10 Dec 2021
J. Powell: Act II
During the month of November, markets were consumed with the typical list of concerns of late: the Fed, inflation, jobs, and the impact of the newest COVID-19 variant – Omicron. But any unease surrounding the potential for disruption at the Fed during a time of high inflation and the beginning of the end of QE (quantitative easing) – however temporary, given the codependent nature of the Fed-market relationship – was put to rest with the renomination of Chairman Powell. In doing so, President Biden went against the wishes of progressives and opted for policy continuity, and he had the support of ranking members of the Senate Banking Committee, as well as Treasury Secretary Janet Yellen.
Powell’s second term will not lack for degree of difficulty. Red hot growth in the fourth quarter, expected to hit 8.6% according to the Atlanta Fed’s GDPNow forecast as of December 7th, unemployment of just 4.2%, which has fallen back into the 3.8% to 4.3% range deemed to satisfy the condition of “full employment”, and the persistence of high inflation, have all led to the demise of the use of the word “transitory”. As such, the Fed will likely quicken the pace of tapering to conclude that effort in advance of raising rates next year. And of course, the Fed must find a way to do that without strangling growth and sending asset prices into a tailspin. Powell may come to rue the decision to stay for another term.
While the November’s jobs report[1] was disappointing on the surface – only 210,000 jobs were added – some 600,000 people re-joined the labor force, and the participation rate increased to 61.8%, its highest level since the pandemic began. Given the ongoing labor shortages, this increase in supply, perhaps incentivized by higher wages, was viewed by many economists as a healthy turn of events. While the impact of the Omicron variant on the jobs picture won’t be known for some time, initial comments from the vaccine providers suggest that at least the mRNA versions can be modified in a fairly condensed time frame if necessary, and health officials are suggesting that while more contagious, this new variant may be less deadly, all of which should be positive for employment.
What happened in the markets in November?
- Equities: Taking Oxygen on the Sideline
After an explosive month in October, equities could have been forgiven for taking a breather in November. However, the reason for the pullback wasn’t simply a pause on the way to bigger and better things, but rather the risk-off inducing Omicron news and the realization that the Fed will have to be more aggressive than previously thought to tame inflation.
Going into the Thanksgiving holiday week, U.S. equities, especially small caps, had added nicely to their October bounty, but that was short lived, and all equity categories that we utilize at Frontier ended in the red. From worst to best were: international small caps (-5.6%), international large caps (-4.7%), emerging markets (-4.1%), U.S. small caps (-2.3%), and U.S. large caps (-0.7%). Once again, the S&P® 500 seemed to conquere all.
Contributing to the negative performance of foreign equities, as a whole, was the surging dollar. The MSCI EAFE Index, as indicated above, fell by approximately 4.7% in dollar terms, but was only down 2.4% in local currency terms. That headwind has shaved about 8.5% off international equity returns to U.S. investors year-to-date.
At the sector level, tech led the pack, with the S&P 1500 Information Technology Index gaining 4.0%, propelled by strong performance from semiconductors and hardware. The only other sector in positive territory was Consumer Discretionary; the other nine sectors were all in the red, with energy (-5.6%) and financials (5.4%) bringing up the rear.
- Bonds: We’re Not Dead Yet
The yield on the 10-year fell by 12 basis points (bps) during the month, and the yield curve continued to flatten, with the difference between 10-year and 2-year Treasuries falling by 16 bps. On the long end, the curve is inverted, with the 30-year ending the month at 1.78% and the 20-year ending at 1.85%. Given these conditions, most flavors of fixed income performed well, with long-term Treasuries leading the way, gaining 2.9% (and bringing their 6-month run to an impressive 9.7% return).
Elsewhere, TIPs added 0.9%, municipals advanced by 0.9%, and the Bloomberg U.S. Aggregate Bond Index returned 0.3%. Taking credit risk into account, the outcome wasn’t as positive, investment grade corporates moved up by just 6 bps, and high yield lost almost 1%.
The bond market now expects the Fed to roughly double their tapering volume from $15 billion per month to $30 billion[2], which would accelerate the QE end date from June to March.
- Commodities: Nursing Growth Scare-Related Wounds
While economic growth concerns were not kind to equities, they were downright painful for commodities, with the Bloomberg Commodity Index falling by almost 7.3% for the month. Of the 26 sub-indices that makeup the Index, 20 of them were in negative territory, with WTI down 19%, and natural gas, petroleum, heating oil and Brent Crude contracts not far behind. Coffee was the one winner, posting a gain of 12.4%.
How are Frontier strategies positioned?
Model Allocation Changes
Our asset allocation work resulted in minimal changes to the strategies going into the month. The only shift in excess of 1% was within our Capital Preservation Strategy, where we decreased cash by 2% to add to high-quality bonds.
As has been the case for most of the year, our equity positioning exhibited biases toward U.S. and international small caps, as well as emerging markets within our more aggressive strategies. Across our Globally Diversified Strategies, our biggest overweights were to managed futures, high-quality bonds within the more conservative strategies, and long-term Treasuries in all but the Capital Preservation Strategy. Absolute return and high yield are the areas that continue to be the most underweight.
Performance Attribution
For the second straight month, REITs and U.S. large caps led the way, while small caps, international and emerging stocks trailed, all of which negatively impacted relative performance. Our managed futures exposures were also a headwind. However, our bond positioning, that is, our overweight to long-term Treasuries and underweight to high yield, was decidedly positive, as was our underweight exposure to commodities. In total, on a gross of fee basis, our most conservative strategies outperformed their benchmarks, while our more aggressive strategies trailed.
[1] CNBC, “Powell says Fed will discuss speeding up bond buying taper at December Meeting, November 20, 2021
[2] Bureau of Labor Statistics
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ASSET CLASS |
INDEX |
INDEX DESCRIPTION |
U.S. Large Cap Equity |
S&P 500 |
Represents US large company stocks. It is a market-value-weighted index of 500 stocks that are traded on the NYSE, AMEX, and NASDAQ |
U.S. Small Cap Equity |
S&P 600 / Russell 2000 |
Measures the performance of the small-cap segment of the U.S. equity market. |
U.S. Equity |
S&P 1500 |
Replicates the performance of the U.S. equity market. |
International Equity |
MSCI EAFE |
An equity index which captures large and mid cap representation across 21 Developed Markets countries around the world, excluding the U.S. and Canada. |
International Large Cap Equity |
MSCI EAFE Large Cap |
An equity index which captures large cap representation across Developed Markets countries. |
International Small Cap Equity |
MSCI EAFE Small Cap |
An equity index which captures small cap representation across Developed Markets countries around the world, excluding the US and Canada. |
Emerging Markets |
MSCI Emerging Markets |
An Index that captures large and mid cap representation across 27 Emerging Markets (EM) countries |
Commodities |
Bloomberg Commodity |
This is a broadly diversified index that allows investors to track commodity futures through a single, simple measure. The DJ-UBSCISM is composed of futures contracts on physical commodities. |
U.S. Investment-Grade Bonds |
Barclays U.S. Aggregate Bond |
Measures the performance of the U.S. investment grade bonds market. The securities must have at least one year remaining to maturity, must be denominated in U.S. dollars and must be fixed rate, nonconvertible and taxable. |
U.S. Municipal Bonds |
Bloomberg Municipal Bond |
A market-value-weighted index for the long-term tax-exempt bond market |
U.S. TIPS |
Bloomberg U.S. Treasury TIPS |
Represents inflation-protected securities issued by the U.S. Treasury. TIPS are indexed to the non-seasonally adjusted Consumer Price Index for All Urban Consumers |
U.S. Corporate High Yield Bonds |
Bloomberg U.S. Corporate High Yield |
Measures the USD-denominated, high yield, fixed-rate corporate bond market |
U.S. Long-Term Treasury Bonds |
Bloomberg U.S. Treasury 20+ |
Measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury with 20+ years to maturity |
U.S. Investment Grade Corporate Bonds |
Bloomberg Barclays U.S. Corporate |
Measures the investment grade, fixed-rate, taxable corporate bond market |