12 May 2022
A swing and a miss
First quarter GDP (Gross Domestic Product) came in at -1.4%, falling well shy of the Bloomberg consensus estimate of +1%, and nowhere near the +6.9% growth seen in the fourth quarter. The negative headline number was a bit misleading however, as the miss was primarily due to net exports (we imported more goods than ever before) and to a lesser extent, the depletion of inventories. Demand, as measured by final sales to private domestic purchasers actually rose by a healthy 3.7%. Further, real personal consumption is right on the pre-COVID-19 trend. All of which means that the Fed has plenty of heavy lifting ahead of it, and it’s not alone. According to BofA, globally, the percentage of central banks hiking rates – just shy of 40% – is the highest since 2008.
Market participants have also been watching indicators of wage growth to gauge just how high inflation will remain for the foreseeable future, and as the Employment Cost Index (ECI) came in at 1.4% for the first quarter, well above expectations of 1.1%, that spooked a bond market already on edge. On a year-over-year basis, the ECI was up 4.5%, but given the level of inflation, real disposable income has plummeted from a year ago, and the savings rate is now below the pre-COVID-19 range.
What happened in the markets in April?
1. Equities: Large not in charge
In a change of pace, U.S. large caps underperformed all major equity categories for the month, with the S&P 500® shedding close to 9%. Growth stocks within the index plummeted by 12.5%, in what was their worst month since the COVID-19 plunge of March 2020, while the value component fared considerably better, returning -4.9%. Consumer staples was the only sector in positive territory, and all of the big tech names (e.g. Nvidia, Amazon, Tesla) underperformed the S&P 500, as investors reassessed the multiples that they were willing to put on earnings from the high growers. Further, according to MarketDesk, the number of times that margin pressures were mentioned on earnings calls reached a decade high during the month. Estimated operating margins for S&P companies are still at a robust 12.2%, but that is down from the all-time high of 13.5% reached in the second quarter of last year.
Overseas, international developed equities performed remarkably well, all things considered, with the MSCI EAFE Index down only 1.4% in local currency terms. However, given the strength in the dollar, U.S. investors suffered a 6.5% loss in the very same stocks. Within emerging markets, thanks in large part to relative strength in China, equities fell by a slightly less stomach churning 5.6%. As was the case in the U.S., value stocks outperformed globally.
2. Bonds: Treasury troubles and corporate collapse
Fixed income markets were in total disarray during the month, as investors questioned just how aggressive the Fed will need to be to quash inflation. The yield on the 10-year Treasury climbed 57 basis points (bps) to end the month at 2.89%, punishing duration. Long-term Treasuries were down 9.4% and investment grade corporates were off by 5.5%, bringing their year-to-date losses to 19.4% and 12.7%, respectively. High yield bonds continued to outperform their higher credit quality peers, despite increasing odds of a recession, returning -3.6%, and leveraged loans, which are also issued by non-investment grade companies, came in about flat for the month, demonstrating their lack of interest rate sensitivity.
In other corners of the bond market, losses were a bit more contained, as TIPS were down a relatively modest 2% and municipal bonds fell by 2.8%, outperforming the Bloomberg U.S. Aggregate Bond Index by 102 bps.
3. Commodities: Still king, but showing cracks
Commodities returned 4.1% for the month, extending their dominant performance from the first quarter, but gains were no longer uniform under the surface. While natural gas, oil, and certain agricultural commodities like soybean oil and wheat, all of which continue to be affected by events in Ukraine, were in positive territory, more than half of the sub-components of the Bloomberg Commodity Index posted negative returns. Copper futures, which are particularly sensitive to the economic outlook, fell by 7.4%.
How are Frontier strategies positioned?
Allocation changes
At the beginning of the month, certain Frontier strategies increased their target allocations to managed futures and bank loans by reducing allocations primarily to investment grade bonds. Relative to our long-term allocations, and dependent on the strategy, 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 strategies, commodities, and U.S. large-caps. Overall, we are positioned approximately in-line with expected long-term risk targets, although our conservative strategies are still situated cautiously.
As we’ve communicated at multiple points, given valuations and earnings expectations, we continue to see better long-term opportunities in out of favor equity segments, namely U.S. and international small caps, and emerging markets, although U.S. large caps do dominate the weightings within the equity complex on an absolute basis, with the exception of our most aggressive strategy, Global Opportunities.
While rates have risen materially, increasing the expected returns to most fixed income categories, real return expectations remain quite low by historical standards, give the overall level of yields and the current and expected rate of inflation. We maintain significant exposures to high quality bonds in our more conservative strategies, as well as meaningful, but not particularly large exposures to long-term Treasuries within our more aggressive strategies, while mostly avoiding TIPS, high yield, and international bonds.
Performance attribution
On a gross of advisory fee basis, but net of mutual fund expenses, all of Frontier’s Core Strategies outperformed their respective benchmarks for the month, with the exception of Long-Term Growth, which trailed slightly. Performance was helped by many of the tilts within the equity portions of our portfolios, as our primary underweighted equity class, U.S. large caps, underperformed every other equity category to which we allocate. Our managed futures positions were also nicely additive, generating positive returns in an otherwise sea of red. Detracting from performance were our long-term Treasury positions and our 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.
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.
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.
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.
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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 |
| 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. |
| 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. |
| 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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