14 Sep 2022
CEO Confidence Caves
According to The Conference Board[1], corporate leaders’ expectations have plummeted to levels consistent with past recessions, matching that of the early COVID-19 days and reaching a degree of pessimism only surpassed in recent decades during the tech implosion of the early 2000s and the 2008 Global Financial Crisis. And yet the job market, while cooling noticeably, continues to show strength[2]. While only 315k jobs were added last month, far below the 526k jobs gained in July, it was still a healthy number. The unemployment rate ticked up to 3.7% from 3.5%, primarily because the labor pool grew, which may help to relax what has been a very tight labor market, easing wage pressures along the way.
All of which the Fed must surely be viewing with some degree of satisfaction. However, Chairman Powell’s comments at the recent Jackson Hole Economic Symposium left no doubt in investors’ minds that they will do whatever it takes to return price stability to the economy, even while acknowledging that doing so will bring “some pain to households and businesses.”
Across the ocean, the European Central Bank has likewise indicated its resolve to put a lid on inflation, stating that it would raise its key interest rate to 0.75% from 0%, which follows on the 50-basis point rate hike in July, and will be the biggest increase since the early days of European Union (EU)[1]. This even though recession fears are growing, in large part because of what could be a significant energy crisis this winter.
While none of the above should have been terribly surprising to investors, they have not taken these developments in stride. August was a rough month all around, with only four of fifteen asset classes that Frontier models gaining ground. Outside of small gains for floating rate loans (+1.1%), emerging market equities (+0.4%), T-bills (0.2%), and commodities (+0.1%), everything was in the red. Managed futures, which we also utilize, but is a strategy, not an asset class, yet again provided welcome relief, with funds that we employ advancing by between 0.8% and 5.1%.
What happened in the markets in August?
1. Equities: Earnings fears mount
With increased talk of an earnings recession, rising rates, and a new understanding of the Fed’s hawkishness, equities struggled during the month. All broad-based indices were in the red, except for emerging markets (+0.4%), thanks to strong showings by Brazil (+7.1), India (+4.5%), and Turkey (+19.5). Within developed markets, growth stocks bookended returns, with the Russell 2000 Growth declining by only 0.9%, while the S&P 500 Growth and MSCI EAFE Growth indices were off by 5.3% and 6.1%, respectively. Save for U.S. small caps, value outperformed across geography and market cap. And the U.S. dollar once again hacked away at returns to international investments, with EAFE stocks in local currencies outperforming returns to U.S. dollar denominated investors by almost 250 basis points.
At the sector level (S&P 1500 sectors), energy (+2.8%) and utilities (+0.1%) stood alone in positive territory, while healthcare (-5.7%) and tech stocks (-6.1%) trailed.
2. Bonds: Fed fortitude solidifies
While various inflationary indicators cooled in August, investors’ perception of the Fed’s resolve shifted after the Jackson Hole meeting, helping to push rates up, with the 10-year moving from 2.67% at the end of July to 3.15% at month end. At present, the market implied probability of a 75-basis point hike later this month has eclipsed 90%, and Fed Funds futures now indicate a terminal rate of 4%. In such an environment, fixed income securities withered, apart from floating rate loans, which benefitted from rising rates and gained 1.1%. But elsewhere it was another difficult month for bond investors, with munis down 2.2%, high yield off by 2.3%, TIPS declining by 2.7%, and investment grade corporates returning 2.9%. Long-term Treasuries, no surprise, brought up the rear, returning -4.4%.
3. Commodities: Weather & war take their toll
While commodities as a group were flat for the month, returns across the commodity complex diverged greatly on individual fundamentals. Extreme weather in India (rains), Brazil and China (heat), and the U.S. (drought) has led to cotton shortages and concerns about a continued shrinking of supply, all of which pushed cotton futures higher by about 17% for the month. Natural gas prices continued to move higher (+11%) on concerns that Russia would shut off the flow of gas through the Nord Stream 1 pipeline, a fear that came to fruition just after month end; natural gas futures are up almost 70% over the last two months. On the plus side from an inflation perspective, both WTI and Brent crude were down, off by 7.9% and 5.5%, respectively. While the traditional inflation and fear hedge, gold, shed 2.9%, and its more useful sibling silver (useful by industrial standards, that is), fell by 11.9%.
How are Frontier strategies positioned?
Allocation changes
Going into September, there were few common allocation changes across Frontier’s strategies, except that in our more conservative strategies we increased the target allocations to absolute return. Relative to our long-term allocations, we are overweight long-term Treasuries, managed futures, emerging market equities, small caps both in the U.S. and overseas, and bank loans. We are underweight absolute return, commodities, high quality bonds, and U.S. large caps. Overall, our moderate-risk strategies are positioned approximately in-line with expected long-term risk targets, our conservative strategies are situated more cautiously relative to their risk budgets, and our more aggressive strategies are seeking to take advantage of attractive equity valuations.
Performance attribution
For the month, within Frontier’s Core Strategies – Capital Preservation, Conservative, and Balanced – all outperformed their benchmarks on a gross of fee basis, while our more aggressive strategies – Moderate Growth, Long-Term Growth, and Global Opportunities – all trailed. Our Specialty strategies also underperformed their respective benchmarks. In general, our overweight exposure to managed futures and emerging market equities was a positive, while our overweights to U.S. and international small caps negatively impacted relative results. Our underweight to REITs and overweight exposure to floating rate loans in certain strategies was also beneficial. Across our fixed income allocations, our overweights to long-term Treasuries continued to be detrimental to performance.
[1] www.ecb.europa.edu
[1] www.conference-board.org/
[2] U.S. Bureau of Labor Statistics
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| ASSET CLASS | INDEX | INDEX DESCRIPTION |
| U.S. Large Cap Equity | S&P 500 Growth | Represents US large company growth stocks. |
| U.S. Small Cap Equity | S&P 600 | Measures the small-cap segment of the U.S. equity market. |
| U.S. Equity – Growth | Russell 2000 Growth | A market capitalization-weighted index based on the Russell 2000 index. The Russell 2000 Growth Index includes companies that display signs of above-average growth. |
| U.S. Equity | S&P 1500 | Serves as a benchmark indicator for over 90% 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 Growth | MSCI EAFE Growth | Captures large and mid cap securities exhibiting overall growth 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 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 Bonds | Bloomberg US Corporate High Yield | Measures the USD-denominated, high yield, fixed-rate corporate bond market. |
| Municipal Bonds | Bloomberg Municipal Bond Index | Covers the USD -denominated long -term tax exempt bond market. |
| 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. |
| Long-Term Treasuries | Bloomberg U.S. Treasury 20+ Year | Measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury with 20+ years to maturity. |
| 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. |