12 Sep 2023
Rough month. Good outlook.
The gap between job openings and the number of unemployed continues to shrink, and while the unemployment rate did tick up to 3.8% recently, the labor market appears to be stabilizing. The increase in the number of jobs in August at 187k came in above expectations for 170k, and the rise in unemployment was fully explained by an increase in the labor participation rate, which the Labor Department said came in at almost 63%.
U.S. consumers keep watching their net worth increase and continue to shell out cash. The Commerce Department reported that Personal Consumption Expenditures rose a healthy 0.8% in July, up from 0.6% in June and ahead of estimates for 0.7%, the fastest rate since January. Americans spent more on groceries, recreational goods, and vehicles, as well as on a host of services. Add to that the fact that household debt service as a percentage of disposable incomes remains well below its average over the past four decades and that household wealth hit another new high during the second quarter, according to Barron’s, and you can’t help but conclude that the engine of U.S. growth is purring.
In his Jackson Hole remarks, Fed Chair Jerome Powell argued for holding rates steady at their coming meeting while keeping options open for hiking again later this year if warranted. At this point, the futures markets put a 93% chance that the Fed stays put this month.
It was a difficult month for capital markets, with the threat of an automotive strike looming and increasing tensions with China keeping investors on edge. Post-month-end, China ordered central government officials in certain areas to stop using iPhones, and Bloomberg reports that a ban could be expanded. As Apple is the largest company in the world and derives about 20% of its revenues from China, that’s no small thing. But then again, there are always things to worry about, and for now, the U.S. economy is in solid shape.
What happened in the markets in August?
EQUITIES: TROUBLES IN THE EAST, BUT U.S. EARNINGS IMPROVING
Concerns surrounding China’s debt, housing markets, and consumer demand took center stage once again, leading to a pullback of almost 9% for Chinese equities and, with that, a decline of 6.2% for emerging market equities. That contributed to a risk-off environment that saw small caps fall by 4.1% and international developed stocks decline by 3.8%. For those dwelling on the risk in the East, it’s worth noting that according to The Wall Street Journal, Apple’s market cap exceeds that of all Chinese equities within the MSCI All Country World Index, and Chinese equities trade at about half the multiple of U.S. equities; the risks are widely understood and would seem to be priced in.
In the U.S., earnings season came to an end, and while corporate earnings fell for the third straight quarter, they were better than predicted. FactSet reports that analysts are now raising quarterly Earnings Per Share (EPS) for the S&P 500® for the first time in two years. However, only four of eleven sectors have experienced increases, with consumer discretionary, communication services and information technology accounting for the biggest gains. Regardless, the improving aggregate earnings outlook helped the S&P 500 to rally off its recent bottom into month end, cutting its loss to -1.6%. Given where earnings bumps have been the largest, it’s not surprising that Growth stocks widely outperformed Value during the month, returning -1.1% vs. -2.8%.
BONDS: CRACKS IN CREDIT QUALITY BUT NOT CREDIT PERFORMANCE
The yield curve continued to flatten in August, with the 10-year minus 2-year increasing by 15 basis points (bps) and the 10-year minus 3-month advancing by 11 bps. The yield on the 10-year increased by 0.12%, and the bond market lost 0.6%, with long-term Treasuries leading on the downside with a return of -2.8%. Sentiment for, and performance of, Treasuries wasn’t helped by Fitch’s credit downgrade for the U.S. government from AAA to AA+. They cited “…a steady deterioration in standards of governance” over the past two decades as part of their rationale for their decision.
Interestingly, with bankruptcies rising, recovery rates for defaulted loans falling precipitously, and high yield spreads widening by six bps, high-yield bonds gained 0.3%, and leveraged loans advanced by 1.2%. Asset-backeds also held up well, adding 28 bps, but all other fixed-income sectors were down. Investment grade corporates lost 0.8%, and munis fell by 1.4%. The 5-year inflation breakeven rate ended the month at 2.15%, down from 2.27% a month earlier, as various inflationary indicators cooled.
COMMODITIES: ENERGY REMAINS ENERGIZED
The energy complex was the only major commodity group to post gains for the month, with heating oil up 5.2% and WTI Crude gaining 3.3%. The IEA attributes the gains in oil prices to OPEC supply cuts, improving macroeconomic sentiment, and all-time high world demand. Additionally, Baker Hughes reports that the U.S. oil rig count has declined from 621 at year-end to 512 at the beginning of September.
Elsewhere, agricultural futures fell by 1.5%, with both wheat and corn suffering large losses, while sugar and cotton gained. Precious metals were down 1.7%, and industrial metals fell by 4.7%, which is at odds with an economic outlook that has steadily been improving.
How are Frontier strategies positioned?
ALLOCATION CHANGES
Due to the complexities of attempting to generalize about allocation changes across our Core, Specialty, Tax-Managed, Multi-Asset Income, and Faith-Based Strategies and the additional difficulties of properly conveying how those asset allocation changes flow through to trade level activity, we are instead directing clients to our monthly trade summaries, which describe in detail what trade activity occurred by strategy, and why.
Focusing on our Core Strategies, relative to their long-term asset allocations, which serve as policy portfolios guiding our dynamic allocation decisions, we favor U.S. and international small caps, emerging market equities, managed futures, floating rate loans, and cash/short-term bonds. We are generally underweight U.S. and international large cap stocks, REITs, commodities, and both high-yield 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 occur.
Return expectations for emerging market equities and international small caps not only continue to remain near the tops of their respective 20-year ranges, but they’ve improved over the past year. Expectations for managed futures, floating rate loans, and T-bills are likewise high relative to history and are also above their year-ago levels. U.S. large caps and REITs remain near their 20-year lows.
PERFORMANCE ATTRIBUTION
Our market cap positioning in both the U.S. and overseas was a headwind to absolute and relative performance. Emerging market equity exposure hurt as well, as did our underweight to commodities. On the fixed income side, our exposures to leveraged loans and high yield bolstered absolute returns, and our overweight to the former helped relative to benchmarks. Both of our primary risk-management tools, long-term Treasuries and managed futures, were down for the second straight month, which hurt overall performance. Relative to one another, two of the four managed futures funds that we utilize outperformed long-term Treasuries, and two underperformed for a bit of a wash overall.
Past performance is no guarantee of future returns. Performance discussed represents total returns that include income, realized and unrealized gains, and losses. Nothing presented herein is or is intended to constitute investment advice or recommendations to buy or sell any type 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 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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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 back tested 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 is 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.
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.
Inflation is the decline of purchasing power of a given currency over time. A quantitative estimate of the rate at which the decline in purchasing power occurs can be reflected in the increase of an average price level of a basket of selected goods and services in an economy over some period of time. The rise in the general level of prices often expressed as a percentage, means that a unit of currency effectively buys less than it did in prior periods.
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| ASSET CLASS | INDEX | INDEX DESCRIPTION |
| U.S. Large Cap Equity | S&P 500 | Represents US large company stocks. |
| U.S. Growth | Russell 3000 Growth | A market-capitalization-weighted equity index that seeks to track 3000 of the largest U.S.-growth traded stocks. |
| U.S. Value | Russell 3000 Value | A market-capitalization-weighted equity index that seeks to track 3000 of the largest U.S.-value traded stocks. |
| International Developed Equity | MSCI EAFE | An equity index which captures small-cap representation across 21 Developed Markets countries around the world, excluding the U.S. and Canada. |
| Global Equity | MSCI ACWI | Designed to represent performance of the full opportunity set of large- and mid-cap stocks across 23 developed and 27 emerging markets. |
| Emerging Market Equity | MSCI Emerging Markets | Captures large and mid cap representation across 24 Emerging Markets (EM) countries. |
| Chinese Equity | MSCI China | Captures large and mid cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g., ADRs). |
| Investment Grade Corporates | Morningstar US Corporate Bond | Measures the performance of fixed-rate, investment-grade USD-denominated corporate bonds with maturities over 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. |
| 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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