09 Feb 2023
A great start
Amid a head-scratching array of conflicting data and competing narratives about what 2023 will bring, capital markets put on a banner performance to start the new year. For the month, every major equity and fixed income index that we track was in the black. From Chinese equities that were flying high (high as a balloon, perhaps?), to REITs, to Munis, you name it, it went up. Explanations for the fireworks included a familiar cast of characters, one Goldilocks (economy), and one Bear (market rally…I’m not exactly certain what happened to the other two bears, hopefully, they were left behind in 2022).
The inversion of the yield curve, defined here as the 10-year Treasury yield less the 3-month Treasury yield, hit its most negative level since the early 1980s near month end, and that metric has successfully predicted all eight of the last recessions going back to the 1970s (source: GMO and FRED). But the job market keeps saying that it will have none of that, thank you. According to the U.S. Bureau of Labor Statistics, payrolls increased by over half a million in January, more than double expectations, and unemployment hit 3.4%, a rate not last seen since 1969. All of which is certainly giving the Fed ulcers. Shortly after month end, they raised rates by another quarter point, and in his comments after the Federal Open Market Committee (FOMC) meeting, Chairman Powell said, “We’re talking about a couple of more rate hikes to get to that level we think is appropriately restrictive.” Futures markets quickly shifted from predicting there was only about a 30% chance for two more rate hikes, to indicating a probability of a 60% chance. Even so, based on equity market performance month-to-date (as of February 6th), investors aren’t overly concerned about those additional hikes and seem to believe that a recession, if it occurs, will be fleeting.
Overseas, Europe is also holding up far better than expected even in the face of higher inflation, central bank tightening, and a horrific and senseless war. The European Union’s statistics agency recently reported 2022 calendar year growth of 3.5%, which was faster than that experienced in either the U.S. or China. Further, Eurozone unemployment remains at an all-time low, and Citi’s Economic Surprise Index for Europe continued to rise into January, well above the level for the U.S. All of which helps explain the resurgence of international developed equities over the past six months. It’s likely too soon to suggest that the S&P 500®’s dominance is over, but after an almost 15-year stretch of such, as defined, and measured by JPMorgan (source: JPMorgan Guide to the Markets), perhaps a change is in the air.
What happened in the markets in January?
EQUITIES: SLOW EARNINGS, ACCELERATING GAINS
Chinese equities continued their scorching advance, adding almost 12% for the month, and bringing their three-month total return to 53%. A tough act to follow for sure, but REITs rebounded nicely after a rough December, gaining an impressive 10.7%. U.S. small caps in general also posted a strong month, ranging from +9.5% for value shares to about 10% for growth. International small caps (+7.5%) likewise posted an excellent month but failed to beat their large-cap peers, which returned a not-too-shabby 8.1%. And to round things out, the S&P 500 gained 6.3%.
With about 50% of S&P 500 companies having reported earnings thus far, GAAP earnings are 3.1% below the prior quarter, while operating earnings are showing a 2.7% advance on margins estimated at 11.4%, according to S&P. However, with a slew of earnings still to come, FactSet is reporting an estimate for a 5.3% decline in operating earnings year-over-year, which if true would be the first such decline since the third quarter of 2020. They go on to say, “Looking ahead, analysts expect earnings declines for the first half of 2023, but earnings growth for the second half of 2023…For all of CY 2023, analysts predict earnings growth of 3.0%.” As always, markets are forward-looking, and at least for the moment, appear to be looking past a potentially disappointing first half.
BONDS: TREASURIES TAKE AN EARLY LEAD
Long-Term Treasuries came out of the gates with a fire in their belly, advancing by 6.4% as the yield on the 10-year fell by about 40 basis points, ending at 3.5%. The yield curve inverted further, as short rates rose and longer rates fell. Corporates, both high yield and investment grade, finished up about 3.9%, while bank loans gained 3%. Municipal bonds also enjoyed an almost 3% gain and the National Association of State Budgeters released data showing that based on enacted budgets, state governments have record-high reserves, which is good for both the credit quality of the Muni market and for weathering a potential recession. Rounding out the major bond categories that Frontier utilizes in strategies, TIPS improved by 1.9%.
COMMODITIES: THE PAUSE AFTER THE PARTY
After shining in 2022, gaining over 16% as both stocks and bonds fell, commodities as a group were off by 49 basis points in January. But as always, there were major differences across the commodity complex, with industrial metals like tin (+19.3%), zinc (+14.6%), and copper (+11.4%) doing quite well on solid economic data and hopes of a shallow recession if any. Gold also had a strong showing, returning 6%, and is on a bit of a run over the past three months, advancing by almost 18%, as investors have been betting that the pace of rate hikes will slow/end soon. On the losing side was the energy complex, which witnessed natural gas futures plummeting by 34%, followed by WTI crude, which was down 1.6%. Warmer weather in both the U.S. and Europe, along with a falling dollar has put pressure on prices.
How are Frontier strategies positioned?
ALLOCATION CHANGES
There were essentially no meaningful changes to the asset allocations for Frontier’s Core Strategies going into February, and no trading activity occurred.
Within the Frontier’s Tax-Managed Strategies, the biggest asset allocation changes going into the month were reductions to municipal bonds, in favor of credit, both high-yield bonds and floating-rate loans. However, at the trade level that was not consistent across strategies, and additionally, trades were placed to both align portfolios with their respective risk targets, as well as to harvest losses where possible.
Within Frontier’s Specialty Strategies, only Absolute Return Plus experienced allocation changes that led to trades; long-term Treasuries were reduced in favor of Managed Futures.
Overall positioning remains in favor of U.S. and international small caps, emerging market equities, managed futures, long-term Treasuries, and high-yield bonds. Our more conservative portfolios are also overweight floating-rate loans. We are generally underweight U.S. and international large-cap stocks, REITs, commodities, and high-quality bonds at the asset allocation level, but differences between the asset allocations and actual exposure at the fund level can and will differ.
PERFORMANCE ATTRIBUTION
For the month, Frontier’s more aggressive, Core Strategies (i.e. Moderate Growth, Long-Term Growth, and Global Opportunities) were all ahead of their respective benchmarks. Our more conservative strategies underperformed benchmarks but were able to generate solidly positive performance.
All of Frontier’s Specialty strategies soundly outperformed their respective benchmarks. Within our Tax-Managed Strategy lineup, all our strategies, except for Global Opportunities and the three tax-managed versions of our Specialty strategies, underperformed their respective benchmarks on a pre-tax basis.
From an asset allocation perspective, in general, across our strategies, our overweights to U.S. small caps and emerging markets were beneficial, as was our underweight to U.S. large caps, which underperformed all other equity classes. Our underweight to REITs and our positioning in international developed equities hindered results, even while adding substantially to absolute returns. On the fixed income side, strategies that were overweight to long-term Treasury benefited. Managed futures funds, which we’ve been utilizing largely as a diversifying asset at a time when fixed income has failed in that role, hurt performance for the month, with all the funds that we utilize ending flat or slightly in the red.
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| ASSET CLASS | INDEX | INDEX DESCRIPTION |
| U.S. Large Cap Equity | S&P 500 | Represents US large company stocks. |
| U.S. Small Cap Equity | S&P 600 | Measures 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 Large Cap Equity | MSCI EAFE Large Cap | An equity index which captures large cap representation across Developed Markets countries around the world, excluding the US 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. |
| Chinese Equity | China Shanghai Composite | Measures the value of all stocks (A-shares and B-shares) traded on the Shanghai Stock Exchange. |
| Emerging Market Equity | MSCI Emerging Markets | An Index that captures large and mid cap representation across 27 Emerging Markets (EM) countries |
| Investment Grade Corporates | Morningstar US Corporate Bond | Measures the performance of fixed-rate, investment-grade USD-denominated corporate bonds with maturities greater than one year. |
| High Yield Bonds | Morningstar U.S. High Yield Bonds | Measures the performance of USD-denominated high-yield corporate debt. It is market-capitalization weighted. |
| TIPS | Morningstar US TIPS | Represents inflation-protected securities issued by the U.S. Treasury. |
| Municipal Bonds | Morningstar US Municipal Bond | Measures the performance of fixed-rate, investment-grade USD denominated tax-exempt debt issued by U.S. state, U.S territory, and local government entities with maturities greater than one year. |
| 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 | Morningstar US 10+ Yr Treasury Bond | Measures the performance of fixed-rate, investment-grade USD-denominated Treasury bonds with maturities greater than ten years. |
| REITS | FTSE NAREIT Equity REIT | A free-float adjusted, market capitalization-weighted index of U.S. equity REITs. |
| Commodities | Bloomberg Commodity | 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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