Perspective : Feb. 2022 Monthly Capital Markets Perspective

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Raptor Rehabilitation

The birds of prey at the Fed have taken flight, making investors on the ground more than a bit nervous as they contemplate the impact of higher rates on the economy and equity valuations. Over the past few weeks, the odds of five rate hikes in 2022 have continued to climb, reaching 100% recently, according to Fed Funds futures. In addition, given the unexpectedly strong jobs report[1] that came out February 4th, showing that employers added 467,000 jobs during the month of January, the chance of the rate hike cycle beginning with a 50-basis point hike at the March meeting has also increased, hitting 27%.

With the rapid spread of Omicron, many economists thought that overall economic growth would be starting to show signs of stress. In fact, while 4th quarter U.S. Real GDP (Gross Domestic Product) grew at a 6.9% annualized rate and was 5.5% above the year ago level[2] – the highest such reading since 1984 – first quarter estimates had been coming down sharply. The Bloomberg consensus estimate for 1st quarter GDP growth reached 2.8% recently, from a high of close to 4.5% at the beginning of December, and the Atlanta Fed’s nowcast as of February 1st suggests that growth has stalled. But the aforementioned jobs report may just change the trajectory of those short-term estimates, while reinforcing the notion of slower longer-term growth, as it gives the Fed the data it needs to push ahead with hikes.

Of course, with earnings season upon us, market participants have other things to occupy their attention other than economic data. According to Standard & Poor’s (S&P), with 48% of companies reporting thus far, both operating and as-reported earnings are about flat from the end of the third quarter. And investors are a bit jumpy, evinced by the dramatic plunge in Meta’s stock price yesterday following its earnings release. The decline erased more than $230 billion from its market cap, which according to multiple news reports was the biggest one-day loss, in dollar terms, in history. Barron’s added that there are only about 30 S&P 500® companies that have market caps in excess of that amount, which puts an exclamation point on the magnitude of that loss.

What happened in the markets in January?

  1. Equities: High Growth Gets Clobbered

With real rates advancing rapidly, rate sensitive growth stocks suffered greatly during the month. The Russell 2000 Growth Index fell off a cliff, losing 13.4%, and international small growth stocks didn’t fare much better, returning -11.2%. Quality small caps, as represented by the S&P 600, performed considerably better than the Russell 2000, which is packed with negative earners; the return gap was 2.4%. The S&P 500 had its worst month since March of 2020, declining by 5.2%, with energy stocks the only component in positive territory (+19.1%). Foreign developed stocks held up a bit better, losing 3.5% on a fully hedged basis, but U.S. investors can thank a stronger dollar for an extra 130 basis point loss on those positions. Emerging market equities were the least worst place to be invested, falling by “only” 1.9%.

  1. Bonds: Real Rates Cause Real Pain

The yield on the 10-year Treasury increased by a healthy 27 basis points during the month to end at 1.79%, and more importantly, real rates at that maturity rose by 39 basis points, which was a material headwind to bond prices. Everything within the fixed income complex was down, except for bank loans, which gained a meager, but greatly appreciated, 0.14%. The Bloomberg U.S. Aggregate was off by 2.2%, high yield and munis were both lower by 2.7%, and investment grade corporates lost 3.4%. Long-term Treasuries fell by 4.3%, as investors fled from duration.

  1. Commodities: Rally Mode Returns

After a bit of a lull during the fourth quarter, commodities again came on strong for the month, as the December CPI (Consumer Price Index) print came in at 7.1%[3]. The Bloomberg Commodity Index gained 8.8%, propelled higher by a surge in energy prices, as winter storms battered much of the country, and concerns about a Russian invasion of Ukraine grew. Natural gas futures rocketed higher by 37%, WTI and Brent crude rose by 17.7% and 14.9%, respectively, and heating oil gained 17.7%. Weather also helped push agricultural futures up by 5.8%, while industrial metals cooled off a bit, but still managed to gain almost 3%.

How are Frontier strategies positioned?

Allocation Changes

Our asset allocation positioning across our lineup of strategies remained essentially static going into January. The little trading activity that did occur at the beginning of the month was to realign certain exposures within allowable ranges, make modest tweaks to fund manager weightings and combinations, complete trades in taxable strategies that had been on hold until year-end had passed, and to harvest some short-term losses. Our equity positioning continues to favor tilts to small caps and emerging markets, even though U.S. large caps generally have the largest absolute weightings. And within the fixed income complex, our most notable over and under weightings continue to be to long-term Treasuries (over) and high yield bonds (under).

Performance Attribution

Our equity tilts generated mixed results for the month. On the positive side, emerging market equities, while down, largely outperformed U.S. and international developed stocks, which positively impacted performance on a relative basis. Our underweight to REITs was also beneficial, but our preference for small caps over large, both domestically and abroad, hurt relative and absolute returns before advisory fees. Within the fixed income sleeve, our underweight to high yield boosted relative performance, while our overweight to long-term Treasuries detracted. Underweights to commodities likewise was detrimental to relative and absolute performance.

[1] Bureau of Labor Statistics

[2] Bloomberg

[3] U.S. Bureau of Labor Statistics

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Nominal GDP measures a country’s gross domestic product using current prices, without adjusting for inflation. Contrast this with real GDP, which measures a country’s economic output adjusted for the impact of inflation.
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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.
International Developed 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 Small Cap Growth Equity
MSCI EAFE Small Cap Growth
An equity index which captures small cap growth 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 Growth
Measures the performance of those Russell 2000® companies with higher price-to-book ratios and higher forecasted growth values.
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.
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.
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.
Bank 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.
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.

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