trend is strengthening, as we are steadily moving leftwards on the chart over the last 12 months. Spelling it out, stagflation remains a real possibility, which can hardly come as a surprise at this point.
A similar story is told by forward-looking expectations, as inflation is expected to continue to rise, and growth will continue to decline.
These data support the current market sentiment. Inflation continues to remain elevated, while growth – previously strong on the back of Covid-19 – has begun show clear signs of slowing. We are thus very near the inflationary bust quadrant.
The next inflation print for June 2022 will be published on 13 July. How it comes in in relation to the expected 8.8% and previous 8.6% will remain to be seen. And the market prices in another 75bps rate hike in the July 2022 meeting with a 90+% probability according to futures prices.
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.
And before we jump that, remember to leave your feedback for this format; if it is worthwhile and what other info/data you would find to be relevant.
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.
June 2022 Portfolio Update
An environment of slowing growth and rising inflation should benefit assets like gold and inflation-linked bonds, while commodities could be harmed by the falling growth element as demand for base metals and energy declines in this environment as we have seen since March 2022. But structural mechanics of the energy markets with continuing drawdowns from the US Strategic Petroleum Reserve and Cushing (where WTI contracts settle physically) is not being restocked ahead of winter, in combination with the strategic significance of oil and natural gas between Russia and Europe ahead of the coming winter, could cause another leg higher in energy prices despite falling growth.
VIX could rise as well, if the current selloff in equities stops being as orderly as it has been until now. So far, we have not yet seen any spikes in the VIX above 40, despite the S&P 500 having declined about 20% so far this year.
If we start with my eToro portfolio, which is an All Seasons Portfolio that is levered 1.34x times, the performance over the month was continuing trading somewhat down over the month.
The only asset that was not in the reds was actually the VXX ETF which tracks the two front months of VIX futures contracts, as I managed to take advantage of a small spike in VIX up to 34 by mid-June before scaling down that position ahead of the usual retracement. This asset had a positive impact of 0.60% of my monthly returns, despite this position only making up about 1-2% of my portfolio allocation at the time.
But as all other assets were rather negative in this rising rate environment, the portfolio was dragged down as well unfortunately, as can be seen from the below chart which shows the development of each asset class.
As for return contribution, taking into account that I allocate different weights to each asset as a part of my All Seasons Portfolio strategy, here below is a waterfall chart of how each asset contributed to this month’s total performance. Commodities, with the sell off in energy was the worst contributor but while the Bloomberg Commodity index was down about 12% in June, it brought down my portfolio by just 1%. That is the joy of diversification.
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 this blog at the same time by doing so!
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 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, June continued in the same spirit as May, namely in a negative fashion.
VIX and gold were the only positive notes this month, and the performance of the latter, and the reason why the gold position was positive in my DEGIRO portfolio and not my eToro portfolio, is that my DEGIRO portfolio is priced in EUR instead of USD. As the euro weakened against the dollar over the month, there is some currency effect at play here, and that is why gold (priced in EUR) was positive.
But not even weakening EUR could rescue my portfolio performance this month.
As for portfolio allocation, I remain overweight in commodities, as well as TIPS vs. long-term treasury bonds, just as I have so far this year in anticipation of the stagflationary environment. Perhaps later in the autumn, there could be opportunities to start neutralizing the bond exposure toward the original aimed allocation of more nominal bonds, but we will keep an eye out on the macro environment before making that adjustment.
The decline of my portfolio over the lat three months is at part with S&P 500 (price in EUR) but is rather disappointing for a safe portfolio. Here, the weak performance of commodities in the recent repricing has been the main driver as they have not offset falling stocks and bonds. In environments of rising rates, everyone is a loser.
Here follows a chart of how each asset class performed over the month, and as mentioned, only VIX and gold were positive, while the rest were down to various degrees.
Next follows the 3-month chart below for each ETF, there has been an increasing divergence between asset classes with the inflation-hedges on top. Also the global multi-strategy stock ETF in JPGL has held up quite well during a period of sell-offs in major indices (S&P 500 and Nasdaq to name a few). This is a pleasant outcome, as this added stability is what I sought when adding this ETF a few months ago.
Lastly, as usual, here is the table of my ETFs and the changes laid out in table form.
|ETF||Name||Asset Class||2022-05-31||2022-06-30||Change (Hold)||Change (ETF)|
|UIMB||UBS LFS Bloomberg TIPS 10+ UCI ETF(USD)Ad||TIPS||€883.74||€888.03||0.49%||-3.88%|
|FRC4||UBS LFS-Blmbrg Eur InflLnk10+ UCIT ETF(EUR)Ad||TIPS||€630.54||€594.58||-5.70%||-5.70%|
|DTLE||iShares $ Treasury Bond 20+yr UCITS ETF EUR H D||LT Treasury Bonds||€629.16||€633.36||0.67%||-5.14%|
|DBXG||Xtrackers II Eurozone Gov Bond 25+ UCITS ETF 1C||LT Treasury Bonds||€658.62||€601.38||-8.69%||-8.69%|
|3TYL||Wisdomtree Us Treasuries 10Y 3X Daily Le||LT Treasury Bonds||€278.25||€263.55||-5.28%||-5.28%|
|M9SA||Market Access Rogers Int Com Index UCITS ETF||Commodities||€600.12||€568.98||-5.19%||-5.19%|
|JPGL||JPM Global Equity Multi-Factor UCITS ETF - USD acc||Stocks||€2,090.91||€1,964.02||-6.07%||-6.07%|
|VOOL||Lyxor S&P 500 VIX Futures Enhcd Roll UCITS ETF A||VIX||€32.50||€100.80||210.15%||3.38%|
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.
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