The Pacific Financial Group’s Asset Allocation Committee features a group of our partners and strategists that meeting quarterly. Each share their viewpoints and outlook on the markets and their strategies.
- Inflation is expected to remain high throughout 2022, but we may be near the peak, if not already at it.
- U.S. equities are favored over international developed and emerging market equities, specifically value stocks over growth. In fixed income, most strategists are shorter duration.
- In May, the Federal Reserve hiked rates by 50bps, as expected.
- Healthcare, energy, and financials are expected to perform well given the mid-to late cycle environment. However, it is important to choose investments in financials wisely. While rising rates tend to benefit financials, this may be outweighed by a decline in mortgage businesses.
- Correlations have risen between asset classes.
- Although the current environment may continue to be volatile, all strategists had a favorable outlook for long term returns.
Michael Krause, CFA, Partner
Counterpoint manages a high-yield, bond timing strategy within the PFG Tactical Income fund. They are a quantitative boutique manager, utilizing both high-yield corporates and high-yield municipal bonds. Counterpoint is following trends in the high yield market as a signal for the rest of the fixed income markets. The Tactical Income Fund and Tactical Municipal Fund both received risk-off signals in January of this year to move out of high yield and into cash or treasuries. Largely, the price action that is coming out of Treasury markets has been driving all the substandard performance in fixed income. In the High Yield Corporate fund, Counterpoint went to low duration treasuries, effectively weighting the portfolio duration under one year. The Municipal Bond Fund has been in cash, which has been a good place to be.
Yield curves are very flat right now, which indicates that the market thinks the Fed will overshoot and that inflation will likely moderate. The spreads are saying that inflation will not be long lived, but there is some disagreement from the fixed income market. Fed futures now have 9 rate hikes priced in. The Fed Funds rate is only around 33 bps, so we are entering into a very new regime. Still, Counterpoint is risk-off for the next few months until a new signal says otherwise.
Justin Blesy, CFA, Exec VP, Asset Allocation Strategist
When looking at the U.S. Aggregate Bond index, short term treasuries and investment corporate bonds have had their worst quarter since the 1980s. Further, credit and emerging markets have also performed poorly due to rising rates. Over the past 12 months, inflation has risen exponentially; a large part of this stems from the supply chain challenges that have continued throughout the quarter. Automotive and travel services sectors were leading the inflation issues, with food and energy topping them off. Outside of food, energy, automotives, and travel, most areas are not far off from the long-term average. While this will still pose an issue for the remainder of 2022, it is believed that we are near, if not at, the peak of headline inflation, and will likely see the CPI readings dip back below 4% by the end of 2023.
PIMCO is cautious on duration and focusing more on a diversified mix of credit, higher up in the quality. Other areas of focus include high yield and emerging markets bonds. Investment grade credit was increased during the quarter, bringing the total allocation to around 10%. Lastly, today’s yields look great for long term returns; there may be near-term pain now, but long-term is a much more attractive place to be in terms of fixed income overall.
Brett Boor, CFA, Senior ETF Analyst
Invesco is one of the top 5 ETF producers and one of the longest asset managers to be in the ESG space, with around $1.5 trillion in total assets. Thematic ESG is an exciting, dynamic space that is really growing. Ninety percent of the worlds GDP is on a net-zero carbon commitment, requiring a huge expansion of clean energy. The Thematic ESG model itself includes 7 different equity funds spanning the globe, which are all passive and focused on thematic ESG that tends to be very solution-focused. These funds specifically target key technologies within three areas: clean energy, clean technology, and clean water. The emergent technology is on a 5-10 year timeline, maybe even 20 years, but the energy transition is real, and investing in these types of companies presents a very exciting opportunity.
Lea Miller, Product Strategist, Multi-Asset Strategist & Solutions Group
The Target Allocation ESG Model’s performance is down across the board, and a little down against the benchmark for the quarter. However, at the end of this month, the model will be approaching five years of positive returns. The model is currently overweight U.S. equities. The small cap allocation within this model is proving to be an outperformer, while we are seeing some foreign DM equites and U.S. large caps take away from performance.
Coming into this year, BlackRock was worried about European manufacturing as a result of the supply chain crisis and oil restraints, leading them to trim foreign DM and EM exposure to allocate more towards U.S. equities. There were two trades this past quarter, one in January and one in March. The January trades trimmed their overall equity exposure. Specifically, foreign exposure was reduced and added to U.S. equities. BlackRock has seen a lot of success in having that U.S. equity overweight over time. The March trades were in response to the Ukraine-Russian war, further decreasing exposure to underweight foreign equities, and reallocating it to U.S. small, mid, and large caps.
BlackRock expects muted inflation effects for the rest of 2022, although this is dependent on the current geopolitical circumstances. There are still some supply chain disruptions which have produced commodity price shocks and higher input costs, leading BlackRock to believe higher inflation and lower global growth are expected for the remainder of the year. In terms of the Fed and rate hikes, a 50bps hike is expected at the May meeting. While there are still uncertainties for European companies, U.S. equities are expected to hit most earnings estimates, leading them to be optimistic for positive returns in 2022.
James Macey, CFA, CAIA, Senior Investment Strategist, BNY Mellon Investment Management
The first quarter of 2022 was a volatile quarter for both bonds and equities. Global equity markets had their first negative quarter since the early days of COVID as a result of the geopolitical tensions from the Ukraine-Russia conflict. There are a lot of concerns within fixed income, particularly in the U.S. regarding Fed policy, and the shape of the yield curve. Commodities were one of the few “bright spots” throughout the quarter, recording returns around 25%. Large cap value was the lone safe haven in equities, which ended almost flat.
Energy, utilities, and staples did relatively well over the quarter, and there was a general shift from growth equities to value equities out of fear of rising rates and their possible impact on the market. Inflation has been a substantial issue with CPI readings coming in with the highest numbers in over 40 years. The March reading marked the 12th consecutive month that CPI rose 50 or more bps month over month. The producer side of this, the PPI, is growing at even higher levels. Given that the producers are facing higher input costs, it is expected that these costs will be passed on to consumers. This leads BNY to believe that inflation will remain high, at least until the summertime, and then will most likely begin to recede in the latter half of the year. The Ukraine-Russia conflict had a huge impact on the market, especially regarding energy. Commodities, such as oil, metals, wheat, etc., performed well as a result. Unfortunately, the higher oil prices are expected to have a higher impact on U.S. retail energy prices. Concerning fixed income, the Bloomberg U.S. Aggregate Bond index was down 5.9% for the quarter. Fixed income presents a very hawkish environment from a monetary perspective, and continued rate hikes are expected going forward, with a possible 50-75 bps hike at the May meeting.
In terms of the BNY Diversifier Strategy, the BNY Natural Resources Fund was the biggest driver. It is only about 6% of the portfolio, but accounted for half of the portfolio’s alpha in the first quarter. The portfolio is slightly underweight bonds versus the Bloomberg U.S. Aggregate Bond index, with an overweight to more inflation sensitive equities. The global real estate allocation was trimmed in favor of the global natural resources fund. Floating rate debt was increased to a maximum overweight.
Michael Stillitano, CFA, J.P. Morgan Asset Management
This quarter has been a very challenging environment, especially for multi-asset investors. Coming into 2022, JPM expected a slowdown in the markets for several reasons. The first was that economic growth could not be sustainable at the rate it delivered in 2021, with U.S. real GDP growth of 5.5%. Further, earnings growth was well in excess of 20% last year. Second, policy was expected to get tighter. With inflation rising, it was very clear that after the first week of 2022, that the Fed was going to be much more hawkish. Lastly, geopolitical headwinds were on the radar. Not to say that the Russia-Ukraine conflict was by any means expected, but rumblings of flaring geopolitical risks at the end of 2021 were surfacing.
As the quarter transpired, investment changes were made. In general, JPM reduced equity exposure, primarily by selling developed international equities. In JPM’s view, Europe is at the forefront of the geopolitical tensions overseas, importing around 40% of its natural gas from Russia. With the growing talks of an embargo on Russian energy in Europe, they would essentially be “signing themselves up for a recession”. Therefore, the European year-over-year GDP forecast was reduced from 4.5% to 1% for 2022. In response, JPM has sold a significant amount of European equities and reallocated it to core bonds.
Within equities, JPM is allocating more towards U.S. equities. The probability of a recession in the U.S. is very low. Even with slowing growth, tighter policy, and the current geopolitical tensions, this is not expected to negatively translate enough into the U.S. economy. U.S. growth should remain relatively strong on the back of a strong U.S. consumer, especially with U.S. household balance sheets being the strongest they have been in years - for the first time in 30 years, the U.S. consumer has more cash on their balance sheet than debt. While inflation may remain high, it is starting to roll over and, if JPM’s prediction of 4% year-over-year core CPI materializes for 2022, it is possible that the Fed would not need to move as aggressively. In conclusion, JPM has a modest underweight to duration, is neutral on equities with a preference on U.S. equities over foreign, and believes credit looks a lot more attractive than it did at the start of 2022.
Capital Group | American Funds
Stanley Moy, CFA, CAIA, Multi-Asset Investment Product Manager
The American Funds Growth Strategy was down for the quarter and trailed its benchmark. Growth as a style was generally out of favor, but there were some particularly poor stock selections that accounted for the underperformance. Materials did better, along with some contributions from Canadian Natural Resources and EOG Resources, as energy was up sharply during the quarter. The main detractors were allocations within information technology and communication services sectors. The managers are confident, however, that this portfolio is positioned well going forward.
The American Funds Conservative Income portfolio outperformed its benchmark for the quarter, with lower volatility and a higher yield. The underlying fixed income funds continued to navigate well through this tough environment, mitigating some of the general pain in the markets. Also, some exposure to TIPS was helpful.
Looking ahead, financials have potential across several industries including banks, capital markets, and diversified financial services. Rising rates should be generally good for financials, but they must weigh this against any drop-off in their respective mortgage businesses. Activity within M&A is expected to be high this year, mainly because companies across sectors continue to become more efficient and grow.
Kyan Nafissi, CFA, Vice President, Investment Director
Fidelity’s Equity Sector Business Cycle model is a quantitative model, underpinned by a business cycle signal. Fidelity’s view is that we are still in mid-cycle, but the mid-cycle is maturing. On a positive side, the reopening after COVID has produced strong wealth effects with a dramatic rise in consumer net worth, and a very strong housing market with tight inventory. Downside risks include the potential for policy error. If the Fed removes stimulus too early it could slowdown growth too much, and if they keep rates low for too long, they could challenge their own credibility, resulting in possible rising inflation expectations. With the slight uptick in late-cycle probabilities, along with declining growth and earnings growth expectations in the economy, some changes to the portfolio were made. In December, the portfolio transitioned from a mid-cycle portfolio with a tech overweight to a more late-cycle portfolio. In January, Fidelity became even more defensive.
Going forward, the portfolio has a mix of mid and late-cycle positionings. There is an overweight to industrials, which does well when the economy is expanding. Further notable positions include being overweight energy, materials, and healthcare, while being underweight information technology and consumer discretionary.
Janus Henderson Investors
Matt Peron, Director of Research, Portfolio Manager
Janus Henderson came into the year cautious on equities and credit markets, to some extent, knowing that the transition from early-cycle to mid-cycle can be very turbulent, especially when coming into a late-cycle as dramatic as this. A bumpy transition was expected with the concern that rates were far too low given where inflation and growth was. In some respects, the markets priced in expected rate hikes in stride. That said, there were offsetting issues presented with the new Omicron wave and the geopolitical tensions.
Going forward, Janus remains pro-risk, but to a lesser extent. They have reduced their short duration exposure and allocated it into more defensive equities, as they do not believe we are out the woods quite yet with respect to more volatility. However, Janus is more optimistic that most of this instability will be behind us as we enter into the second half and fourth quarter of 2022.
Meeder Investment Management
Joe Bell, CFA, CMT, CFP® (Co-Chief Investment Officer)
Bob Meeder (President and CEO)
Meeder started the year relatively defensive, with a 66% equity allocation and a 34% defensive cash position within the Tactical Allocation Strategy. This cautious approach stemmed from valuations being somewhat stretched over the past few years in U.S. equities. The fact that interest rates and economic growth have been muted over the past few years have somewhat warranted these high valuations. This has started to change over the past few months, with rates not only starting to rise higher, but expecting to rise even further, with a possible rate hike of 50 bps at the May meeting. There was a lot of weakness under the surface when looking at the health of the market at the start of the year. The S&P 500 was up about 20% from March of last year to the start of 2022, while Russell 2000 small cap stocks were down about 5%. They started to see weakness from small and mid caps trickle over to large caps at the start of the year, followed by increased volatility. Meeder remains very cautious and believes gains in 2022 are going to be harder to come by than the previous year. On the stock selection side, Meeder remains overweight healthcare and energy, and slightly overweight financials, while remaining underweight international.
Disclosure: The information provided herein is the opinion of The Pacific Financial Group (“TPFG”), a registered investment adviser, and may change without notice at the discretion of TPFG. Market Data is as of the time period noted and TPFG makes no warranties as to the accuracy of the information or any representations made or implied at any time given. The information should not be construed or interpreted as an offer or solicitation to purchase or sell a financial instrument or service. The information is for informational purposes only and should not be relied on or deemed the provision of tax, legal, accounting, or investment advice. Past performance is not a guarantee of future results. All investments contain risks to include the total loss of invested principal. Diversification does not protect against the risk of loss. There are no affiliations between TPFG and any company mentioned herein. Commentary provided by an unaffiliated company are the express opinion of the third party author. All information may be changed without notice. Capital Group® | American Funds® are registered marks of The Capital Group Companies, Inc. BlackRock® is a registered mark of BlackRock, Inc. MFS is a registered mark of MFS Investment Management. JPMorgan is a proprietary mark of JPMorgan Chase & Co. Fidelity Institutional AM® and the Fidelity Investments logo are registered service marks of FMR LLC. PIMCO is a proprietary mark of Pacific Investment Management Company LLC. BNY Mellon is a proprietary mark of The Bank of New York Mellon Corporation. Meeder is a proprietary mark of Meeder Investment Management. Janus Henderson Investors is a proprietary mark of Janus Henderson Group PLC. Counterpoint is a proprietary mark of Counterpoint Asset Management, LLC. In each instance, the mark is used with permission. No representation is made by The Capital Group Companies, Inc., BlackRock Inc., MFS Investment Management, JPMorgan Chase & Co., Fidelity Institutional Wealth Adviser, LLC (“FIWA”), Pacific Investment Management Company LLC, The Bank of New York Mellon Corporation, or Meeder Investment Management, or by anyone affiliated with such entities, regarding the advisability of investing in any investment product offered by Pacific Financial Group.