News & Views

Set Your Expectations: Dynamics of and Rebounds from Bear Markets

A bear market for the benchmark S&P 500 came out of hibernation Monday (6/13) as the index breached the 20% loss level from its previous high January 3, 2022. Bear market conditions did not hibernate as long as usual this go around as only 22 months passed since the March 23, 2020, end of the prior, COVID-induced bear market, which only lasted a little longer than a month. This marked the shortest span between two bear markets since at least the Great Depression, as shown in the following table from S&P.

On average bear markets last a little more than 18 months. The most recent edition of bear market-dom defines the 15^th iteration since 1929 of the unwelcomed phenomenon. This translates to the S&P 500 spending a little less than 25% of the time since the start of the Great Depression under bear market conditions, including more often than not from 3Q29 through 2Q49.

Looking for a little less dark-and-gloomy: the 12 post-1957 bear markets lasted on average a little over 12 months. The average negative return for these bear markets was 33%. Overall since 1957 the S&P 500 spent about 20% of the time trading through bear territory.

The following table, also from S&P, proves even sunshinier. It offers data on the timing and magnitude of recoveries from bear market conditions since 1957. This table excludes the 1990 bear market as that one only touched the 20%-decline condition. For the resulting 11 bear market recovery observations, the S&P 500 averaged 1% a week later, 3% after a month, 4% 6 months later, 15% after a year, and 30% 3 years later.

Only the Tech Wreck of 2001 remained negative 3 years after the onset of bear market conditions, albeit via a relatively very shallow, single-digit-loss ongoing drawdown. Probably more important for sanity at this point in the cycle, however, is the fact that for 77% of the time periods in the table above, or 49 of its 66 observations, the S&P 500 closed above its bear market level. The whipsaw of 2008, though, which saw mild positivity for a month after the arrival of the bear only to lose more than 25% over the next 6 months, offers a painful dose of potential reality. If solutions fail to eliminate the root driver of the negative condition causing the bear market, investors will continue to sell equities.

Inflation, Ugh.

Too much money chasing too few goods and services: inflation. Inflation is not a difficult concept to describe or to understand. Little Jill has an extra stick of gum that Jack would like to buy for a nickel. All looks good for Jack to enjoy a stick of gum until Billy, who also would like a stick of gum, arrives with a nickel and a penny he found on his walk over. Jill, ever the rational seller, agrees to sell Billy her last stick of gum for $0.06. Voilà, the Jill-Jack-Billy market for gum just experienced 20% price inflation.

The gum market balanced with just Jill and Jack involved, but Billy’s $0.06 – more money – unbalanced the market. If Jill’s mom happened to show up with another stick of gum – more supply – the market balances, providing both Jack and Billy still want a piece of gum. This balancing function that Jill’s mom provides in our very, very simple example represents what the US economy now sorely lacks, a balancing function.

This morning’s 8.6% annual increase in the U.S. Consumer Price Index (CPI) surprised – again – to the upside as compared to the consensus expectation for an 8.3% increase in year-over-year prices. The above figure from The New York Times offers a breakdown by major product and service category of the drivers of this 8.6% indexed figure. Unless you pulled a Rip Van Winkle and fell asleep for the past year, I’m sure you’re quite aware that gas prices at the pump, soft drink prices at the grocery, and clothing prices at the mall, all are higher along with the prices for just about everything else.

For any number of reasons, ranging from:

• COVID shutdowns that limited production and transportation of goods and services,
• Ukraine – Russia war that disrupted trade flows,
• Insufficient workers to increase production of stuff and to serve consumers, and
• Ineffectual government policies that further these economic imbalances,

the world cannot supply sufficient goods and services to satisfy demand given the magnitude of money available to purchase goods and services. This imbalance places outsized pressure on the US Federal Reserve, unfortunately, to reduce the amount of money available to purchase goods and services. Alternatively, consumers could choose to scale back their consumption of stuff. They could opt to save some of this excess money they currently chose to spend. Alas, it’s the job of government to do for the people what they cannot do for themselves and reduce consumption by decreasing the amount of money available to buy stuff. Enter all of the discussions about the Fed increasing interest rates and engaging in quantitative tightening, or reducing the amount of money flowing through the economy.

This is where it gets complicated, though. Everyone freaks out about the Fed raising rates too much and pulling too much money out of the economy. Exacerbating these fears concerning the Fed’s actions, the potential for consumers to come to their senses and start saving some of their money and not buying so much stuff. Doubling down on these problems:  provider of goods and services solve their issues and oversupply the market and have to fire some workers. What was a robust economy growing at an attractive rate with historically low unemployment goes off the rails and into a ditch. Ugh.

All of a sudden one begins to see why even the greatest economics PhDs screw this up. Solving inflation requires balancing an equation but with far, far too many variables of unknown interdependencies. In order to help these struggling, anxiety-riddled PhDs balance this inflation equation, a rational consumer – the main character of every economics textbook – might choose to walk more, drive less, go on a diet, turn off the A/C, open a window, and save some dough. Or not…

Dollar-Cost Averaging: Benefit from Volatility

Dollar-cost averaging provides investors a tool with which they may use volatility to their advantage. Properly employed, the process offers benefits for buyers and sellers of traded assets ranging from stocks to bonds, cryptocurrencies, sports bets, and collectibles. Trading costs, both in terms of effort and commissions, mark drawbacks to the method.

In purchasing or selling assets at various points in time and at various prices – the procedure described by dollar-cost averaging – market participants with longer term perspectives may manage short-term market dynamics. Consider the following example:

• An individual investor wishes to purchase 1,000 shares of stock in a biotech company, we’ll call it Hypothetical Biovations (HYPO for short),
• Hypo will announce its quarterly earnings before the market opens in three days, and
• Management may (or may not) provide positive (or negative) results from a clinical trial for one of Hypo’s new drugs on their earnings conference call at 10:30 AM ET, an hour after trading opens for Hypo shares.

Our HYPO investor incurs several risk-points in pursuing their biotech investment, such as:

1. Overall stock market volatility (beta) that may drive changes in HYPO share price irrespective of any specific company phenomena,
2. Aversion or affinity within the investment community for the Healthcare sector or Biotech subsector of which HYPO is a member,
3. Analysts’ analysis and opinions on the probability that HYPO will miss, meet, or exceed their expectations for the company’s quarterly results and/or future performance, and
4. Views within the HYPO investment community on the potential success, or lack thereof, of the company’s new drug.

Utilizing dollar-cost averaging to potentially manage through this litany of risks – the other side of which are opportunities – might involve our HYPO investor buying a one-quarter (250 shares) position prior to any company-specific events. For the sake of adding specificity to our example, let us assume HYPO shares trade for $10 each upon our investor initiating their position for an outlay of $2,500.

Subsequent to this initial purchase, one of HYPO’s sell-side analysts decides to downgrade HYPO shares from Buy to Neutral a day prior to the company announcing quarterly earnings. In response HYPO shares trade 10% lower to $9 per share. The investor picks up another 250 shares at this $9 figure, resulting in a weighted-average price of $9.50.

Exacerbating this downside momentum, a day later HYPO just meets expectations for its quarterly financial performance. Also, management chooses not to mention any new drug developments in its earnings press release: shares give up another 10% and trade to $8.10 after the markets open. Our investor – eyes on the long-term prizes they expect HYPO to offer – picks up another 250 shares at $8.10 per share, bringing their average cost to $9.275 per share.

An hour later in management’s commentary concerning future prospects for HYPO, they mention the positive clinical trial results that our investor thought might materialize on the call. Shares on this news shoot 10% higher than their $8.10 low to $8.91 per share. Our investor rounds out their 1,000-share position at this $8.91 per share price, bringing their weighted average price per HYPO share to just over $9.00 (see table below).

Hypothetical Investment in Hypothetical Biovations (HYPO)

We’ll provide a positive ending to our HYPO example. Sell-side analysts’ upside revisions that incorporate their more robust expectations for HYPO’s new drug cascade through the market. As a result HYPO’s share price moves through the $10 level, leaving our investor with a tidy $1,000 profit vis-à-vis their $9.00 dollar-cost average-driven average weighted price as well as the $10 figure at which they initiated their position

Of equal potential value for investors considering employing dollar-cost averaging in their efforts, the method works for exiting positions as well. To illustrate this simply replace the “buy” related verbs in the above paragraph with “sell” verbiage: the figures remain the same. While our example employs a relatively short time frame of several days, driven by a specific event, the principle defining the prospective value of dollar-cost averaging in to or out of tradeable assets typically works over a wide range of timeframes and market conditions.

Why Downward Moves in Equity Markets Feel So Painful

Adages, aphorisms, sayings, and such gain popularity because they so often prove to be correct. A handful of my favorites:

• The market can remain irrational longer than you can remain liquid.
• This time it’s different.
• Bulls make money. Bears make money. Pigs get slaughtered.
• The market is a discounting mechanism.

With this missive I’ll focus on the last maxim: the stock market as a discounting mechanism. Equity markets in 2022 increasingly discount an impending recession. The drivers of this phenomenon range from supply shortages and logistical challenges driving outsized inflation to war, pollical strife and gridlock. Regardless of which of these factors most influences asset prices, their cumulative impact on sentiment probably exacts the most meaningful effect. The fact that negative sentiment commences to outpace fundamental factors really should not surprise investors, but it does so…repeatedly.

The following graphic from Morningstar details the degree to which the precipitous equity market downturn of 2007 to 2009 (black box) substantially outpaced the fundamentals of the S&P 500 (green box) over that period of time. While S&P 500 fundamentals deteriorated 17% over this period, the total return for the Index declined 58%!

Recent research from Credit Suisse First Boston detailed a similar relationship between equity market activity to start 2022 and fundamentals (see following table). Whereas the median S&P 500 stock price dropped 24.4% since its peak level, S&P 500 earnings expectations increased 3.3%. The breadth of this expected earnings improvement remained broad as all eleven sectors posted improvements in their earnings prospects.

Obviously, the market discounts not earnings growth, but rather significant and painful earnings contraction. The massive money-making opportunity here exists in determining which discounting component is wrong: prices or earnings forecasts. My guess is that it will prove to be a little of both. As such, I prefer to err on the side of picking companies with more easily trackable earnings (Energy and Materials, for instance) and with large and established bases of operations (like Microsoft, ServiceNow, Cigna, and Humana).

It’s Not to Early to Start Thinking about a Midyear Financial Review

The Although temperatures in many parts of the US recently felt summer-like, several weeks of spring remain. Consumer price inflation and asset market volatilities probably make those temps feel even hotter. These phenomena may have resulted in relatively large changes in incomes, expenses, as well as the sources of these incomes and expenses. As such, for many of us the next few weeks before summer and, hopefully, vacations arrive, may prove fruitful for midyear financial plan reviews.

I recommend commencing a review by creating a checklist with timeline-delineated items:

• Near-term
• Medium-term
• Long-term

Typically, breaking jobs down into smaller tasks aids in execution. Additionally, using a timeline, with the most important items near the top, offers a risk-based manner to address items just in case the process gets pushed to the back-burner by more pressing items.

Near-Term Financial Review Items:

Near-term items for review fall into three main categories: 1) Income, 2) Expense, and 3) Benefits. Checking income for most of us should be a relatively quick exercise involving cursory reviews of a recent paystub and the bank account into which your employer regularly deposits your earnings.  Providing those figures meet (or hopefully exceed) expectations, the review could progress on to evaluating expenses. If a budget exists, which I recommend, reconciliation of checking, savings, and investment account balances with mid-year expectations offers a potential roadmap for identifying “gaps” in the income-expense relationship. Potential next steps could involve evaluating credit card statements and/or bank account withdrawals for the sources of any gaps. While that paystub remains easily accessible, do a quick check-up on Flexible Savings and Health Savings Account balances, along with a review of tax withholding. This is a fine time to schedule any planned doctors’ or dentist’s visits yet to be booked as well.

A couple other items may be added to this Near-Term List as well. Given the prevalence of identity theft, a periodic credit report review is a financial review best practice. Thinking about charitable giving mid-year also may prove useful for you as well as for the recipients of your gifts.

Medium-Term Financial Review Items:

Quick glances at retirement, education, and emergency fund contributions and balances represent medium-term items for a productive financial review. Assure that deductions flow in the proper amounts to the proper accounts. Given the large moves thus far in 2022 for many assets classes, it likely will prove beneficial for many people to spend some time on their asset allocation plans. Reconcile that current account holdings compare well with target weightings by asset class and/or sector. A rule of thumb for emergency funds are that they cover three months of projected expenses: with inflation running hot maybe a little more needs to be held in reserve here. Finally, take looks at outstanding debt balances: mortgages, student loans, etc. to gauge payments made thus far in 2022 match with expected balances.

Long-Term Financial Review Items:

Confirmation that estate plans and wills reside where they are supposed to be come near the top of the Long-Term List. Similarly, assuring that safe deposit box keys, passwords, and similar items and information are where they are supposed to be remains a good idea. Reviewing beneficiary information for retirement and other financial accounts while documents are front-of-mind and accessible could save a great deal of time and frustration in the future.

“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.

A Yesteryear Name Focusing on Tomorrow: Old-School Tech

The 2022 wreck in Tech stocks, which declined ~19.8% as measured by the price change in Vanguard’s IT Index Fund (VGT), took a short reprieve yesterday (4/25/22). More share price pummeling commenced today (4/26/22), however, as one can see in the Yahoo! Finance chart below.

Much of this Tech stock price downdraft came amidst generally robust earnings and cash flow. In fact, the number of 4- and 5-star rated Tech stocks in Morningstar’s coverage universe, as reflected in the graph to the right, more than quadrupled from less than 20 for 1Q21 to almost 70 mid-week last week. Notably, that was before the acceleration of the price rout Friday, 4/22/22, and earlier this morning! Not known for being aggressive with its ratings and future estimates, such an increase in Morningstar’s highly rated Tech stocks obviously grabbed attention.

As I reviewed early 1Q22 earnings performances on Tech stock in particular also warranted interest: Corning (GLW). We neither advocate for buying to selling GLW shares, although we include them in our Conservative and Moderate Model Portfolios. Rather, we thought investors might be interested in a number of things about GLW. First, many may be surprised that the old-school glassmaker counts as a Tech stock. For 170 years, though, Corning’s been at the forefront of materials and glass technology counting cathode ray tubes for televisions, Gorilla Glass for iPhones, and fiber optics, among its inventions and improvements. Folks that buy and sell stocks irrespective of their industry classifications don’t care how S&P or whoever else categorizes companies by sector but doing so proves crucial in building and maintaining diversified portfolios.

Second, by virtue of its creative applications of materials and glass technologies GLW built a very diverse set of end markets that not only benefits its financial performance and its investors, but also that yields solid observations on the state of these end markets. These observations, in our experience, often prove valuable for insights and conclusions for investments in Tech and other sectors. In its latest release of financial and operating results for 1Q22, for instance, GLW noted a 28% year-over-year increase in Optical Communications revenue. No guarantees here, but this significant increase could bode well for Telecom Equipment providers (Cisco, Arista Networks), cell-tower companies (American Tower, Crown-Castle SBA Communications), and/or enterprise cloud service providers (Microsoft, Amazon, Alphabet). Display Technologies also posted a double-digit, 11%, increase in sales for 1Q22 vs. 1Q21 with management specifically calling out positive exposure to Samsung’s Galaxy S22 Series smartphone. Maybe this indicates a little market share erosion for Apple: no way to tell for certain but it bears watching. Another interesting point on the diversity of GLW’s product portfolio that contributed to upside business results: Corning’s Life Sciences segment produced the vials from which 5.5 billion doses of COVID-19 vaccines were delivered.

Now, at this point, a discriminating investor might ask: “As the world hopefully won’t need 5.5 billion doses of any vaccines in the near future, won’t declines in this business hurt GLW’s future performance?” In response we anticipate that GLW’s management would reply that it expects the company’s Automotive segment, which saw revenue drop 9% from 1Q21 due to semiconductor availability and supply-chain issues, to more than make up for any loss in its Life Sciences segment. Just our guess, though. Anyway, here’s a breakdown of GLW’s 1Q22 sales by segment with prior period comparisons.

Going Contrarian for Conservative Investors

A little while back I decided it time to go contrarian for Solyco Wealth’s Conservative Model Portfolio. I dropped its Cash allocation to 10% from 15%, added that 5% to its Equity weighting, and reallocated its long-term domestic bond exposure to floating rate senior loans. With the already low-yielding iShares 20+ Year Treasury Bond ETF (TLT) down a double-digit percentage to start the year amidst the Fed just commencing its interest rate hiking cycle in response to escalating inflation, it felt right go at least a little bit on the offensive.

For investors with a risk-averse, conservative style I see three factors on the horizon potentially causing them disproportionate harm:

1. Exiting risk assets altogether and going to cash,
2. Holding this massive cash balance as inflation significantly erodes the future purchasing power of the cash, and
3. Failing to re-enter the stock and bond markets until they recover and, thereby, missing the most attractive opportunities to recoup their early 2022 losses.

I addressed Point #1 by deploying more cash and not falling victim to a perceived “flight to safety.” High quality equities with strong balance sheets and pricing power define excellent opportunities foe conservative investors to benefit from inflationary environments. I don’t think upping Solyco Wealth’s Equity allocation to 25% from 20% places the portfolio at an outsized level of risk. In fact, thus far in 2022 the Conservative Model Portfolio’s Equity allocation is only down 5.2%, 230 basis points ahead of the S&P 500 and 330 basis points ahead of the 8.5% loss for the supposed-to-be-conservative iShares Core US Aggregate Bond ETF (AGG).  As always, however, past performance is no guarantee of future results…

Not only did I choose to put more cash to work for the Conservative Model Portfolio in my efforts to battle the deleterious impacts of rising rates on bond prices and purchasing power but also, I rejiggered the fixed income allocation for the portfolio to take advantage of highly likely future interest rate increases. This action firmly addresses, in my mind, both points #1, and #2 above. In anticipation of higher interest rates, I initiated the Model Portfolio on 9/8/21 holding 5% allocations to private capital providers Ares Capital Corp. (ARCC) and Hercules Capital (HTGC), which trade like equities but manage multi-billion dollar portfolios of primarily adjustable rate loans to smaller private companies. Year-to-date ARCC and HTGC generated total returns of +5.4% and +15.1%, respectively, including dividend yields of 7.9% and 10.4%. In the current environment of low loan default rates, these companies should enjoy relatively smooth operations. As defaults rise – an all-to-frequent response to rising rates and marginalizing economic growth – the attraction of companies like ARCC and HTGC drops dramatically, however. We also pivoted out of the long-end of yield markets, selling the Model Portfolio’ 5.1% holding in TLT in exchange for a 5% position in the SPDR Blackrock Senior Loan ETF (SRLN), which offers floating-rate loan exposure to companies that, generally, maintain higher credit profiles than those services by ARCC or HTGC. Thus far in 2022, SRLN is down 0.4%.

Two primary risks I incurred in taking the above-detailed actions several days ago: 1) I miss – at some indeterminate point in the future – outperformance from TLT equal to or greater than the 11.5% loss the portfolio took while holding it and 2) The 5% increased allocation to Equities and the swap to SRLN fail to compensate for the missed opportunity presented by not retaining TLT through its recovery. Notably, the Conservative Model Portfolio, however, already, avoided an additional 700 basis points of losses from TLT while gaining 70 basis points of gains from holding SRLN. Better late than never…

Model Portfolios Outdistance Benchmarks in 1Q22 and Since Inception

As exhibited in the following data table, Solyco Wealth’s four model portfolios, which offer investors solutions across the risk spectrum, outperformed their benchmarks after fees in 1Q22 and since inception (9/8/2021). Performance for the Moderate and Moderately Aggressive models exceeded that of the S&P 500 since inception while performances for each of the for portfolios after fees exceeded that of the S&P 500 since the first of the year.

Solyco Wealth Model Portfolio Performance, After Fees, Since Inception and 1Q22

Past Performance Is Not Indicative of Future Results

Solyco Wealth used Morningstar Direct to calculate the above returns for since inception and 6-mpnth period from September 8, 2021, through March 31, 2022.
The above table reflects a 1% annual management fee, or 0.56% since exception and 0.24% year-to-date through 3/31/2022.
Actual client investment performance likely will differ from respective model portfolio performance due to several factors including: 1) Timing of securities purchases and sales, 2) Dividend reinvestment choices, 3) Securities held outside the model portfolio, 4) Weighting differentials for certain securities relating to whole versus partial share accounting, 5) Timing and pricing of rebalancing actions, and other minor factors.
Conservative benchmark = total returns for 10.0% Russell 3000 Index, 65.0% Bloomberg US Aggregate Bond Index, and 10.0% MSCI World ex-US Index and 15.0% cash allocations.
Moderate benchmark = total returns for 22.5% Russell 3000 Index, 45.0% Bloomberg US Aggregate Bond Index, and 22.5% MSCI World ex-US Index, and 10.0% cash allocations.
Moderately Aggressive benchmark = total returns for 32.5% Russell 3000 Index, 25.0% Bloomberg US Aggregate Bond Index, and 32.5% MSCI World ex-US Index, and 10.0% cash allocations.
Aggregate benchmark = total returns for 45% Russell 3000 Index, 5.0% Bloomberg US Aggregate Bond Index, 45% MSCI World ex-US Index, and 5.0% cash allocations.

Relatively strong equity performances benefited Solyco Wealth’s model portfolios across all four strategies with stock picks in the Moderately Aggressive and Moderate models performing particularly well. Fixed income allocations, generally, remained challenged in both the since inception and the 1Q22 time periods.

In the Aggressive model allocations to Shopify, YETI, and Viatris hampered performance while positive contributions from Earthstone, Schlumberger, Sociedad de Quimica y Minera, and Vertex Pharma, offset those headwinds. In the Moderately Aggressive portfolio positive contributions from Schlumberger, Pioneer Natural Resources, Sociedad de Quimica y Minera, and Vertex Pharma, easily made up for the downside moves from Nike, Comcast, Autodesk, and American Tower. Similarly, the Moderate model experienced negative contributions from its holdings in Comcast, Taiwan Semi, and Blackrock, that Schlumberger, Pioneer Natural and Lockheed Martin more than made up for. Unfortunately, the 20% overall allocation to equities in the Conservative model proved insufficient to offset the fixed income headwinds presented from its longer duration and international debt allocations despite outsized upside benefits from Lockheed Martin, Schlumberger, and TotalEnergy.

Volatility probably will remain elevated as compared to 4Q21 until the Ukraine-Russia situation concludes. No guesses as to when that happens, however… Barring a significant escalation of the conflict, we anticipate asset market volatility not approaching the levels experienced in late February and early March, though. The fact that the Fed commenced their cycle of interest rate increases and that the rate of increase of consumer expenditures appeared to slow, if only modestly, late in 1Q22, lend some confidence to this expectation for reduced volatility.

For the time being remaining overweight Energy and Health Care equities appears to be a good idea. Potentially adding to Industrials stocks if inflation actually slows, supply chains loosen up, and infrastructure spending rotates up the Federal agenda presents a possibility for additional capital deployment heading into Summer 2022 as well. Increased fixed income and cash holdings appear to only be solid investing ideas if the Ukraine situation re-escalates or another crisis arises, which we decidedly hope is not the case.

As always, please give us a call if you’d like some help defining and meeting your financial and investing goals:  (713) 444-3560.

Allocating to International Markets Nowadays

Investing best practices continue to advocate for diversifying US markets exposures with allocations to international markets. With similar headwinds negatively impacting international markets to the same, or in many instances worse, degree as the domestic asset markets, many investors likely question the near- to medium-term value of this diversification. Doubling down on this investor skepticism for international investing: the fact that foreign markets, in general, only offered diversification by lagging US asset markets over much of the past 10 years (chart below).

Since its early-September 2021 inception, Solyco Wealth underweighted international exposures for both its equities and fixed income allocations across its four model portfolios. Certainly numerous specific situations and equities across non-US markets offered abundant opportunities to reap significantly positive returns uncorrelated with domestic investments: MercadoLibre (MELI) in 2020, PetroBras (PBR) 2006 to mid-2008, AliBaba (BABA) 2017 to 3Q21, and many more. However, the relentless encroachment of domestically listed, US companies on international markets in the age of globalization also must figure into investors’ analysis as well, in our opinion.

If a US-listed company, with readily available financial data, corporate presentations, and management commentaries – not to mention shares that trade on a widely recognized exchange during domestic working hours – offers similar end market exposure to a foreign-listed equity, the value of diversification, in our view, should be heavily scrutinized. We remain cognizant of the familiarity, or “home,” bias that this view reflects. Similarly, we posit that firms and individuals solely focused on international investing remain susceptible to a propensity to “talk their book,” exhibiting similar behavioral biases. To combat these behavioral hurdles, Solyco Wealth executes a 180-degree lookback as part of its evaluation process of domestic and international equities. This process enabled us to discover and add to our model portfolios what we evaluate to be outstanding international operators like Sociedad de Quimica y Minera out of Chile, Taiwan Semiconductor, France’s TotalEnergies, and the Swiss engineering and industrial concern ABB, among others.

While we have yet to “pull the trigger” with respect to adding China-specific exposure to our portfolios due to government policies and resulting increased regulatory scrutiny, we continue to closely monitor select Chinese equities. The downdraft in equities prices in China resulted in a very attractive valuation proposition, as shown in the chart to the right. However, we have yet to gain sufficient comfort to deploy capital.

Similarly, with several countries’ central banks ahead of the Fed in raising interest rates, we continue to watch emerging market debt, both in local currency and in US dollar terms. Without a resolution on the Russia-Ukraine situation, however, we remain loath to accept these assets risk-reward ratios.

Looking forward a host of factors probably alter the international investing landscape: demographics, trade restrictions, geopolitical strife and wars, tax policies, etc. Just as with our current approach, however, we recommend that investors adopt: 1) a standard approach to generate investment options across a wide variety of markets, 2) a set framework with which to evaluate and rank these options, and 3) a policy for periodically evaluating these choices in the context of current market conditions, investing goals, and investment alternatives.