Insights – Interest Rate Risk and Asset Correlations with Future Cash Rate Expectations

"Is the All Seasons Portfolio strategy not working anymore?"

With an annual drawdown for such portfolios almost as bad as for the stock market YTD (S&P 500 currently being down 16% since 1 January, having briefly been below -20%), I am not surprised that I have been hearing this question more and more recently. Is this a bug or a feature?

The first seven months of 2022 can be illustrated by two major themes in terms of financial markets: a) significant underperformance of major asset classes such as stocks and bonds, and b) rising rates.

The latter constitutes one of two undiversifiable risks for investors, as when the cah rate rises, that impacts asset prices as returns of risky assets always compete with the return of cash.

In this article, we explore interest rate risk and how most major asset classes have correlated with the future cash rate expectations over the first seven months of 2022. We try to answer the question on if the All Seasons Portfolio strategy is broken, or if the playing field has been reset and that we can expect better performance ahead.

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Portfolio Update – June 2022

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 take a closer look at how this all affects the markets and my All Seasons Portfolio.

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Portfolio Update – May 2022

Market update of May 2022 includes a growing dependency on the next few inflation prints, as these will determine the strength of Fed's reactions and in extent the direction of the stock and bonds markets.

With negative QoQ real GDP growth in the US and continuing high inflation, we are not far from a technical recession and truly entering a stagflationary environment. While not there completely yet, the risk will put pressure on growth assets and nominal bonds, why broader exposure to other assets is recommended.

In my All Seasons Portfolio, the above factors impacted monthly returns negatively, but I expect my strategy to be prepared for the uncertainty ahead with continuing overweighting to inflation assets.

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Portfolio Update – April 2022

Market update of April 2022 includes a continuing emphasis on interest rate risk on the back of rising inflation, albeit recession fears raise questions of the timing of rate hikes and the impact on the economy. We'll analyze what the indicators tell.

As a result of the current inflationary environment, strongest portfolio performers include commodities, gold and VIX in April, but much of the profits were offset by losses in bonds. Portfolio overall remained stable.

In my strategy, a couple of tweaks have been implemented last month: i) tactical tilt toward inflation-linked bonds from nominal bonds, and ii) introduction of leverage through margin. Read more about these changes in this month's post.

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Portfolio Update – February 2022

This month, I will be trying a slightly changed format for this monthly update post.

Previously, I have combined a deep dive/insights text with an update of my portfolio performance, but I have been considering changing things up a bit.

Instead, I will today be first focusing only on a market update for the past month, together with looking a trends in economic growth and inflation (remember, the four regimes that the All Seasons Portfolio strategy is designed to fend off), before presenting my portfolio update on the back of it.

In February 2022, as well see from the indicators, we remain in an inflationary boom - for now - but it seems like stagflation could be on the horizon as the growth rate is falling.

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eToro Post – Systematic Trading and Strategic Rebalancing of Commodities

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This pot was originally shared on my eToro feed on 13 March 2022. Make sure to follow me there as well, and did you know that you can copy my trading there for free? Create an account today, copy my portfolio by searching for user "Allseasonsport" to automatically duplicate my All Seasons Portfolio strategy effortlessly.

The benefit of a systematic strategy - like the one I run here on eToro - rather than a discretionary strategy is that you don't get in your own way when following rules that are proven to work.

Hence, by taking a trader/person with cognitive biases out of the equation, you increase the probability of success by avoiding mistakes caused by limits of the human brain.

It is intuitively hard to buy assets that are trending, as it feels more expensive by the day when the price goes up, and you tell yourself you will "buy the dip".

The problem is that when that dip occurs, the trend may be broken and the asset is no longer an attractive buy. That is when our cognitive biases hinder us from success.

When we go against rules, we tend to make mistakes, as the rules were set in place for a reason.

Due to these rules, I will be strategically rebalancing Commodities and Long-Term Treasury Bonds in my eToro portfolio as they have exceeded their rebalancing spans. Read more about my reasoning here.

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