“Tell Me More About Inflation,” Said No One

The Raise your hand if your sick and tired of hearing about inflation. Yeah, me too. I raised my hand and I’m sitting in a room, by myself.

So, I’ll go a step further and illustrate how Solyco Wealth attempted to “harden” its investors’ portfolios to endure the pernicious effects of inflation. A handful of other phenomena the same amount of people want to hear more about that want to listen to more commentary on inflation complicate the situation: rising interest rates, global political turmoil, supply chain snafus. My 13- and 14-year-old daughters can now recite intelligent memes on these topics as their so ubiquitous as to be on TikTok, whatever that is.

Let me first say that I largely avoided trading client portfolios through the deepest downturns of early March and late April 2022. I’ll take the “win,” but most portfolios entered 2022 with sizeable cash balances. With 8%+ inflation chewing away at probable future purchasing power, however, holding cash to avoid volatility seemed like admitting defeat to a self-proclaimed stock picker such as myself. Solution, I drew down cash and leaned into these downturns by investing a decent amount of these cash balances. In fact, for the Conservative Model Portfolio I reduced the target cash balance 500 basis points to 10% from 15%.

I retain allocations to fixed income ranging from 5% in my Aggressive Model Portfolio to 65% in that aforementioned Conservative Model Portfolio. However, I started out with a much shorter duration than that of the Bloomberg Aggregate Bond Index against which I benchmark my portfolios and I shortened that duration even further. Hopefully recognizing the value of a benign environment for company defaults and for adjustable-rate securities, I allocated 10% of the less-risky portfolios to publicly-traded, private capital providers Ares Capital (ARCC) and Hercules Capital (HTGC). As compared to the approximately 14.3% and 12.7% respective losses for the iShares 20+ Year (TLT) and 5-10 Year (IGIB) ETFs, ARCC and HTGC, respectively, offered returns of +5.9% and -3.2% while offering dividend yields multiples of those offered by those bond ETFs. Furthermore, I swapped out of TLT altogether in favor of more flex-rate debt with a the SPDR Blackstone Senior Loan ETF (SRLN). I anticipate the trade-off for the expected better price performances and higher yields from ARCC, HTGC, and SRLN, among the other credit-driven investments in the portfolios, being an intensified necessity of monitoring default probabilities.

With respect to picking stocks to counter the impacts of inflation, the overweight to Energy with which we initiated Solyco Wealth’s model portfolios compensated investors well for the risks incurred. Unfortunately, the Ukraine-Russia war elevated these gains, but to the detriments for much of the balance of the portfolios. I also augmented these Energy-related gains by selling covered calls in the options market in order to manage and benefit from higher volatilities. As the outlook for employment remains robust and healthcare facilities re-opened with diminishing COVID cases, Solyco Wealth overweighted Healthcare. While that sector enjoys some pricing power, facilities operators, like Universal Health Services (UHS), which is an Aggressive Model Portfolio holding, got severely clipped by significantly higher contract labor costs: win some, lose some. Finally, we also recently moved to an overweight on Industrials, anticipating that certain subsectors like defense, energy equipment, and automation, would offer outperformance opportunities. While near-term performances largely fell in-line with those of the broader equity market, order rates for companies like ABB and Chart Industries (GTLS) achieved record levels. We remain underweight Consumer Staples, anticipating that raw materials costs will inordinately pressure margins. Names like Archer Daniels (ADM), Bunge (BG), and Kroger (KR) certainly offer appeal, though. Despite their run-up to start 2022, we also continue to avoid Utilities, which generally underperform in rising rate environments as a function of minimal pricing power and diminished relative attractiveness of their dividends. I retained our Tech holdings, which basically round-tripped their late 2021 gains with 2022 declines, as the generally were among the high-margin, high-earning components of the sector. Notably, Amazon (AMZ) and Shopify (SHOP), which sit on the cusp of the Technology and Consumer Discretionary sectors, certainly left marks from their price declines.