07 Feb 2022
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?
- 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%.
- 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.
- 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
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.
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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.
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 countriesaround 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. |