Stocks took a sharp turn lower in September with the S&P 500 falling more than 9%. This setback deflated the bulls who had been energized by a strong rally that began in late June. With this September swoon, stocks are sitting at fresh lows for the year, and hopes for a late-year rally are fading. Bonds have also followed stocks to new lows, and 2022 is shaping up to be the worst year ever for high quality bonds. Investors continue to be confused about possible outcomes. Do aggressive moves by the Federal Reserve send the U.S. economy into a recession, or can the economy absorb the higher interest rates since inflation has already peaked and will soon begin to moderate, thus allowing everyone to breathe a sigh of relief? In September, it was the aggressive Fed and recession fears that drove stock and bond returns.
The table below shows that there has been no place to hide this year in the stock or bond markets, leaving money markets the best option.
The table below shows the allocation changes for all FSA accounts averaged together for 2022. FSA’s actively managed portfolios have been at least 60% in money markets (green area) since mid-March. Currently, most of our strategies are essentially “on the beach.” That is, they are out of the choppy waters of the current stock market and safely on dry land (money markets). As a result, these portfolios were down a fraction of the drop in the overall stock market in September.
One benefit of the rising interest rates has been that money market yields are beginning to climb. Most of the money market assets in your accounts are yielding over 2.5% (and expected to rise further). We are keeping the allocation in the FDIC-insured bank sweep account at a minimal level (because it pays so little) unless withdrawals are occurring.
Getting Through Year End
In the early days of October, stocks are attempting to rally, but we will need more proof of some real momentum before wading back into the waters. There have already been two rally fake-outs this year—a 12% rally in the second half of March and a two-month rally beginning in late June that lifted stocks over 17%. Both advances ultimately failed, and stocks broke to new lows.
How likely is it that the next rally attempt could last instead of flaming out? Unfortunately, we can only know the answer in hindsight. Our process is to respond to market trends. At times, it can be difficult to discern the true nature of the trend, as when long-term indicators point in one direction while the short-term picture looks to be headed in a different direction. And of course, there are times when markets move in ways that defy historical tendencies.
As we pointed out in an earlier market update, stocks tend to perform best in the fourth quarter, especially the period after the mid-term elections. Also, with the major stock indexes now down more than 20%, much of the investor exuberance from the strong pandemic rally has been wrung out.
As an example, the Ark Innovation ETF (ticker ARKK) is down 60% year-to-date and over 75% from its all-time high last year. This ETF owns such high-flying stocks as Tesla, Zoom Video, and Coinbase. Some of these stocks have been pummeled by investors this year, and at some point, some of these names may start to attract bargain hunters. Our more aggressive strategies, such as Tactical Growth and Core Equity, will be first to start wading back into the waters (whenever that might occur). With stocks solidly in a downtrend, the burden of proof is with the bulls to convince us that a serious rally is underway. For now, cash is king.
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)
With bonds continuing their downtrends, this strategy has maintained a high allocation to money markets, ranging from 70% to 90% throughout the quarter. Currently, these portfolios hold a short-term bond fund with 90% in money markets. Most of the money market assets are in a fund yielding over 2.5%.
Income & Growth (Strategy 2)
This conservative strategy has remained defensive all quarter, even as stocks rallied early in the quarter. The money market allocation ranged between 70% to 90% throughout the quarter. We added a 5% merger arbitrage fund to the portfolio as this area had managed to remain in an uptrend despite the volatility in the overall stock and bond markets. Currently, these portfolios hold 85% in money markets funds, 10% in a short-term bond fund, and 5% in the merger arbitrage fund.
Conservative Growth (Strategy 3)
This strategy also maintained a very defensive posture all quarter with the money market allocation ranging between 75% and 90%. As stocks rallied in July, we added a high yield bond fund to the portfolios, as well as a defensive equity fund, but these holdings were sold in late September. Currently, these portfolios hold 10% to 15% in defensive equities and 85% to 90% in money markets.
Core Equity (Strategy 4)
As stocks rallied in July, we increased the allocation to equities in this more aggressive strategy, reducing the money market weighting from 90% to 50%. Then, as the rally fizzled in September, we brought the portfolio money market balances back to 90%. During the quarter, we bought and then sold a small-cap fund, as well as a consumer discretionary sector fund. As we enter October, the Core Equity portfolios hold 15% equities, 10% in an inverse S&P 500 fund, and 75% in money markets.
Tactical Growth (Strategy 5)
At the beginning of the quarter, our aggressive Tactical Growth accounts held 75% to 85% in money market funds. As stocks rallied in July, we increased the equity allocation up to 55%. Then, as stocks retreated in September, we reversed those trades, and Tactical Growth is back on the beach. Currently, these portfolios hold 10-15% in equities, 5% in commodities, and 75-85% in money markets.
Strategies WITHOUT the FSA Safety Net®
Sector Rotation
Sector has continued to perform relatively well in this difficult environment. Performance has been helped by the inclusion of an S&P inverse fund which has risen in the months when the S&P 500 Index has fallen. The portfolio remains at its most defensive allocation with 64% in equities, 16% in an inverse S&P 500 fund, and 20% in money markets. For the October rotation, these portfolios hold energy, biotechnology, retail, and internet sector funds.
Global Rotation
This relatively new strategy is quite defensive currently with only 16% in equities. During the July rally, this strategy increased its equity allocation to 50%, but that was quickly reversed in the September swoon. As we enter October, these portfolios hold 84% in money markets.
Strategies That Remain Fully Invested Through ALL Market Cycles
Global Moderate
This strategy holds a constant 70% allocation to equities with 30% allocated to bonds. With bonds down as much as stocks in the third quarter, this more conservative balanced strategy offered no protection from a fully invested stock portfolio.
Global Growth
This strategy maintains a 90% allocation to equities with a modest 10% allocated to bonds. In addition to large-cap U.S. stocks, this strategy holds small-cap stocks, foreign stocks, emerging markets stocks, real estate investment trusts, and gold.
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.
