The pandemic market rolls on
Our second year with COVID-19 has come to an end, and with that, we close the books on another year of strong gains for most risk assets. That result is thanks in part due to the liquidity picture – roughly $24.5 trillion on the collective balance sheet of the G4 central banks1 – which has continued to provide an advantageous backdrop for capital markets. And while the U.S. Federal Reserve has announced its intentions to quicken the pace of its tapering efforts, less bond buying is still bond buying; it is still stimulative. The liquidity picture remains a positive for asset prices, and while that won’t change quickly, the bathtub stopper has been pulled. Fed funds futures are fully pricing in three rate hikes in the coming year, and there is currently a 76% chance that there could be four hikes, totaling 100 basis points.2
As for the economy, we enter 2022 with a robust job market. Through November, the U.S. added 6.1 million jobs during the year, the largest increase on record. Further, the unemployment rate stands at 4.2%, initial jobless claims recently hit a low not seen since 1969, and the number of job openings has eclipsed 11 million, which equates to about 1.5 job openings for each unemployed individual. Oh, and let’s not forget, 4.5 million people quit their jobs in November!3 If there is a more emphatic sign that workers are confident about their job prospects, I don’t know what that would be.
Overall economic growth has been solid as well, and while U.S. Real GDP (Gross Domestic Product) is expected to advance at a more modest pace next year, i.e., 3.9% vs. 5.6% estimated for 20214, if expectations are met, that would still be well above average since the Great Financial Crisis. Beyond 2022 however, the growth picture appears as if it will settle back into its pre-pandemic growth mode. That return to slow growth can be traced to, among other things, the fact that the U.S. population just grew at its slowest rate since our country’s founding, a mere 0.1%, according to the Census Bureau. Just 393,000 people were added to our total population in the year ending in July.
What happened in the markets in the fourth quarter?
- Equities: Another Ho-Hum, Double-Digit Quarter for the S&P
While REITs were the star of the quarter, returning 16.3%, the S&P 500® also turned in a solid performance, advancing by 11.0%. More importantly, or perhaps more impressively, the S&P capped its best three-year stretch since 1999, posting a cumulative return of just over 100%. The other equity categories that we model were not nearly as fortunate over the past three months, let alone the past three years. Small caps printed a respectable return of 5.6%, but still trailed their large cap brethren by a large margin, and outside of the U.S., the quarter wasn’t particularly kind to equities. The MSCI EAFE index only returned 2.7% in dollar terms, international small caps eked out a 7-basis point gain, and emerging markets lost 1.3% for the quarter.
As we begin a new year, the question of S&P 500 dominance looms large. The love of U.S. large cap stocks has pushed and kept valuations at or near all-time highs for quite some time. According to research from Goldman Sachs, as of the beginning of October seven of nine valuation measures for U.S. large cap stocks were in the 93rd or higher percentile relative to history. That may not mean much for the near-term prospects of large caps, but it suggests that it just might be time for other parts of the global equity market to have their day in the sun.
- Bonds: Yields Get Stuck in Neutral
The yield on the 10-year Treasury didn’t move a basis point from the close at the end of September through the end of December—it began and finished at 1.52%. Often the road to nowhere is more interesting than the destination, but not so much during the fourth quarter. Bonds as a group were up a single basis point. Modest losses were suffered across non-U.S. treasuries, emerging market debt (local and hard currency), mortgage backeds, asset backeds, and the lower tiers of the high yield market. Modest gains were had by investment grade corporates, leveraged loans, high yield debt and municipal bonds. The standouts for the quarter, oddly enough, were long-term Treasuries (+3.5%) and TIPs (+2.4%), seemingly indicating that investors can’t make up their collective mind about inflation.
- Commodities: Industrial Metals’ Mettle Shines
While commodities as a group were off by 1.6%, industrial metals largely rewarded investors. Zinc, nickel, tin, and lead futures all advanced by double digits, and copper came close (+9.4%). On the other end of the spectrum, natural gas futures plummeted by almost 40% thanks in part to warmer than normal temperatures across the U.S., and yet for the year still managed to finish with a gain of 29%.
How are Frontier Strategies positioned?
Allocation Changes
At the beginning of December, our asset allocation models reflected modest and essentially immaterial changes from the prior month, and as such, no trading activity occurred within our non-taxable globally diversified strategies. However, within our taxable models, we did complete a number of trades to realign the strategies with their target allocations, and at the same time, either realize losses where possible, or avoid distributions, if doing so had a net positive effect from a tax standpoint.
As for our risk exposures, we began the month and ended the year with the same relative positioning that we’ve maintained for an extended period. While our largest equity allocations have been to U.S. large caps, and secondarily, to international developed large caps, our over and under weightings measured against our long-term allocations reflected a preference for small caps both here and abroad, and to emerging market equities. Within the bond complex, we remain overweight to long-term Treasuries across most of our strategies and underweight to high yield bonds. We’ve also maintained overweight positions to managed futures and underweight exposure to the absolute return category.
Performance Attribution
Given the relative outperformance of REITs and the S&P 500 during the quarter, along with a negative absolute return to emerging market equities, our equity positioning generally detracted from performance for the quarter. Our strategies did benefit from being underweight commodities, which posted a negative return, as well as from our bond positioning. While the bond market, as represented by the Bloomberg U.S. Aggregate Bond Index, was essentially flat at +1 basis point for the quarter, long-term Treasuries were the best performing fixed income sector, which gave our strategies a boost.
[1] KKR
[2] The Daily Shot
[3] U.S. Bureau of Labor Statistics
[4] Bloomberg
Past performance is no guarantee of future returns. Performance discussed represents total returns that include income, realized and unrealized gains and losses, but gross of advisory fees. Nothing presented herein is or is intended to constitute investment advice or recommendations to buy or sell any types of securities and no investment decision should be made based solely on information provided herein. There is a risk of loss from an investment in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for an s investor’s financial situation or risk tolerance. Diversification and asset allocation do not ensure a profit or protect against a loss. All performance results should be considered in light of the market and economic conditions that prevailed at the time those results were generated. Before investing, consider investment objectives, risks, fees and expenses. Frontier may modify its process, opinions and assumptions at any time without notice as data is analyzed.
Information provided herein reflects Frontier’s views as of the date of this newsletter and can change at any time without notice. Frontier obtained some of the information provided herein from third party sources believed to be reliable, but it is not guaranteed, and Frontier does not warrant or guarantee the accuracy or completeness of such information. The use of such sources does not constitute an endorsement. Frontier’s use of external articles should in no way be considered a validation. The views and opinions of these authors are theirs alone. Reader accesses the links or websites at their own risk. Frontier is not responsible for any adverse outcomes from references provided and cannot guarantee their safety. Frontier does not have a position on the contents of these articles. Frontier does not have an affiliation with any author, company or security noted within. Frontier reserves the right to remove these links at any time without notice.
Exclusive reliance on the information herein is not advised. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell any securities, commodities, treasuries or financial instruments of any kind. This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal, investment or tax advice. Frontier does not directly use economic data as a part of its investment process.
Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. The estimates, including expected returns and downside risk, throughout are calculated monthly by Frontier and will change from month to month depending upon factors, including market movements, over which Frontier has no control. They are only one factor among many considered in Frontier’s investment process and are provided solely to offer insight into Frontier’s current views on long-term future asset class returns. They are not intended as guarantees of future returns and should not be relied upon in making investment decisions.
Hypothetical expected returns have certain limitations, are discussed for illustrative purposes only and it should not be assumed that actual results will match the hypothetical expected returns referred to. Unlike actual performance, hypothetical expected returns do not represent actual trading and since trades have not been executed, the results shown may have under or overcompensated for the impact, if any, of certain unforeseen market factors. Hypothetical expected returns, whether backtested or forecasted, have many inherent limitations and no representation is being made that any account will or is likely to achieve the results expected. In fact, there are frequently material differences between hypothetical expected results and actual results achieved. One of the limitations of hypothetical expected results in that they do not take into account that material market factors may have impacted the adviser’s decision-making process if the firm were actually trading clients’ accounts. Also, when calculating the hypothetical expected returns, the adviser has the ability to change certain assumptions and criteria in order to reflect better returns. There are numerous other factors related to the markets in general or to the implementation of any specific investment strategy that cannot be fully accounted for in the preparation of hypothetical expected results, all of which can adversely affect actual trading and performance. Importantly, it should not be assumed that investors who actually invest in this strategy will have positive returns or returns that equal either the hypothetical expected results expected. In addition, performance can, and does, vary between individuals.
In reviewing the performance information presented here, we recommend that you consider both the returns generated and the level of risk that was assumed in generating those results. We believe that performance information cannot be properly assessed without understanding the amount of risk that was taken in delivering that performance.
Real GDP measures a country’s economic output adjusted for the impact of inflation.
Real Return – The annual percentage return realized on an investment, which is adjusted for changes in prices due to inflation or other external factors
Frontier provides model strategies to various investment advisory firms and does not manage those models on a discretionary basis. The performance and holdings of model strategies may vary from strategies managed by Frontier.
© Morningstar 2022. All rights reserved. Use of this content requires expert knowledge. It is to be used by specialist institutions only. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results.
It is generally not possible to invest directly in an index. Exposure to an asset class or trading strategy or other category represented by an index is only available through third party investable instruments (if any) based on that index.
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ASSET CLASS |
INDEX |
INDEX DESCRIPTION |
U.S. 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 |
International Equity |
MSCI EAFE |
An equity index which captures large and mid cap representation across 21 Developed Markets countriesaround the world, excluding the U.S. and Canada. |
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 Market Equity |
MSCI Emerging Markets |
An Index that captures large and mid cap representation across 27 Emerging Markets (EM) countries |
U.S. Small Cap Equity |
Russell 2000 |
Measures the performance of the small-cap segment of the U.S. equity universe. |
U.S. REITS |
FTSE NAREIT Equity REIT |
A free-float adjusted, market capitalization-weighted index of U.S. equity REITs. |
Investment Grade Bonds |
Bloomberg 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. |
Mortgage-Backed Securities |
Bloomberg Barclays U.S. Mortgage-Backed Securities |
Includes all publicly issued, U.S. Treasury securities that have a remaining maturity of 10 or more years, are rated investment grade, and have $250 million or more of outstanding face value |
Treasury Inflation Protected Securities (TIPS) |
Bloomberg Barclays U.S. Treasury US 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 |
Investment Grade Corporates |
Bloomberg Barclays U.S. Corporate OAS |
Represents the Option-Adjusted Spread (OAS) of the Bloomberg Barclays U.S. Corporate Index, which measures the investment grade, fixed-rate, taxable corporate bond market. |
Emerging Market Debt |
Bloomberg Emerging Market Local Currency Sovereign Bond |
Rules-based, market-value-weighted index engineered to measure the performance of local currency sovereign debt issued by emerging market countries. |
High Yield Debt |
Bloomberg US Corporate High Yield |
Measures the USD-denominated, high yield, fixed-rate corporate bond market. |
Municipals |
Bloomberg Municipal Bond |
A market-value-weighted index for the long-term tax-exempt bond market. |
Leveraged Loans |
S&P / LSTA U.S. Leveraged Loan 100 |
Designed to reflect the performance of the largest facilities in the leveraged loan market. |
Long-Term Treasuries |
Bloomberg US Treasury 20+ Year |
Measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury with 20+ years to maturity. |