We are awash in uncertainty. Will Congress raise the debt ceiling, and will there be a government shutdown? Could another debilitating Covid variant emerge? Might another terrorist attack occur on U.S. soil? Will the economy continue to grow? Will Tampa Bay continue its sports dominance (baseball, football, hockey)?
Of course, life has always been this way. Even during the seemingly pleasant times of the 1950s, we were worried about a nuclear attack from the Soviets. In addition, the horrors of World War II remained etched in everyone’s collective psyches.
As humans we think often of the future, and of course, the future is unknown, so we are constantly dealing with outcomes that cannot be known with certainty. As a result, we attempt to forecast and make guesses.
Two common ways to make sense of the future are to look at history and to look for patterns. And that is what we do at FSA. We look at history to make inferences about the future, and we look for patterns that tend to repeat over time to help make decisions. Obviously, no attempt to discern what the future may hold will be accurate all the time. In fact, the best one can hope for is 50% accuracy. But that can be a successful strategy if you keep your mistakes small and hold on to your winners.
So, here we are in early October of 2021. A pandemic continues to play havoc with lives and livelihoods in the U.S. and abroad. Yet the stock market at home is close to all-time highs. Concern over a potential government shutdown, as well as raising the debt limit, helped to push down returns in September just a bit, even though stocks managed a slight gain for the quarter.
We did notice participation narrowing in the third quarter, with foreign stocks down, small cap stocks down, and only four out of eleven industry sectors positive. For bonds, it was another lackluster quarter, as a September rally in interest rates pushed prices down which erased some nice gains earlier in the quarter.
For the most part, FSA portfolios remain fully invested at their maximum equity allocation, although we have trimmed back slightly in a few strategies. At this point, the broad market has not retreated enough to trigger any violations of the FSA Safety Nets®; however, as you know, these are customized for each specific holding which we monitor regularly and will reduce/sell any position that violates its exit price.
Besides the aforementioned issue of narrowing participation, the stock market looks healthy to us from a technical standpoint. Stocks look poised to finish the year on a positive note, once we get through the political uncertainty of the next several weeks.
From a fundamental perspective, while the overall environment is also healthy — with economic growth for this third quarter estimated at higher than 3% — there are some clouds building on the horizon. Some companies are having a hard time finding qualified employees right now, and many are also struggling with disruptions to their supply chains (all the intermediate goods and supplies that a company needs to make its product). In addition, inflation has been a growing concern as well. So far, the market has been content to treat this higher inflation as temporary, but more and more observers are beginning to question that perspective. If inflation becomes a longer term issue, it will have an effect on interest rates and consumer expectations.
There is no shortage of uncertainty as we enter the final quarter of the year. But that is always the case. Usually, many of the things we worry about create no long-term issues for the stock and bond markets. Interestingly, issues that do have the greatest impact often come upon as a surprise. So, as a firm, we made a decision long ago, based on feedback from our clients, to focus on avoiding the worst of the market drawdowns. Our approach to managing uncertainty is to pay attention to the risks and be quick to respond if those risks begin to play out in the markets.
Portfolio Update
Keep in mind that because we manage clients’ portfolios individually, the holdings in your particular accounts may differ somewhat from the averages.
Income (Strategy 1)
Once again, we made no trades in the Income strategy during the quarter. We continue to be comfortable with our mix of high yield and multi-sector bond funds. Even though it has been a difficult year for fixed income, this asset class remains a viable safe haven when stocks become more volatile.
Income & Growth (Strategy 2)
Trading remained subdued in this conservatively balanced strategy. As volatility began to pick up in September, we raised cash by selling a U.S. equity fund, as well as cutting back the allocation to an international fund. As the final quarter of the year gets underway, these portfolios hold 40% in equities and 45% in bonds and roughly 15% in money markets.
 Conservative Growth (Strategy 3)
Trading was light in this strategy during the quarter as the pullback in September was not severe enough to warrant any trades. Earlier in the quarter, however, we sold the remaining small-cap position and sold one of the value funds and invested those proceeds in a large-cap growth fund. At the beginning of the fourth quarter, these portfolios hold 75% in equities, 20% in bond funds, and 5% in money markets.
Core Equity (Strategy 4)
Stocks remained a challenge in the third quarter as fortunes ebbed and flowed from value to growth and from small-cap stocks back to large-cap stocks. We exited the small-cap, the emerging markets, and the energy funds, while adding positions in real estate, health care, foreign, and large-cap growth funds. Currently, the portfolios hold 95% in equities and 5% in money markets.
Tactical Growth (Strategy 5)
Trading was active in this eclectic strategy. In general, we exited small-cap, emerging market, and industrials funds, while adding commodities and large-cap growth. Currently, these portfolios hold 70% to 75% in U.S. equities, 10% in foreign funds, 10% in commodities, and 5% to 15% in money markets.
Sector Rotation (Strategy 6)
Rotation between growth and value sectors has been active this year, which has increased turnover in this aggressive strategy. For October, these portfolios hold an eclectic mix, including financial, banking, real estate, health care, and technology funds. Interestingly, the rotation also picked up the inverse S&P fund which will act as a cushion if stocks continue to struggle.
In closing, we would like to remind everyone that towards the end of the year many mutual funds will pay distributions to shareholders. This action will lower the price of the fund on the day the distribution occurs. There is no loss to the client when this happens, but it often takes a day or two for the distribution to end up back in your account. So, the drop you may see in that fund on a specific day is merely a timing issue. Of course, feel free to call or email us if you have any questions when these things occur in your accounts.
Finally, please remember to inform your advisor of any changes in your life that could affect your investment objective 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.
