13 Jun 2022
A flashback to 1939
The job market continues to sizzle. The Labor Department reported that the U.S. economy added 390,000 jobs in May, well above the consensus estimate of 325,000. Further, April’s numbers were revised upward slightly. Over the past year, on average more than 400,000 jobs have been added each month, making this the strongest period of employment growth going back to 1939, according to the Wall Street Journal. And with about two open positions for every available worker, the streak of job growth could very well continue, albeit at a more relaxed pace.
With jobs aplenty and stimulus money still in the bank, consumers just keep on spending. Households increased their consumption for the fourth straight month in April, but the savings rate fell to its lowest level since the Global Financial Crisis, indicating that many consumers are drawing on savings as inflation continues to run high. While the Fed has committed to 50 basis point (bp) increases in June and July, the probability of smaller hikes from there had been increasing, but the Fed is going to need some help from the job market and the consumer to be able to take a less aggressive stance.
Overseas, the fact that the European Union agreed to ban Russian oil imports arriving by sea by the end of the year, and imposed restrictions on insuring Russian oil in transit, will likely keep oil prices high, which in turn could help sustain high inflation readings. But there is some good news out of China on the supply chain front. After about two months in lockdown, China’s biggest city, Shanghai, reopened yet again. Welcome news as the Caixin China Manufacturing PMI showed that factory activity was very weak in May and below estimates, as reported by DealBook. Getting China back online should help combat inflation.
What happened in the markets in May?
1. Equities: Potholes and blinders
On its way to ending a seven-week streak of declines and posting a meager 0.2% return for the month, the S&P 500® kept investors on their toes, as the index experienced moves of 2% or more on 8 of 21 trading days. With the S&P now down about 13% year-to-date, many market participants seem focused on improved valuations – forward P/E’s (price/earnings) are being highlighted everywhere we look – but there haven’t been meaningful downward earnings revisions yet despite the fact that the Fed is actively trying to slow the economy by increasing interest rates. Barron’s reported that at the end of last year, analysts expected the constituents of the S&P 1500 to deliver average earnings per share of $5.87 for the fiscal year of 2022, but that by the end of May, that number had grown to $6.15. If analysts are behind the curve and they start giving haircuts to their estimates (which they do in most years), those P/Es are likely not going to look nearly as attractive.
Perhaps as a result, investor preferences for smaller names and foreign stocks persisted for the second straight month. The S&P 600 (+1.9%), MSCI EAFE (+0.8%) and MSCI Emerging Markets (+0.4%) all outperformed U.S. large caps. International stocks were helped by a cooling U.S. dollar; the MSCI EAFE Index was off by 0.2% in local currency terms.
Overall, value stocks – small, large, and international – were the biggest winners. MSCI EAFE Value was up 2.5% and the Russell 1000 Value gained 1.9%, while growth stocks had another helping of humble pie; the Russell 3000 Growth fell by 2.3%. At the sector level, energy (+15.5%), media (+8.9%), and utility stocks (4.5%) led the way, as consumer staples (-4.4%) and consumer discretionary stocks (-4.6%) got thumped (all sectors based on the S&P 1500).
2. Bonds: The QT Era (?) begins
Quantitative tightening (QT) has begun, and there isn’t much of a playbook from which to gauge how this will unfold as the Fed reduces its $9 trillion balance sheet. What seems fairly certain however, is that the balance sheet will not go back to anywhere near pre-COVID-19 levels, and thus QT will have less of an impact than QE (quantitative easing) on rates and liquidity. Even so, it could push rates higher if market participants don’t fill the void left by the Fed.
After a dismal April, fixed income markets calmed a bit during the month, and the Bloomberg U.S. Aggregate Bond Index advanced by 0.6%, as the yield on the 10-year Treasury fell by 4 bps to end at 2.85%. Segments that had been outperforming in recent months, namely, high yield, TIPS, and leveraged loans all took a backseat to investment grade corporates, which were up 0.9%, and mortgage-backed securities, which advanced by 1.1%. While not the worst performer, which was an honor bestowed on leveraged loans (-2.5%), long-term Treasuries continued to be shunned by investors, resulting in a 2.2% loss.
3. Commodities: Oil and gas vs. everything else
Helped by WTI crude oil (+11.5%), natural gas (+10.8%), and petroleum (+10.2%), the Bloomberg Commodities Index returned 1.5% for the month, extending its streak of positive months to six (and it has only had two down months in the past year). But as was the case last month, commodities have been anything but a one-way ride, as economically sensitive industrial metals fell by 6.5% and agricultural contracts lost 1.9% due in part to challenging weather conditions.
How are Frontier strategies positioned?
Allocation changes
At the beginning of the month, in general, our strategies increased their target allocations to managed futures by reducing exposure to U.S. equities and long-term Treasuries. At the fund level, in addition to managed futures, we added positions in real assets and global equities in certain strategies. Relative to our long-term allocations, we are overweight long-term Treasuries, managed futures, U.S. small caps, international equities, and bank loans; we are underweight high-yield bonds, absolute return, commodities, and U.S. large caps. Overall, we are positioned approximately in-line with expected long-term risk targets, although our conservative strategies are situated more cautiously.
With small caps trading at least as cheaply as they have relative to large caps in over two decades on certain measures, and with the expected return differential between U.S. and international equities in the 95th percentile, according to our models, we believe we are well positioned for a changing of the guard. Two months of outperformance from those areas may not constitute a trend, but it’s a start.
Performance attribution
On a gross of advisory fee basis, but net of mutual fund expenses, Frontier’s Core Strategies were a mixed bag of outperformance with Capital Preservation, Long-Term Growth, and Global Opportunities beating their benchmarks last month. The primary contributors to generating excess returns were overweights to managed futures and higher international equities allocations relative to the US. The primary detractors to performance were overweights to long-term Treasuries and bank loans, with underweights to commodities.
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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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.
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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 | Measures the small-cap segment of the U.S. equity market. |
| U.S. Equity | S&P 1500 | Combines three leading indices, the S&P 500®, the S&P MidCap 400®, and the S&P SmallCap 600®, to cover approximately 90% of U.S. market capitalization. |
| U.S. Large Cap Equity – Value | Russell 1000 Value | Measures the performance of the large- cap value segment of the US equity universe. |
| U.S. Equity – Growth | Russell 3000 Growth | A market capitalization-weighted index based on the Russell 3000 index. The Russell 3000 Growth Index includes companies that display signs of above-average growth. |
| 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 Developed Equity – Value | MSCI EAFE Value | Captures large and mid cap securities exhibiting overall value style characteristics 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 |
| 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. |
| 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. |
| 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. |
| Leveraged Loans | S&P / LSTA U.S. Leveraged Loan 100 | Designed to reflect the performance of the largest facilities in the leveraged loan market. |
| Mortgage-Backed Securities | Bloomberg U.S. Mortgage-Backed Securities | Tracks fixed-rate agency mortgage backed pass-through securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). |
| 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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