Contents of this month’s post include:
- Market Update of the current economic regime
- Monthly Portfolio Update for November 2022 with a fresh set of charts
Hi there, all well?
It feels good to finally be back behind the keys and again be writing a post for the blog! Having had a major hosting-side issue keeping the blog from running smoothly for a bigger part of the autumn, forced me to take an unwanted break from the upkeep of the site.
Another part of the pause was actually self-inflicted, as I have again picked up studying on a part-time basis besides my job, this blog, and other obligations, which has made me ration with my time. This time, I am taking a course in the history of the global economy, which I find is extensively beneficial for better understanding macroeconomic developments by putting it in historical context.
Rather than going into that now, let us instead focus on the matter at hand, which is a monthly update for my All Seasons Portfolio strategies. We’ll begin, as usual, by reviewing the macro environment before analysing the portfolio development.
November 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 headline inflation rate is still coming down from high levels, having come in at 7.1% for November, and is in a clearly falling trend. This is evident also from the Month-over-Month number, which remains low at 0.1%. This has led to easier communication from the Fed for smaller rate hikes (not to be confused with a “Fed pivot”, which requires rate cuts). But, the “higher for longer” narrative emphasized in the December FOMC meeting press conference was a wet blanket for equity markets.
Another part of the inflation story, which must not be forgotten, is the relationship between cost of living versus the development of wages. See the chart below, which depicts this difference since the autumn of 2020, which clearly shows that the average American has in real terms become poorer, as the wages have not kept up with costs. Additionally, that gap is widening, which can be a contributor to a coming recession, as a salary does not buy as much goods, after utility bills, interest on mortgages, and food.
While consumer spending has so far been resilient, CNN reported that an increasing number of shoppers are dipping into savings or taking more debt to finance the spending. It is thus only a matter of time before the consequences catch up with us when the savings are depleted and the debt needs to be repaid. It is worrisome that the protective barriers against a recession are already being used up now, which would aggravate a coming recession.
The below charts of inflation and GDP growth only show the October figures (the latest month when we have had data available for both inflation AND economic growth).
While inflation has been falling since summer, they remain at elevated levels and it is still too early to finally proclaim that it is over. Remember, that also in the 1970s, after the inflation rate came down after the first stint a second, much worse wave of inflation came at the end of the decade, which was only waned off by Volcker raising interest rates to 20% by the early 1980s.
As for inflation expectations, the 5Y breakeven rate (green line on the right-hand side chart) is parked in the range 2.5-2.6%, remaining well above the long-term goal of 2%.
In terms of economic growth, it doesn’t look good. Having seen a rolling 3-month period slightly positive by end of September, we returned negative in October. Moreover, the PMI – a forward looking growth indicator, is continuously declining, now being below 50 by end of November.
Right: 5Y Breakeven rates and US PMI
(click to enlarge)
The indicators tell us that a recession lies ahead – and possibly even an inflationary recession – but the stock market had not gotten the memo, at least until the mid-December FOMC meeting.
For the near future, gold might be a decent investment if we would see an inflationary stagnation. Note though, that while gold has not performed when measured in US dollars, it has actually been a decent investment so far in other currencies such as the euro or Swedish krona. The dollar has been a strong currency in 2022 thanks to the much quicker and more resolute rate hikes of the Fed when comparing to the ECB or the Swedish Riksbank.
Otherwise, commodities could be a good asset to be in as well, even though they have not performed in the second half of 2022. It all depends on the extent of China’s restrictive Covid policies are lifted and how bad a recession would be in destroying commodity demand. Further geopolitical risk could create bottlenecks and supply issues though, which would make commodities rise higher. I still advocate inclusion of commodities in a diversified portfolio still as a hedge against these currently uncertain risks.
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).
Right: MoM change in %- of US 5Y Breakeven rate vs. PMI to the right (difference of datapoint for month n minus prev 12m avg)
Yellow diamond marks the latest datapoint, with the previous in order of size.
Especially when visualising the development of inflation and economic growth, it is very evident how inflation is coming down. Compared to previous months, the inflation trend has come down significantly in the last few months (vertical axis), even falling to negative territory, i.e. that it is rising slower (the indicator is measuring the last print against a 12-month average), which reflects the pattern seen in the MoM inflation rate chart shown further above.
Economic growth (horisontal axis) remains in a negative trend territory, indicating not only slowing growth, but that the size of the US economy is receding. Note that the growth rate of GDP is not in itself a determinant of whether an economy is in recession, but that a “real” recession definition involves the health of the economy as a whole, including unemployment, bankruptcies, etc. While we might still be in a “technical recession”, when the GDP growth is negative, the labour market remains rather healthy.
But if you review the forward-looking indicators, by the trend of the PMI (horisontal axis of the graph to the right), this is moving further and further toward the left and higher negative numbers. That does not bode well for what might lie ahead.
In other words, it appears we are still in the inflationary bust quadrant, but we should keep an eye out in coming months for the development on the inflation front.
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.
November 2022 All Seasons Portfolio Update
2022 has so far been a difficult year for the All Seasons Portfolio strategy. November, however, gave us some welcomed relief by being the best month in quite some time.
Much of that relief is attributable to the yields of longer-maturity Treasury Bonds having peaked in October, and subsequently come down significantly in November and December. As my two All Seasons Portfolios both have levered exposure to LT Treasuries (3x 20Y+ bonds on etoro and 3x 10Y on DEGIRO), rising bond prices will have a positive impact on my portfolio as a whole.
On the other side of the return spectrum, cryptos (risk assets) and long-volatility both had negative performances in in the ballpark of -20% over the month, albeit of different reasons. For cryptos (Bitcoin and Ethereum), this is partly explained by the lessened risk appetite overall, as well as the spectacular collapse of FTX (fronted by founder Sam Bankman-Fried) in November, which dragged down investors’ exposures to cryptoassets and crypto trading platforms in general. For VIX, stocks were in a positive short-term trend in November, expecting more dovish central bank communication, even though this expectations was crushed by mid-December. But as both crypto and VIX make up such a small share of my portfolios (approximately 2-3% each), the harm on the aggregate portfolio level was rather limited.
Benchmarking against the two Risk Parity ETFs in the US managed by Evoke Advisors that have similar asset allocations as the All Seasons Portfolio (see RPAR and UPAR; only available in the US) my portfolios are at par with them for this year. While I would of course had liked to see my portfolios performing better, being alone in a drawdown is psychologically hard.
If we start with my eToro portfolio, which is an All Seasons Portfolio that is levered 1.34x times, the portfolio ended November by being up 5.76% over the month.
Here below you see how each asset class developed over the month, with the portfolio marked in black. Here it is evident how LT Treasuries (light green) contributed positively by rising almost 40%.
Turning to the return contribution, the below illustrative summary shows how stocks and bonds positively made up most of the portfolio’s return this month. Here you also see how relatively little impact the declines in VIX and cryptos had on the whole portfolio.
The allocation of this portfolio has seen a heavier tilt from stocks and nominal bonds to commodities, gold, and TIPS as part of a dynamic tilt I implemented in August to scale into alternatives when inflation is rising. This is based on a simple model discussed by AQR which implies that if inflation is rising and stock-bond correlation is increasing, an investor may expect higher portfolio returns by allocating to inflation biased assets, as rising inflation hurts both stocks and bonds. You can read the AQR article on their site where this concept is explained.
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.
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 several copiers (excluding friends and family). I very much appreciate 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, November was also a good month, albeit not as good as on eToro. The difference is mostly made up by different levels of leverage, as well as the fact that the portfolios are denominated in different currencies, being USD for eToro and USD for DEGIRO.
As for portfolio allocation, I am somewhat overweight in Stocks, while being underweight in VIX and nominal LT Treasuries. Note that my bond exposure has been overly allocated to inflation-linked bonds for the bigger part of 2022 in this inflationary environment as a measure to protect my capital a bit more against rising rates. While IL Bonds have also suffered, the drawdown has been shallower than for nominal Treasury Bonds. I expect to reverse this temporary measure in the near future.
Over the last 12 months, this All Seasons Portfolio is about at part with the stock market but with lower volatility. However, a drawdown is never amusing, and a lower volatility drawdown is hardly a consolation.
Here follows a chart of how each asset class performed over the month. Similar to the eToro portfolio, Treasury Bonds have been the strongest asset this month, also when measured in euros. Gold was the second-best performer, and it had a good run in both portfolio, albeit it was beaten by Carbon Credits on eToro.
Zooming out to a 3-month chart of each ETF, here it also becomes evident how inflation and interest sensitive assets (stocks and bonds) have recovered over the course of the autumn with Stocks (JPGL), being on of the strongest assets, only beaten by DBXG (European Government Bonds) and FRC4 (Long European TIPS).
Lastly, as usual, here is the table of my ETFs and the changes laid out in table form.
|UBS LFS Bloomberg TIPS 10+ UCI ETF(USD)Ad
|UBS LFS-Blmbrg Eur InflLnk10+ UCIT ETF(EUR)Ad
|iShares $ Treasury Bond 20+yr UCITS ETF EUR H D
|LT Treasury Bonds
|Xtrackers II Eurozone Gov Bond 25+ UCITS ETF 1C
|LT Treasury Bonds
|Wisdomtree Us Treasuries 10Y 3X Daily Le
|LT Treasury Bonds
|Market Access Rogers Int Com Index UCITS ETF
|JPM Global Equity Multi-Factor UCITS ETF - USD acc
|Lyxor S&P 500 VIX Futures Enhcd Roll UCITS ETF A
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