Though we often feel a certain nostalgia for the past, I have mixed emotions for the seventies. Besides being the decade where I spent my awkward teenage years, it was also the decade of leisure suits, polyester, and disco. Also, I remember double-digit mortgage rates, high inflation, long lines at gas stations, and the ignominious end to the Vietnam War, along with social unrest and government scandal.
After we moved into the eighties and beyond, we seemed to leave many of those unsettling times behind–until recently. Dominating the headlines in this first quarter is news about a war in Europe, plus news of the highest inflation in 40 years. The social unrest has been building for several years and was exacerbated by the pandemic but has not slowed down this year.
For those who remember, the seventies were not a good decade for stock or bond investors. Both stocks and bonds returned about 6% on average over that decade; however, after adjusting for the high inflation, so-called real returns were negative.
Given the eerie similarities between then and now, perhaps it should come as no surprise that returns for the first quarter of 2022 were not good for investors. As the table below shows, stock and bond returns were negative, even after a strong two-week rally by stocks in late March. (Without that surge, the indices would have been down more than 10%).
Value stocks, which tend to include energy, financial, and commodity-related stocks, held up relatively well, while more technology-oriented growth stocks underperformed. Energy stocks, not surprisingly, had a strong quarter (up nearly 40%), and utilities were slightly higher, but every other sector was down for the quarter.
Bonds, which typically act as a safe haven, were no place to hide this time around. Due to rising interest rates, bonds of all types lost money. It was the worst quarter for the Barclays Aggregate Bond Index since 1980. Even high yield bonds, which aren’t as influenced by interest rate changes, lost money.
What Lies Ahead
Have we seen the worst of this correction, or is there more to come in the weeks or months ahead? That is the question all investors are pondering.
From our vantagepoint, the answer is uncertain. In the chart below that plots the S&P 500 over the past three years, we have drawn a red trend line showing the general direction of the S&P Index during that period. Clearly, that trend has been upward.
At FSA, our general approach to investing is to be invested in stocks when the markets are moving above their trend lines and to shift more heavily into cash when the markets move below their trend lines. The S&P 500 Index broke below its trend line in February and March, prompting us to move so heavily into money markets. Currently, stocks are bouncing up and down right at the trend lines, which led us to start shifting back into stocks. But the jury is out on whether the favorable trend will hold or stocks will roll over once again.
Clearly, there are a number of crosscurrents for investors to assimilate. Both the pandemic and the war in Ukraine are considered exogenous shocks, that is, shocks to the economic system that are outside of the normal factors that investors need to consider. Those would include:
- Rising inflation
- Rising interest rates
- Global economic growth
- Corporate earnings
How these outside factors (COVID and the war in Europe) affect more market-related factors (inflation, interest rates, earnings, and economic growth) will determine whether stocks can begin to erase their losses and break to new highs or whether 2022 will continue to frustrate investors. If the markets continue to languish, this could be a year of (in the words of the Bee Gees) “Stayin’ Alive.”
Portfolio Update
Keep in mind that because we manage clients’ portfolios individually, the holdings in your particular accounts may differ somewhat from the averages.
Strategies That Employ the FSA Safety Net®
Income (Strategy 1)
It has been a weak start to the year for all types of bonds—whether high yield or high quality. Rising interest rates have a direct negative impact on high quality bonds. Because of this weakness, we sold most of the holdings in the first quarter, though we managed to find a few funds that have been able to hold up relatively well. At the end of the first quarter, Income portfolios held 25% in bond funds and 75% in money markets.
Income & Growth (Strategy 2)
The weakness in the stock and bond markets in the first quarter forced us to sell most of our holdings as they hit their FSA Safety Nets®. As stocks hit bottom in mid-March, we held only one defensive equity fund, along with a modest allocation in bond funds. At the quarter’s end, we held 10% in equities, 20% in bonds, and roughly 70% in money markets.
Conservative Growth (Strategy 3)
Losses in the stock and bond markets forced us to sell most of the funds in this strategy during the first quarter. By early March, the portfolios held 75% in money markets. As stocks rallied near the quarter’s end and moved above their longer-term trend lines, we began to modestly shift back into stocks. Currently, these portfolios hold 35% in equities and 65% in money markets.
Core Equity (Strategy 4)
This equity-oriented strategy became quite defensive by early March as most of the funds broke through the FSA Safety Nets®. By mid-March, these portfolios only contained two value funds as well as our two Core funds, with 75% in money markets. Amid the stock rally that came at the end of the quarter, we began increasing our equity holdings modestly, which brought our overall allocations to 40% equities and 60% in money markets. Meanwhile, we wait for further signs that the stock markets are regaining their strength.
Tactical Growth (Strategy 5)
It was a challenging quarter for even our most active and nimble strategy. As stocks weakened during the quarter, we sold the large-cap growth funds, as well as most broad market funds. That left us with primarily commodity and value-oriented funds and roughly 50% in money markets. We recently have added a few new funds so that as we enter a new quarter these portfolios hold 45-60% in equities, 10-15% in commodities, and 30-40% in money markets.
Strategies WITHOUT the FSA Safety Net®
Sector Rotation
This all-equity strategy, launched in 2015, holds six funds and rotates monthly based on a risk-adjusted momentum score. So far, this strategy has performed quite well this year as a result of its allocation to energy funds and an inverse S&P 500 fund in February and March. For the April rotation, these portfolios hold two financial services funds, plus industrials, basic materials, and consumer staples funds, along with an inverse S&P 500 fund.
Global Rotation
This aggressive strategy, introduced early in 2021, rotates among various asset classes and styles in the stock and bond markets, though it will generally only hold equities when that market is strong. These portfolios began this year with a strong bias towards growth, then shifted toward value in February, only to revert back toward growth in late March. At one point during the quarter, the allocations included 50% in money markets. As we enter the second quarter, however, these portfolios are fully invested, with 48% in large-cap growth stocks, 32% in value stocks, 16% in large-cap stocks, and the remaining 4% in money markets.
Strategies That Remain Fully Invested Through ALL Market Cycles
The following two strategies were developed primarily for younger investors (or investors who are willing to take more risk) who prefer to remain fully invested at all times. These strategies are well suited to investors who contribute to their portfolios on a regular basis (dollar cost averaging) and to clients who are tax sensitive as the rebalancing is done in a tax-optimized manner.
Global Moderate
Launched in 2020, this strategy maintains a fixed allocation between stocks and bonds, with 70% in stocks (large-cap U.S. stocks, small-cap stocks, foreign stocks, real estate, and gold) and 30% in bond funds. All holdings are in exchange traded funds (ETFs) and trading is minimal.
Global Growth
This strategy, which was introduced in 2017, maintains a fixed allocation between stocks and bonds, with 90% in stocks (large-cap U.S. stocks, small-cap stocks, foreign stocks, real estate, and gold) and 10% in bond funds. All holdings are in exchange traded funds (ETFs) and trading is minimal.
Please remember to inform your advisor of any changes in your life that might affect your investment objectives and how we manage your money.
Ronald Rough, CFA
Chief Investment Officer
Disclosures are available at https://fsainvest.com/disclosures/market-update/.
FSA’s current written Disclosure Brochure and Privacy Notice discussing our current advisory services and fees is also available at https://fsainvest.com/disclosures/ or by calling 301-949-7300.
