When describing our investment process to new or prospective clients, we emphasize that we work very hard to control those variables that we can – at least partially – control: expenses, tax efficiency, and managing volatility. Unfortunately, there are many things we cannot control like market performance, geopolitical events, and monetary policy. Often, it can feel as if these “uncontrollables” outweigh the importance of controlling what we can. In practice though, periods like we are in now are especially important to stay focused on our process.
As of October 21st, the S&P 500 was down over 22% this year and the Bloomberg US Aggregate Bond Index is down nearly 18%. If you are a balanced investor, 50% in stocks and 50% in bonds, you would expect to be down about 20%. The good news is that we are not down 20% in our Moderate model, we are down less than 13% (We manage 3 models: Aggressive (YTD -13.8%), Moderate (YTD -12.4%) & Conservative (YTD -9.9%)). We understand that being down 13% does NOT feel like good news but let us explain why it matters. Here is a simple table illustrating how much a portfolio must rebound to recoup various levels of decline:
Investment % decline value % recovery to get back to whole
$100 10% $90 11%
$100 20% $80 25%
$100 33% 67% 50%
$100 50% $50 100%
Recovering 11% to overcome a 10% decline isn’t a tremendous hurdle. In thirteen of the last 20 years the S&P 500 has returned greater than that. Returning 25% is tougher, although it has happened four times in the past 20 years. Up 50%, zero times in the past 20 years. The point being the relative outperformance we have seen in our portfolios compared to benchmarks, have significant positive implications for future account values.
How bad has it been?
Most experienced investors understand and accept that the stock market can be down 20+% each year. Since 1980, two calendar years have seen a 20% decline – 2008 & 2002. If 2022 were to end today, this would be the 2nd worst year in the last 42 years. As difficult as the stock market has been, the bond market has been historically awful! According to Bespoke research, the aggregate bond market performance year-to-date through 9/30 was -14.6%. Since 1949 the previous worst performing bond market was down -4.7%....in other words, this year has seen the worst bond performance we have ever seen by a magnitude of 3X!! There has truly been no place to hide.
Despite the challenging markets, we have continued to apply our process across portfolio’s. In our Moderate model, equity weighting began the year at 67% and we are now down to 40%, most of that reduction occurred in February. We owned commodities throughout ’21 and for the majority of ’22 as they offered a good hedge against inflation. As the Federal Reserve began its fight against inflation, the risks between inflation and a slowing economy became more balanced and we took profits in commodities. Our process has led us to be very overweight in short-term bonds (1–3-year US Treasuries primarily) and cash - together amounting to nearly 40% of portfolio’s in extremely safe and stable investments. In equities, we have a meaningful overweight in large cap value stocks. Historically, the lower valuations and consistent dividends have helped this area hold up better than growth stocks in difficult markets.
Better or worse?
We follow the work of Richard Bernstein Advisors very closely and respect the firm’s long-term, big picture approach. Bernstein often says the market cares much more about “better or worse” than it does about “good or bad.” Take inflation as an example. I think most of us would say that core inflation running at 8.2% (US Bureau of Labor Statistics) is “bad.” When you look at 3-month averages though, you can see inflation is actually getting “better”: Q4’21 avg 0.73; Q1’22 avg 0.87; Q2’22 0.87; Q3’22 0.17%. Many of the highest monthly inflation reports are due to come off the annualized number in coming months.
Valuations are clearly getting better as earnings growth - while slowing - is still positive but stock prices have come down significantly. The forward PE ratio of the market is now 17x vs 25.8x last September. The big question here is will corporate earnings continue to hold up or will a slowing economy cause a significant earnings recession?
Investor sentiment, a contrarian indicator (a more bearish reading is a positive for the market), has been at extremely low levels most of the year as Bearish Sentiment, expectations that stock prices will fall over the next 6 months, is at 55.9%; nearly double the long-term average of 30.5%. Historically, the S&P 500 index has realized above average returns in the 6- & 12-month periods following similar high bearish sentiment (American Association of Individual Investors).
What’s next?
News flash, we have no idea! What we do know, however, is that our process has added significant performance (albeit, just less bad) against benchmarks. While no process is perfect, reducing portfolio drawdowns in difficult markets allows investors a much shorter climb back than a portfolio that experienced more significant drawdowns. This is what we strive to achieve.
We always welcome conversations where we can dig into the “why?” of what we are doing in portfolios. If you have questions, concerns or just want to talk about things, always feel free to call. We value and appreciate our relationship with you tremendously. Please let us know how we can help you.
Best Wishes,
Brett, Steve, Becky, Mike, & Debbie
This Announcement is provided by the Davis Altman Group on behalf of TRUE Private Wealth Advisors, LLC (“TPWA”), an SEC-registered investment adviser. The Davis Altman Group is the business name of a limited liability company owned by certain investment adviser representatives of TPWA, and which owns a membership interest in TPWA. Investment advisory services provided through TPWA. Securities offered through Purshe Kaplan Sterling Investments, member FINRA/SIPC, headquartered at 80 State Street, Albany, NY 12207. Purshe Kaplan Sterling Investments and TPWA are not affiliated companies. Fidelity Investments, which serves as custodian for many TPWA client accounts, is an independent company, unaffiliated with the Davis Altman Group, TPWA, or Purshe Kaplan Sterling Investments. Not insured by any state or federal agency. Neither TPWA nor Davis Altman Group guarantees, warrants, or agrees to accept any liability for any errors or omissions in this Announcement or any other communication (including any attachment) sent by email transmission, including without limitation, the failure of any email transmission (including any attachment) to be secure, free from viruses or other malware, free from errors or corrupted data, or free from loss, destruction, or late delivery.
