Jens Jensen

May 8, 2024

Incorporating Alternative Investments into Multi-Asset Class Portfolios

Jens Jensen

May 8, 2024

Historically, access to asset classes and investment strategies outside of stocks and bonds has been limited for many investors, with concerns such as high minimum investment requirements and a lack of liquidity acting as barriers to entry. Fortunately, financial innovation and the proliferation in exchange-traded funds (ETFs) over the past 20 years means that many strategies and asset classes that were either out of reach or off-limits are now widely available in a liquid, transparent and tax efficient wrapper. For example, commodities in the energy, agriculture, industrial metals, and precious metals spaces are all available via ETFs that own commodities futures. Hedge-fund style strategies such as global macro, managed futures, merger arbitrage, and long/short equity are available in liquid, low-cost ETFs. Leveraged and inverse ETFs are available. Defined outcome strategies that use derivatives contracts are available. ETF “fund-of-funds” that focus on private credit and private equity are available, as are managed futures strategies (CTA’s). Additionally, as of January this year, even bitcoin can now be owned via an ETF in most brokerage accounts.

The widespread availability and accessibility of these strategies and asset classes, commonly referred to as “alternatives,” gives investors additional tools with which to enhance and diversify balanced portfolios. The traditional stock-and-bond-only 60/40 model, we believe, is limiting. Stock-and-bond-only portfolios miss out on the strong return potential and diversification benefits that come with owning alternatives. We believe that a small, dedicated allocation to liquid alternatives should be considered foundational to a well-diversified portfolio. Our CST multi-asset class portfolios currently have a 2% strategic allocation to alternatives.

With that said, considering the diverse nature and goals of the assets and strategies that fall under the umbrella term “alternatives”, it is very important to be selective. Please read on for details about our favored alternatives in the current investment environment and their strategic allocation within our multi-asset class models.

1. Diversified Commodities

Commodities have low correlations to traditional asset classes and have historically acted as an excellent hedge against inflation. Commodities are “real assets” that react to changing supply and demand fundamentals in different ways than stocks and bonds. The supply and demand for commodities is affected by factors such as capex within commodity industries, geopolitics, and regulation/policy. While stock prices are primarily determined by discounting expected cash flows stretching far into the future, commodities must clear in the spot market, meaning that the price of commodities futures reflects short-term supply and demand dynamics.

As evidenced by the recent strong US Consumer Price Index (CPI) print of 3.3% YoY for Q1 2024, the fight against inflation is far from complete, especially given the current backdrop of above-trend growth and heightened geopolitical risk. As such, we believe that commodities’ intrinsic exposure to inflation provides purchasing power protection. We also see long-term prospects for commodities given the chronic undersupply in the market. A lack of investment in recent years combined with policy efforts to address climate change and re-shore supply chains are likely to be supportive for commodities as an asset class from a secular perspective.

Our preferred vehicle for commodity exposure is Invesco’s Optimum Yield Diversified Commodity ETF (ticker PDBC). This provides diversified exposure to a basket of commodities including approximately 58% energy commodities (such as crude oil, gasoline, heating oil and natural gas), 17% agricultural commodities, 14% base metals and 11% precious metals.

After waiting to see the price momentum move into an uptrend, we added a 1% allocation to PDBC in our multi-asset class models in mid-March.

2. Managed Futures

Managed futures managers, known as Commodity Trading Advisors (CTAs), develop sophisticated quantitative models and algorithms to analyze market data and identify trading opportunities. These models often incorporate factors such as price trends, volatility patterns, and market sentiment indicators to make trading decisions. Managed futures strategies have a strong track record of delivering positive alpha with very low correlations to equities.

We think that managed futures are an excellent diversifier of traditional market risks in today’s environment given their ability to follow trends, both positive and negative, which provides potential for positive absolute returns, even in a market downturn.

Our preferred investment vehicle for managed futures is Simply Managed Futures Strategy ETF (ticker CTA). It provides a systematic long/short managed futures strategy designed for absolute return and portfolio diversification. It employs four underlying systematic models including a price trend strategy, mean reversion strategy, carry strategy, and risk-off strategy. CTA does not hold equity futures, thus reducing its correlation to equity market beta. CTA holds a 0.5% allocation in our multi-asset class portfolios.

3. Digital Assets

In early January, the SEC approved the first spot bitcoin ETFs, giving investors the ability to hold bitcoin in traditional brokerage accounts for the first time. Bitcoin ETFs allow investors to side-step the complexities that come with buying crypto directly through crypto exchanges and owning crypto directly in crypto wallets. It marks a key moment in the maturity of the asset class and is encouraging mainstream adoption.

Bitcoin tends to polarize opinion. Crypto-bulls believe that Bitcoin is a groundbreaking technological innovation with the potential to disrupt traditional financial systems and revolutionize various industries. Additionally, bulls argue that Bitcoin provides a hedge against the devaluation of fiat currencies, particularly times when governments and central banks engage in expansionary policy. Bitcoin is often compared to gold in that it is a store of value that is not subject to government manipulation or inflationary pressures (the supply of Bitcoin is capped at 21 million coins).

Crypto-bears on the other hand, question bitcoin’s value given there are no cash flows associated with owning it and, despite its decade-long existence, it has yet to achieve widespread adoption as a medium of exchange or store of value outside of speculative trading.

But whether you are a bull or a bear, bitcoin’s utility from a portfolio construction perspective is indisputable. Bitcoin is volatile but has extremely low correlations to other assets. From a total portfolio perspective, this risky investment actually contributes to the creation of a safer portfolio. The important caveat here is that this investment must be sized appropriately. Our CST multi-asset class model portfolios hold only a 0.5% allocation to HODL, Van Eck’s Bitcoin ETF.

Conclusion

Alternative investments help diversify portfolios from the economic, earnings and interest rate risks that are present in stocks and bonds. Commodities, managed futures and bitcoin in particular, are three investments that can be owned easily and cheaply, and we believe will provide the best upside in today’s environment while maintaining low correlations to stocks and bonds. Especially in today’s climate of higher-for-longer inflation and interest rates, we believe that the inflation protection that these investments provide will help deliver superior risk-adjusted returns.

Disclosures: This information was produced by, and the opinions expressed are those of Accuvest as of the date of writing and are subject to change. Any research is based on Accuvest proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however Accuvest does not make any representation as their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. Any sectors or allocations referenced may or may not be represented in portfolios of clients of Accuvest, and do not represent all of the securities purchased, sold, or recommended for client accounts.

The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results. Actual results may vary based on an investor’s investment objectives and portfolio holdings. Investors may need to seek guidance from their legal and/or tax advisor before investing. The information provided may contain projections or other forward-looking statements regarding future events, targets, or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and they may be significantly different than those shown here. The information presented, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.

Jens Jensen

February 15, 2024

Is the Fed’s Fight Against Inflation Complete?

Jens Jensen

February 15, 2024

Strong equity market performance in 2023 came as a surprise to most investors. The S&P 500 defied fears of an economic recession, contracting leading economic indicators, tightening financial conditions, slowing EPS and an inverted yield curve. It ended up 26.50% on the year. A large part of this equity performance can be attributed to the deceleration in the rate of inflation, which pulled forward investor bets on an end to the Federal Reserve’s interest rate hiking cycle and a pivot to rate cuts. By December 31st 2023 the market was pricing in 6.3 rate cuts of 25 bps each by the end of 2024. This implied a Fed funds rate of 3.75% by the end of 2024.

Like equity markets, the economy maintained strong momentum coming into this year. Fourth quarter 2023 real GDP growth, paced by a strong consumer and solid government spending, was 3.3% on an annualized quarter-over-quarter basis, suggesting top-line nominal growth close to 6%. The Conference Board’s Consumer Confidence Index, echoing ongoing labor market strength amid three months of rebounding job openings, registered its strongest reading since December 2021. S&P Global’s US Composite PMI Output Index, furthermore, exhibited greater-than expected expansion in both services and manufacturing, and capital goods orders surprised to the upside, confirming strong ISM survey readings. Construction spending also ran ahead of estimates, and leading economic indicators have turned less negative. Topping it all off, January nonfarm payrolls revealed a massive reacceleration in hiring, with over 350,000 jobs added.

So, evidence is mounting that we have achieved an economic soft landing. But there is an important catch-22 at play which seems to have flown under the radar. Can a strong economy and a tight labor market allow inflation to continue its downward trajectory? We believe that investors were treated to the answer to this question in the recent core CPI data which showed that inflation rose 0.4% MoM and 3.9% YoY (see chart). Albeit backward looking, this upside surprise (economists had forecast a rate of 3.7%) ought to serve as a warning to investors that are banking on interest rate cuts. 3.9% remains well above the Fed’s 2% target, and the disinflation that began in autumn of 2022 (and corresponded to the trough of the 2022 market drawdown) is not guaranteed to follow a consistent path down back to 2%.

Combined with a hot labor market and strong economic growth, the Fed’s fight against inflation is not over. As a result, rate cuts may need to be delayed until inflation can truly be said to be under control. Indeed, expectations for rate cuts have been tempered significantly this year, even before the high inflation print. As of February 14th 2024, expectations for the Fed funds rate at the end of 2024 stand at 4.36%. Compared to pricing at the beginning of the year when the market expected 6.30 rate cuts of 25bps each by December, it now expects only 3.88 rate cuts of 25 bps each by December.

Implied Fed Funds rate as of December 31st 2023:

Implied Fed Funds rate as of February 14th 2024:

For its part, the bond market has been digesting what is likely to be a higher-for-longer interest rate regime. The 10-year yield has risen from 3.9% at the beginning of the year to 4.3% today and the 2-year breakeven rate (2-year forward inflation expectations as priced by the market) has spiked from 2% at the beginning of the year to 2.6% today. However, equity markets appear to have shrugged off these significant shifts in inflation and interest rate dynamics. As of February 14th, the S&P 500 is up nearly 5% year to date and is hovering above 5000, just off all-time highs.

We are of the opinion that the 2023 “no recession surprise” and the “Fed pivot to rate cuts” is largely priced into current US equity valuations. Now, the market’s apathy towards a higher-for-longer cost of capital gives rise to valuation and economic pressures - and thus to downside potential in equity markets. We are not bearish, economic activity has proven resilient and return to 2022 inflation numbers is unlikely. That said, we do not anticipate a repeat of 2023’s +20% returns from US equities in 2024, and if markets fail to adequately digest a higher for longer interest rate regime, we could see downside risk when investors belatedly realize that rate cuts will be delayed because of “sticky” inflation. We are therefore remaining defensive in our equity portfolios. We are using buffered ETFs that have downside protection and upside caps in order to remain invested in equities and participate in the economy’s growth, but protect ourselves on the downside. We are also staying selective, especially in the US, and prefer large caps with strong balance sheets and high brand relevancy over smaller cyclical companies.

Jens Jensen

November 30, 2023

Economic Resilience and the Consumer

Jens Jensen

November 30, 2023

A healthy consumer is critical to a healthy economy. In the US, consumption accounts for 68% of the country’s $28 trillion GDP[1]. Globally, consumption accounts for 60% of the world’s $100 trillion GDP[2].

Coming into the year the outlook for the economy was gloomy. There were a host of economic indicators suggesting that an economic slowdown, if not an outright contraction, was imminent. Leading economic indicators were in contraction territory, financial conditions were tightening, new building permits were rolling over, the earnings per share (EPS) growth rate was slowing, CEO confidence was bleak and the 2yr-10yr yield curve was 70 basis points inverted. Most importantly, inflation was running at 6.5% YoY and the Federal Reserve had just raised interest rates by 450 basis points over the course of 9 months (the fastest rate hiking cycle since the early 80’s). All considered, the consensus among economists was a 65% probability of a US recession by the end of 2023[3].

Fast forward to today and these predictions have proven far too pessimistic. In fact, between Q2 and Q3[4] 2023, US GDP grew at a very impressive rate of 5.2% (annualized).

So where is this economic resilience coming from? The answer: the consumer.

How has Consumer Spending Remained Strong?

· Excess Savings

The average consumer emerged from the COVID pandemic with a very strong balance sheet. Monetary and fiscal expansion during the pandemic saw savings rates spike and an enormous stockpile of excess savings accumulated. By JP Morgan’s estimate, excess savings peaked at $2.3 trillion in 2021. Since then, consumers have steadily drawn on these savings, allowing them to maintain spending patterns.

· Low Mortgage Service Costs

Despite high interest rates on new mortgages, aggregate household debt service costs remain low. In the US, over 90% of homeowners have a fixed-rate mortgage, and more than 40% of all mortgages originated in 2020 and 2021 (when borrowing costs were at historic lows). Therefore, the average rate on the American mortgage is currently ~3.5%, which has effectively immunized many homeowners from the spike in mortgage rates to ~7%.

· Strong Labor Market

Since the pandemic, consumer spending has also been buoyed by the strength of the labor market. And while job openings have come off record highs, they remain very high by historical standards.

Source: US Department of Labor, JP Morgan

The labor market has been able to remain so strong partly because there was a large spike in early retirements and voluntary exiting of the labor force during the pandemic. In fact, labor force participation in the 65+ cohort has yet to return to pre-pandemic levels.

The jobs-workers gap has also yet to be filled due to a significant decline in immigration over the years, a trend that was amplified during the pandemic. In 2021, about 245,000 people from outside of the country migrated to the U.S. – nearly a 50% decline from the previous year, and less than a quarter of the 1 million international migrants in 2016. The foreign-born contribution to the labor force has only recently closed the gap with its pre-pandemic trend.

This tight labor market has given employees bargaining power when it comes to wage negotiations, and it provides workers with greater job security. This has been the primary driver of resilient consumer spending.

Trouble Ahead?

We doubt that the steady decline in excess savings can be counted upon as a regular driver of spending in the future. Indeed, beneath the strong Q3 growth numbers there are some warning signs. For example, the Q3 spending burst came with a decline in the savings rate (from 5.2% in Q2 to 3.8% in Q3[5]), rather than an increase in wage growth. The US personal savings rate as a percentage of disposable income currently stands at 3.8%, well below the long-term average rate of 8.6%[6]. Eventually, consumers should either run out of savings or reduce consumption to rebuild savings. In either case, it will come at the expense of growth in consumption and recent spending patterns.

Additionally, consumers will not be able to remain insulated from higher rates for much longer. Low mortgage payments will not continue indefinitely as new homebuyers enter the market, old mortgages are paid off and homeowners trade-up. In fact, the impact of higher rates can already be seen in non-mortgage consumer credit segments. Auto and credit card delinquencies have now surpassed pre-pandemic levels. Additionally, consumers are bracing for the impact of the return of student loan repayments, which were suspended for several years, and are now required again for most borrowers.

Arguably the biggest risk to a resilient consumer is a rising unemployment rate. As we look ahead, there are signs of weakening in the labor market, indicating that consumers may be forced to rein in spending. The chart below shows that the jobs-workers gap remains at decades highs. However, this gap has begun to narrow, with Goldman Sachs anticipating further weakening:

Similar weakness can be seen in the job quits rate, which has slowed and returned to levels similar to 2018/2019. JOLTS layoffs are ticking higher as well. Importantly, the falling quits rate has coincided with falling wage growth, suggesting the labor market is regaining balance.

We think the consumer, along with the economy, will face headwinds in 2024. Recent bottom-up consensus revisions to 2024 EPS reflect our concerns. So far this year, 2024 earnings estimates for the Consumer Discretionary sector (-5%) have been worse than revisions for the broader index (-3%) and the Consumer Staples sector (-1%).

Similarly, consumer surveys indicate a strong pullback in spending intentions on discretionary items, towards non-discretionary essentials. Morgan Stanley’s Consumer Pulse Survey released on October 30 revealed that consumers plan to pull back on spending the most over the next six months for home appliances, consumer electronics, food away from home, home improvement, and leisure activities, (discretionary spending) while allocating more towards groceries and home supplies (essentials).

Implications on the Markets

The consensus probability of a recession in 2024 is now 50%, although the probability of a soft landing has risen since the Federal Reserve indicated that its rate hiking cycle is likely over. While investors should never underestimate the consumer’s propensity to spend, we anticipate that excess savings will fall, the unemployment rate will rise, and the full impact of higher interest rates will weigh on confidence. In this investment environment, we maintain a selective and defensive stance in our equity portfolios while tilting allocations towards attractive value in fixed income and alternatives.

[1] Source: Bureau of Economic Analysis

[2] Source: World Bank

[3] Source: Bloomberg US Recession Probability Forecast index, which is median forecasted probability of recession derived from the latest monthly & quarterly surveys conducted by Bloomberg and from forecasts submitted by various banks.

[4] Source: Bureau of Economic Analysis. SAAR as of Q3 2023

[5] Source: Morgan Stanley

[6] Source: Bloomberg

Jens Jensen

November 2, 2023

Q4 2023: Outlook, Positioning and Performance

Jens Jensen

November 2, 2023

Market Outlook: Stay Defensive

At the heart of our cautious Q4 outlook is our belief that the Federal Reserve will hold interest rates “higher for longer” – i.e., keep rates at restrictive levels for longer than the market is anticipating. We think the Fed will do this because the economy has been remarkably resilient. The consumer has yet to pull back on spending and the labor market remains extraordinarily tight - which is putting upward pressure on inflation. The Consumer Price Index (CPI) remains at an uncomfortably high rate of 3.7%, well above the Fed’s 2% target. Therefore, we believe the Fed will remain steadfast in its fight against inflation and will continue to target slower growth and a cooler labor market by keeping rates high.

While lagging and coincident economic indicators have been strong in 2023 (e.g., GDP, industrial production, personal income, and inventories) we see concerning leading indicators and signs of weakness ahead. For example, auto loan and credit card delinquencies have now surpassed pre-pandemic levels and indicators such as the leading credit index, consumer expectations for business conditions, ISM manufacturing new orders, and building permits are all in contraction territory. Indeed, the Conference Board’s US Leading Economic Indicators Index last registered -7.6% YoY (exhibit 1).

**Exhibit 1**
Source: The Conference Board as of 9/30/2023

The consumer has been key to the economy’s resilience this year. But there are signs that spending is slowing. Savings that were accumulated during the pandemic have been drawn down significantly. In fact, for consumers in the bottom income quartile, these savings are exhausted. An imminent pullback in spending can be seen in Morgan Stanley’s consumer health survey, where consumers report that they intend to cut spending in almost all categories. The only areas where spending is expected to increase are in basic consumer staples, namely groceries and household items/supplies (exhibit 2).

**Exhibit 2**
Source: Morgan Stanley as of 8/30/2023

We anticipate headwinds for the consumer and the economy on the horizon as the full impact of the Fed’s tightening cycle is felt. As such, we are concerned that the 12% earnings growth estimates for the S&P 500 in 2024 are too optimistic. With the price/forward earnings ratio for the S&P 500 Index at ~18x and the ten-year treasury yield approaching 5%, we think valuations are too high to support softer earnings growth. We also see elevated downside risk because high valuations are compounded by concentration risk at the index level. The top 10 stocks in the S&P 500 are very expensive at 25.9x earnings (exhibit 3), and they constitute fully 31.9% of the index (exhibit 4).

**Exhibit 3**
Source: JP Morgan as of 9/30/2023

**Exhibit 4**
Source: JP Morgan as of 9/30/2023

We think that the equity market has yet to fully reflect the implications of rising real rates, elevated inflation expectations and a shrinking equity risk premium. We think more downside is in store, so we are hedging our portfolios using buffered ETFs. We are similarly cautious in our fixed income portfolios. Q3 was a very difficult quarter for longer-dated bonds, whose term premium continues to adjust to the possibility of higher for longer interest rates. And with the yield curve still inverted, there may well be further downside to bond prices. We plan to hold the core of our fixed income portfolio to maturity and are keeping maturities in the 2024 to 2028 range. We will wait for a clear change in the upward interest rate trend before we extend our bond ladder out beyond 2028.

Positioning and Performance Review

Equities:
Our equity portfolio outperformed the All-Country World Index (ACWI) in Q3 due to our defensive positioning. Approximately half of our equity portfolio is composed of ETFs that have downside protection and an upside cap. We hold US equity buffered ETFs that track the S&P 500 index (tickers: BFEB and BAUG), an International Developed equity buffered ETF that tracks the EAFE index (ticker: IAPR), and an Emerging Market equity buffered ETF that tracks the EEM index (ticker: EAPR). With all of the major equity indexes down on the quarter, these hedged positions significantly helped relative returns. In terms of detractors from performance, US equity markets fared better than international equities in Q3. Therefore, our long-only international equity exposure via Goldman Sach’s multi-factor ETF (ticker: GSIE) detracted from relative returns.

As we move into Q4, we continue to maintain a cautious view on equities and we have recently reduced our equity exposure in our CST models. We trimmed our international equity positions in EAPR and GSIE as international equities are demonstrating relative weakness versus the US. We are now marginally underweight the asset class.

Fixed Income:

Our fixed-income portfolio also significantly outperformed in Q3. Our core fixed income holdings consist of short and intermediate target-term bond ETFs which are exposed to much less interest rate risk than the longer duration benchmark (the Bloomberg US Aggregate Bond Index, commonly referred to as AGG). With interest rates moving higher in Q3, especially at the long end of the yield curve, our shorter-duration portfolio outperformed. Our position in EM Debt via Morgan Stanley’s Emerging Market Sovereign Debt closed-end fund (ticker: EDD) was the only position that detracted from relative returns.

With the proceeds from our equity trims we increased our fixed income exposure by adding to our position in JP Morgan Ultra-Short Income ETF (Ticker: JPST). Fixed income is our preferred asset class in Q4, but we believe that interest rate risk remains high. Therefore, we prefer to keep our maturities in the 2024-2028 range.

Alternatives:

Our satellite position in cryptocurrencies delivered strong positive returns over the quarter and continues to serve as an excellent diversifier in portfolios. Our preferred vehicle for crypto exposure is the Bitwise 10 Crypto fund (ticker: BITW). It provides broad exposure to the asset class as it holds the 10 largest currencies, and importantly, it trades at a significant discount to net asset value (NAV). The benefit of buying funds at a discount to NAV is the opportunity for a narrowing of the discount, which creates a potential source of additional capital appreciation. Q3 provided a good case study in the benefits of this vehicle - despite most crypto coins falling in price over the course of the quarter, BITW’s discount to NAV narrowed, ultimately leading to positive price performance.

We have recently initiated a small position in Managed Futures through the Simplify Managed Futures Strategy ETF (ticker: CTA). Managed Futures strategies have an excellent track record of strong performance and low correlations to equities and fixed income. Simplify Managed Futures Strategy ETF uses a diversified suite of models to generate absolute returns with downside protection.

Jens Jensen

September 11, 2023

Fixed Income Insight: Using Bond Ladders to Mitigate Reinvestment Risk

Jens Jensen

September 11, 2023

There are few indicators that attract as much attention in the asset management world as the yield curve. The yield curve is a visual representation of the annualized yields of bonds of equal credit quality but differing maturity dates. The U.S. Treasury yield curve is referenced most often, but there are curves for other segments of the fixed income market such as those for investment grade corporate bonds, high-yield bonds, and municipal bonds. The yield curve is scrutinized as it is a reliable indicator of market sentiment and offers glimpses into investors' expectations for economic growth, inflation, and future Federal Reserve policy. Similarly, Central banks and policymakers monitor its movements to gauge the appropriate stance of monetary policy. For asset managers, the curve plays a crucial role in shaping investment strategies.

What is the Curve Telling Us?

The screenshot below plots the yield curve for U.S. Treasuries as of July 31, 2023. It also shows what the yield curve used to look like at the end of 2021 and 2022.

One of the most striking features of this chart is the extent to which yields have risen since the end of 2021. Across the entirety of the curve, yields have shifted higher. This is true not just of Treasuries but also in other segments of the fixed income market. The implication is that fixed income as an asset class has become a much greater investment opportunity than it has been in a long time.

Another important takeaway from yield curve concerns its shape. It is currently “inverted,” meaning that a lower annualized yield is on offer for long-term bonds than for short-term bonds. The curve can change shape over time because yields do not move in lockstep. Since 2021, shorter maturity bonds have experienced a greater shift higher than longer maturity bonds. The yield on a 1-month T-Bill for example, has risen by ~ 5.5% while the yield on a 10-year government bond has risen by ~ 2.5%. This remarkable shift higher at the “short end” of the curve is due to the Federal Reserve raising the Fed Funds rate (the overnight rate) to combat inflation. The Fed’s decisions have a direct impact on short-term rates while longer term rates are determined by the bond market.

Considering the inverted shape of the curve and the high yields on offer, T-Bills have clearly become an attractive investment opportunity. Indeed, we strongly encourage our clients to invest any cash set aside for near-term liquidity needs into short-term T-Bills. However, in portfolios with medium- to long-term time horizons, we advise extending maturities further into the future. It may seem counterintuitive, but it can make sense to buy a bond with a lower yield and longer time to maturity than a higher yielding one with a shorter maturity. This is because, by extending maturities, investors can have greater control over their cash flows in the future, rather than being subject to reinvestment risk - the risk of having to reinvest a maturing security at a lower interest rate in the future.

Lock-in yields before it’s too late

We anticipate that interest rates across the curve will fall in response to slower economic growth. The Fed appears to be winning the battle against inflation, but in so doing, the economy is taking a hit. Leading economic indicators such as the ISM Manufacturing Index and the Purchasing Managers’ Index (PMI) are very weak. As such, we believe that the Fed is nearing the end of its interest rate hiking cycle, and the Fed Funds rate will soon peak. In fact, the futures market now expects that the Fed will begin cutting interest rates at the beginning of 2024. When the Fed cuts rates it means that those who have been investing in very short-term bonds will face the prospect of reinvesting at lower and lower yields – yields that could even be lower than current long-term rates. Therefore, locking in yields further out along the curve today becomes critical.

Moreover, as we saw in 2022, yields along the curve don’t move in lockstep. Even before the Fed begins cutting rates, we expect the bond market will begin pricing in a lower Fed funds rate in the future. In other words, yields further out on the curve will drop. At that point, the chance to lock-in today’s high yields will have evaporated. The chart below shows how, in the past three rate hiking cycles, yields further out on the curve dropped significantly after the Fed Funds rate peaked. This is especially true of bonds with 3-to-5-year maturities.

Source: Charles Schwab. The dates for the peak rate and six months after for each of the three rate-hike cycles are: 12/19/2018 and 6/19/2019, 6/28/2006 and 12/26/2006, and 5/16/2000 and 11/16/2000.

We anticipate an imminent peak in the Fed Funds rate, and a shift downwards in the yield curve. This means that investors may soon miss the chance to lock in the attractive yields on bonds with a longer time to maturity. Within our separately managed accounts we are using a bond laddering strategy in which we hold multiple target-term bond funds to maturity. Our target-term bond funds extend out to 2028. By holding to maturity, we are locking-in the most attractive points on the yield curve. It gives our clients predictable cash flows and mitigates re-investment risk.

As rates begin to fall, reinvestment opportunities will evaporate across the curve. We advise locking in yields before it's too late.

Disclosures: This information was produced by, and the opinions expressed are those of Accuvest as of the date of writing and are subject to change. Any research is based on Accuvest’s proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however, Accuvest does not make any representation of their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. Any sectors or allocations referenced may or may not be represented in portfolios of clients of Accuvest, and do not represent all of the securities purchased, sold, or recommended for client accounts.

The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results. Actual results may vary based on an investor’s investment objectives and portfolio holdings. Investors may need to seek guidance from their legal and/or tax advisor before investing. The information provided may contain projections or other forward-looking statements regarding future events, targets, or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved and may be significantly different from that shown here. The information presented, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.

Jens Jensen

July 5, 2023

Multi-Asset Class Portfolios: Outlook, Positioning and Performance Review

Jens Jensen

July 5, 2023

Accuvest Outlook: Cautious in the Near Term

Equity markets have surged by double digits year to date as economic growth and corporate earnings have proven more resilient than expected, and the drawdown of excess savings, resilient asset prices, and a strong labor market have supported consumer spending. Markets are also anticipating that lower headline & core inflation as well as challenges faced by US regional banks will draw the Federal Reserve into interest rate cuts at the end of this year. Additionally, enthusiasm around the transformative power of AI has been a powerful catalyst. However, as we move into 2H 2023, we are questioning whether this strong rally is sustainable. We have become increasingly cautious towards equities.

One of the most glaring concerns that we see in equity markets is concentration risk. This is particularly true for the major market cap weighted indexes in the U.S. The S&P 500’s 2023 rally has been driven primarily by the 7 US mega-cap growth stocks—Apple, Microsoft, Nvidia, Amazon, Meta, Tesla, and Alphabet. As of June 14th, they have risen by an average of 86% amid optimism about the impact of AI on their long-term prospects. These seven stocks alone now constitute 28% of the S&P 500 and account for 80% of the gains in the S&P 500 so far this year.

In addition to the concentration risk, we are cautious towards the major market cap weighted indexes because these 7 companies have historically high valuations. These companies skew the major indexes to worryingly expensive levels. The 12-month forward P/E for the S&P 493 (i.e., excluding the 7 mega-caps) is 15x, a little lower than the 20-year historical median of 15.8x. Add the 7 stocks back in and the S&P 500’s P/E rises to 19.4x. We are skeptical that these valuations are sustainable in the near term given what we believe will be a challenging economic environment going into the end of the year. From a valuation perspective, international markets are far more attractive.

We are also concerned that the stock market has failed to adequately price-in the possibility that the Federal Reserve will keep interest rates higher for longer. At the June FOMC (Federal Open Market Committee) meeting, Chair Jerome Powell made it clear that the Fed is not necessarily done with tightening and could increase rates by another 50 basis points to ensure that inflation is contained. However, the market appears to be interpreting the Fed’s policy forecast as a “bluff”. As implied by Fed Funds futures, investors anticipate that the Fed will only hike rates one more time this year (a 25-basis point increase) and the first interest rate cut will occur in December of this year (see chart). This disconnect between a hawkish Fed and a bullish market gives us cause for concern.

We also believe that the equity market has been too quick to discount economic reflation and an immediate rebound in corporate profit growth as we are seeing very weak leading economic indicators. For example, the ISM Manufacturing Purchasing Managers Index is at 46.9 and the ISM Manufacturing Report on Business New Orders Index is at 42.6 (a reading below 50 indicates contraction while a reading above 50 indicates expansion). This data suggests that the economy has a way to go before it troughs.

Finally, we believe caution is warranted given that investor sentiment is increasingly one-sided. The VIX (Volatility Index) is at its lowest levels since early 2020 and the AAII (American Association of Individual Investors) Bulls-Bears survey is registering more bulls than bears than at any time since 2021. From a contrarian perspective, this bullish sentiment has historically proven to be a reliable sell signal.

Portfolio Positioning

While we are cautious on equities in the near term, we retain an equal weighting to the asset class. We prefer to manage risk via hedging rather than moving to cash or rotating to less volatile assets. Buffer ETFs are our preferred hedging vehicle as they allow us to retain exposure to equity upside while providing protection on the downside. Remaining invested and maintaining strategic asset allocations are critical to achieving long-term investing goals. At the same time, prudent risk management and volatility reduction is needed in the short term. Large drawdowns can negatively impact immediate financial needs and goals. In today’s highly uncertain environment, we believe that Buffer ETFs are an excellent way to satisfy both of these objectives.

We are moderately underweight fixed income. While we believe inflation has peaked, it remains high, thereby eroding real returns. We are limiting volatility and interest rate risk by allocating to short and intermediate-term maturities. We are taking advantage of higher yields and steepness at the shorter end of the yield curve through a held-to-maturity laddered bond strategy. By laddering target-term bond fund maturities into the future and allowing them to mature at par, the portfolio is locking in today’s attractive yields and delivering predictable income while mitigating interest rate risk.

In alternatives we own a very small satellite position in the Bitwise 10 Crypto Index Fund (BITW). BITW currently has a -56% discount to NAV. We believe that positive expected returns, low correlations and the ability for the discount to narrow make BITW an ideal vehicle to gain exposure to the crypto space. Elsewhere, we have recently exited our position Gold (GLD). Gold has served as an effective defensive real asset this year and we have benefitted from its low correlation and inflation protection. However, recent negative price action has led us to exit our position and rotate into JPMorgan’s Ultra-Short Income ETF (JPST). JPST allows us to take advantage of the attractive yields at the short end of the curve.

Performance Review Q2 2023

Equities

Our equity portfolio modestly underperformed the All-Country World Index (ACWI) in Q2. With the S&P 500 outperforming global equities on the quarter, our dedicated U.S. exposure, which includes U.S. Equity Buffer ETFs (BFEB and BAUG), helped relative returns. Both BFEB and BAUG are well below their caps, each with well over 10% upside potential before the end of the outcome period. On the negative side, as Emerging Markets underperformed on the quarter, our position in the Innovator Emerging Markets Power Buffer (EAPR) underperformed the All Country World Index (ACWI).

Fixed Income

Our short-duration Fixed Income portfolio outperformed the longer duration benchmark, the Bloomberg US Aggregate Bond Index (AGG) on the quarter. Our position in the Emerging Market Sovereign Debt Closed-End Fund (EDD) performed well and was a large contributor. Not only has Emerging Market Debt been a very resilient sector of the fixed income market year-to-date, but a narrowing of the discount to NAV (Net Asset Value) has boosted returns. With the yield curve becoming even more inverted over the quarter, our position in the Interest Rate Volatility and Inflation Hedge ETF (IVOL) detracted from returns.

Alternatives

Gold (GLD) was a detractor from performance in Q2 2023. Gold has served as an effective defensive real asset throughout the year but has recently shown weakness, leading us to exit our position. Our small position in the Bitwise 10 Crypto Index (BITW) helped relative returns.

Contributors to relative performance

· US Equity Buffer ETFs (BFEB and BAUG)

· Emerging Market Domestic Debt Closed-End Fund (EDD)

Detractors from relative performance

· Interest Rate Volatility and Inflation Hedge (IVOL)

· Gold (GLD)

Overweight

· Crypto

Equal Weight

· Equities

Underweight

· Fixed Income

Disclosures: This information was produced by, and the opinions expressed are those of Accuvest as of the date of writing and are subject to change. Any research is based on Accuvest’s proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however, Accuvest does not make any representation of their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. Any sectors or allocations referenced may or may not be represented in portfolios of clients of Accuvest, and do not represent all of the securities purchased, sold, or recommended for client accounts.

The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results. Actual results may vary based on an investor’s investment objectives and portfolio holdings. Investors may need to seek guidance from their legal and/or tax advisor before investing. The information provided may contain projections or other forward-looking statements regarding future events, targets, or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved and may be significantly different from that shown here. The information presented, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.

Jens Jensen

June 28, 2023

Hedging Equity Exposure: Risk Management in Times of Uncertainty

Jens Jensen

June 28, 2023

Risk Management in Times of Uncertainty

US economic resilience, a pause in the Federal Reserve’s rate hiking cycle, and enthusiasm for Artificial Intelligence have fueled double-digit returns in the S&P 500 year to date. This strong market recovery is a welcome relief for investors who suffered through a historic drawdown in both stocks and bonds last year. Now, as we move into 2H 2023, the question is whether this impressive market rally is sustainable. Given the murky economic backdrop, many investors are concerned that there is little room for the market to move higher and prefer to hold cash and other safe assets. Meanwhile, other investors are loading up on risk assets in response to such strong positive momentum. So, should investors be buying or selling equities? Unfortunately, no one has a crystal ball and can answer this question with absolute certainty, especially in the current environment with such a wide range of outcomes.

Given the inherent uncertainty involved in investing, research has shown that attempting to “time” the market has a negative impact on long-term returns. Staying invested and keeping asset allocation consistent are crucial components in achieving financial goals over the long run. Missing out on some of the best days in the equity market because money is sitting on the sidelines is severely detrimental to long-term returns. In fact, the tremendous power of exponential growth through compounding can be seen in research from Putnam Investments who found that if you were to have invested $10,000 in the S&P 500 on 12/31/2007 and remained fully invested, you would have earned $35,461 by 12/31/2022. In contrast, someone who invested $10,000, but missed out on the 10 best days of the market, would have earned only $16,246 (see chart).

But not all investors have long-term time horizons. In the short run the stock market can be extremely volatile. Over the past 74 years, there have been 14 bear markets, lasting an average of 13 months, with declines averaging -25.3% before markets recovered. These drawdowns can have a strongly negative impact on immediate financial goals and needs. Large losses also require even larger gains to get back to even and many investors (especially those near or in retirement) don't have time to wait to recover from a large drop in portfolio value. For many of our clients, capital preservation through prudent risk management is paramount.

Staying invested in volatile equities is important in achieving long-term goals, but at the same time, risk management and volatility reduction are important in achieving short-term goals. Given the current uncertain environment, Accuvest believes that hedging equity exposure can best satisfy these two investing principles. Our hedging strategy allows us to avoid the pitfalls that come from trying to time the market while still retaining capital appreciation potential. We can maintain equity exposure in our portfolios with confidence knowing that downside risk and volatility are reduced.

Our Hedging Strategy Explained

Our hedging strategy makes use of Defined Outcome Buffer ETFs. Buffer ETFs are innovative exchange-traded funds that track the performance of an underlying index such as the S&P 500 but provide investors with a predetermined level of downside protection (a “buffer”). Many buffer ETFs in our portfolios have 15% downside protection. This means that if, at the end of the outcome period (usually one year), the market is down 15%, the fund will be down 0% (flat). If the market is down 16%, the fund will only be down 1%. If the market is down 17%, the fund will only be down 2%. And so on.

Downside protection can be implemented in portfolios in other ways, such as the use of puts or by moving to cash. But the beauty of hedged ETFs is that they retain upside potential. If the underlying index performs well over the course of the outcome period, the funds will appreciate up to a predetermined level (the “cap”). Currently, buffer ETFs are offering excellent upside – many have a cap above the 20% level. To illustrate the concept of a “cap”, a fund that offers a 20% cap can be used as an example. If the market is up 20% at the end of the outcome period, the fund will also be up 20%. If the market is up 21%, the fund will only be up 20%. If the market is up 22%, the fund will only be up 20%. And so on.

Buffer ETFs are built using three “layers” of options contracts. The first layer involves buying a deep-in-the-money call option on the reference asset (the stock market index). The second layer is a put spread. Together the long call and put spread deliver exposure to the underlying investment with a downside buffer. Finally, the third layer consists of selling a call. The call is sold as far out of the money as possible, while still generating enough premium to cover the cost of the buffer (layer 1 and 2). The sale of this call is what creates the upside cap.

To summarize, by accepting a limit on growth potential in the form of an upside cap, these ETFs create a built-in buffer against loss over a defined outcome period, usually one year, after which the ETF resets its exposure and buffer zone. The “payoff profile” of these ETFs is depicted in the graphic below:

Source: Innovator ETFs

Historically, these types of defined outcome vehicles have only been available through certain bank and insurance products, often in the form of structured notes. These legacy products are opaque, illiquid, and come with punishingly high fees. They are also subject to the underlying credit risk of the issuer. In contrast, Buffer ETFs are daily liquid, transparent, tax-efficient, cost-efficient, and are not subject to counterparty risk. Accuvest believes that these vehicles are very attractive given the uncertain market and economic environment. We have the upside potential needed to achieve our clients’ long-term goals but are managing risk in the short term by protecting on the downside.

Disclosures: This information was produced by, and the opinions expressed are those of Accuvest as of the date of writing and are subject to change. Any research is based on Accuvest’s proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however, Accuvest does not make any representation of their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. Any sectors or allocations referenced may or may not be represented in portfolios of clients of Accuvest, and do not represent all of the securities purchased, sold, or recommended for client accounts.

The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results. Actual results may vary based on an investor’s investment objectives and portfolio holdings. Investors may need to seek guidance from their legal and/or tax advisor before investing. The information provided may contain projections or other forward-looking statements regarding future events, targets, or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved and may be significantly different from that shown here. The information presented, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.

Jens Jensen

May 12, 2023

CST Portfolios - April 2023 Review

Jens Jensen

May 12, 2023

Market Review

In equities, the All-Country World Equity Index (ACWI) moved higher in April, continuing its steady climb since the events surrounding Silicon Valley Bank and Credit Suisse back in March. From a regional perspective, international developed ex-USA (EFA) outperformed both the U.S. (S&P 500) and Emerging Markets (EEM). Fixed income was also largely positive on the month as interest rates dropped and spreads tightened.

Macro data in April showed that economic activity has remained resilient this year, especially in the services sector, and inflation continues to moderate. However, leading economic indicators such as Manufacturing PMI (Purchasing Managers Index), new Building Permits and the ISM Business New Orders Index are signaling concern and the closure of another US financial institution, First Republic, at the end of the month suggests that the cumulative impact of central bank tightening may have further implications for asset prices and the economy.

Portfolio Review

Equities

Our equity portfolio outperformed the All-Country World Index (ACWI) in April largely because of our position in GSIE (Goldman ActiveBeta International ETF). GSIE is an international developed, non-US equity ETF that employs multi-factor analysis whereby stocks are scored on four distinct factors: Value, Momentum, Quality, and Low Volatility. GSIE has consistently outperformed the global benchmark this year as they are overweight Western Europe.

Our exposure to emerging markets via GEM (Goldman ActiveBeta Emerging Markets ETF) detracted from relative returns. Emerging markets were dragged down by China, where policy uncertainty and geopolitical risk continue to spook investors.

Moving forward, we favor defensive exposure in equities, particularly in the United States. Our US exposure comes through hedged ETFs that use options to create a downside buffer and an upside cap. These innovative ETFs are low-cost, liquid, and come with no counterparty risk. We have a cautious outlook towards equities in the short term, and Buffer ETFs allow us to maintain our equal-weight exposure to the asset class but provide downside protection and lower beta.

Fixed Income

Lower interest rates, a weaker US dollar, and a narrowing of the discount to NAV (Net Asset Value) helped our position in EDD (Morgan Stanley Emerging Market Domestic Debt Closed-End Fund) contribute to our fixed income portfolios’ outperformance against the US Aggregate Bond Index (AGG) in April.

At the same time, falling interest rates saw the shorter duration positions in our laddered bond portfolio underperform. 2023 High yield bonds (IBHY), 2024 Investment grade bonds (IBDP), and 2026 investment grade bonds (IBDR) detracted from relative returns versus the AGG.

We are moderately underweight fixed income as we move into May. While we believe inflation has peaked, it remains high, thereby eroding real returns. We are limiting volatility and interest rate risk by remaining short duration within our portfolios and we are taking advantage of the high yields at the shorter end of the yield curve through a bond laddering strategy. By laddering target-term bond fund maturities into the future and allowing them to mature at par, the portfolio is locking in today’s attractive yields and delivering predictable income while mitigating interest rate risk.

Alternatives

Our position in GLD (Gold) posted positive returns in April. Gold has served as an effective defensive real asset throughout the year. It has also improved the risk/reward profile of our portfolios by providing diversification benefits.

Detractors from Performance

Contributors to Performance

ActiveBeta Emerging Markets ETF (GEM)
Laddered iBond ETFs

ActiveBeta International Developed Equity ETF (GSIE)
Emerging Market Domestic Debt Closed End Fund (EDD)

Overweight

UnderWeight

Gold

Fixed Income

Disclosures: This information was produced by and the opinions expressed are those of Accuvest as of the date of writing and are subject to change. Any research is based on Accuvest proprietary research and analysis of global markets and investing. The information and/or analysis presented have been compiled or arrived at from sources believed to be reliable, however Accuvest does not make any representation as their accuracy or completeness and does not accept liability for any loss arising from the use hereof. Some internally generated information may be considered theoretical in nature and is subject to inherent limitations associated therein. Any sectors or allocations referenced may or may not be represented in portfolios of clients of Accuvest, and do not represent all of the securities purchased, sold or recommended for client accounts.

The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results. Actual results may vary based on an investor’s investment objectives and portfolio holdings. Investors may need to seek guidance from their legal and/or tax advisor before investing. The information provided may contain projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved and may be significantly different than that shown here. The information presented, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.

Jens Jensen

April 11, 2023

Q1 2023 Review: Markets Climbing a Wall of Worry

Jens Jensen

April 11, 2023

Market Re-Cap

Performance Heatmap:

Both equities and fixed income posted strong returns in Q1 as the global economy avoided recession, China continued to re-open, the US labor market remained strong, and lower energy and oil prices helped reduce inflation.

In equities, on the back of successful efforts to rebuild gas reserves and a milder-than-expected winter, European equities outperformed. In the US, large cap growth dominated, with mega-cap stocks such as Apple, Amazon and Microsoft exhibiting relative strength. From a sector perspective, technology and communications outperformed while financials and energy lagged. In fixed income, falling interest rates rewarded duration, with the U.S. Aggregate Bond Index returning 3.2% and long-term Treasuries up a full 7.4%. Credit spreads also remained contained in Q1, helping high yield bonds.

While financial markets may have ended the quarter on a high note, investors were exposed to major bouts of volatility in the iterim. The month of March in particular was a roller coaster ride as the collapse of Silicon Valley Bank (SVB) led to fears about the stability of the banking system. The bond market was shaken, with the most widely watched gauge of bond market volatility - the ICE BofA MOVE index - surging to the highest level since 2008. Fears of deposit flight subsequently caused bank lending to pull back, thereby tightening financial conditions (see chart) and, according to most economists, increasing the probability of a recession.

And yet, by the end of the month, markets had closed higher. This is largely because investors increasingly believe the fallout from the SVB debacle will lead to an imminent pause in the Federal Reserve’s rate-hiking cycle. Indeed, over the course of the month, the 10-year Treasury yield declined by nearly 50-basis-points and the entire Fed funds futures curve was repriced significantly. As many as four rate cuts are now anticipated by January 2024 and the yield curve, while still inverted, has steepened meaningfully.

Spotlight on Banking Stability

Another reason markets moved higher is because contagion fear in the banking system is contained. The market views SVB’s collapse as idiosyncratic in nature and a systemic crisis as highly unlikely. Flush with deposits from fast-money Venture Capital firms and other corporate accounts at a time of historically low interest rates, SVB failed to adequately match duration between its high-quality assets and deposit liabilities. As higher capital costs prompted corporate outflows, SVB was forced to sell its long-term Treasuries, the value of which had plummeted as interest rates rose. A capital raise to cover those losses failed, and a run on deposits occurred. Ultimately, regulators were forced to step in and ensure deposits. This aggressive action, alongside historically strong liquidity and capital positions at larger US institutions, appears to have minimized systemic risk and calmed markets. Measures of funding stress are well behaved, and the Federal Reserve has offered extraordinary liquidity through its discount window.

In short, we do not see systemic risk or similarities with the 2008 financial crisis. The financial crisis originated in cheap credit and lax lending standards. This is not the case today as lending standards have tightened significantly in the past 15 years and banks have steadily been increasing their tier 1 capital ratios (see charts).

Source: (Left) Federal Reserve Bank of New York, Refinitiv Datastream, J.P. Morgan Asset Management. Mortgages are grouped by FICO score. Subprime are those with FICO scores below 659, prime those between 660 and 759 and superprime those above 760. (Right) Bloomberg, FDIC, IMF, Refinitiv Datastream , J.P.Morgan. Core tier 1 ratios are a measure of banks' financial strength, comparing core tier 1 capital (equity capital and disclosed reserves) against total risk weighted assets. Europe shows average of France, Germany, Italy, Spain and UK. Guide to the Markets Europe. Data as of 31 March 2023.

Accuvest Market Outlook and Positioning

Systemic risk to the financial system may be contained, and a more accommodative Fed is on the horizon, but this does not mean all is rosy in the near term, especially considering that U.S. Leading economic indicators are flashing red, commercial real estate looks vulnerable, financial conditions have tightened, earnings estimates are falling, and margins are likely to come under pressure. As such, we expect a range-bound market in 2023.

Within equities we are positioned defensively with our core US exposure in buffered ETFs. In a rising market, these buffered ETFs are likely to underperform due to their lower beta and upside caps. But when markets are falling, the downside buffer will provide significant protection. This is a trade-off we are happy to take in this uncertain, macro-driven environment. We are overweight international equities as both European and Emerging Market revenue and earnings growth is expected to exceed the US, valuations are much more attractive, and a weakening US dollar is likely to provide an important tailwind.

We are moderately underweight fixed income as we move into Q2. While we believe inflation has peaked, it remains high, therefore eroding real returns. Because of the risk that the window to lock-in high yields may be evaporating, we have incrementally been adding to longer maturity target-term bond funds to our bond ladder.

In alternatives, we continue to value the diversification benefits that commodities bring to portfolios. Should Gold’s recent rally begin to reverse, we will be quick to exit the position and rotate to other areas of the commodity complex that exhibit relative strength.

CST Separately Managed Accounts: Performance Review

Equities

In Equities, our position in GSIE (Goldman ActiveBeta INTL ETF) helped relative performance versus the global benchmark in large part due to an overweight to Western Europe. Our position in GEM (Goldman ActiveBeta EM ETF) outperformed the broader EM indexes but underperformed the global benchmark. Our hedged US equity positions also underperformed.

Fixed Income

In Fixed Income, our short duration profile detracted from performance relative to the longer duration benchmark. As yields fell in response to turmoil in the banking sector and in anticipation of a Fed pause, our short duration positions such as IBHY (iBonds HY 2023 ETF) and IBDP (iBonds IG 2024 ETF) underperformed. On the positive side, (EDD) Morgan Stanley EM Domestic Debt Closed End Fund helped returns as did our position in IVOL (Interest Rate Volatility and Inflation Hedge) due to significant steepening of the yield curve.

Alternatives

Our position in gold (GLD) was greatly rewarded in the month of March, more than making up for its lackluster performance in January and February. While it diversified the portfolio and ended the quarter in the black, it underperformed the major equity and fixed income indexes.

The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results. Actual results may vary based on an investor’s investment objectives and portfolio holdings. Investors may need to seek guidance from their legal and/or tax advisor before investing. The information provided may contain projections or other forward-looking statements regarding future events, targets, or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved and may be significantly different than that shown here. The information presented, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.

Jens Jensen

March 20, 2023

February 2023 - CST Portfolio Review

Jens Jensen

March 20, 2023

Market Review

Global equities declined in February after a strong start to the year. There were large regional performance differentials with Emerging Markets hit hard while Europe remained resilient. In the US, almost all S&P 500 sectors fell. Technology was comparatively strong while Energy was amongst the weakest sectors with investors eyeing potential cost pressures.

Fixed Income was also down on the month in aggregate as the yield on the 10-year Treasury note climbed by 40 basis points to 3.92 percent, the highest level since mid-November. Shorter-term rates rose by less, with the 3-month Treasury yield rising by 18 bps to 4.88 percent, the highest level since the middle of 2007. The shape of the yield curve remained deeply inverted, an ominous sign as this has historically been one of the most reliable recession predictors.

At the Federal Open Market Committee (FOMC) meeting on February 1st, Fed Chair Jerome Powell reaffirmed that a slowdown in inflation is underway, and that the Fed’s 2% target is achievable, but stronger than expected economic data and a very tight labor market warrant a hawkish stance. The Fed followed through with a 25 bps increase in the Federal Funds Rate. Minutes from the meeting showed that while almost all members agreed to slow the pace of rate hikes, the consensus was that rates may need to rise further than was initially assumed in order to bring inflation under control. As a result, February was marked by financial markets pricing in the likelihood of a higher-for-longer interest rate regime. By February 28th, the market was pricing in a terminal rate of 5.41%.

A stubbornly tight labor market is of particular concern to the FED as it makes their job of controlling inflation much more difficult. The chart below shows the steep rise in JOLTS nonfarm job openings vs. the number of unemployed workers. The ratio reached record highs during the economic reopening, signaling that demand for labor has outpaced supply and workers feel emboldened to seek out better job opportunities, resulting in elevated labor market churn and upward pressure on wages and prices.

Portfolio Review

Equities

In Equities, our position in GSIE (Goldman ActiveBeta INTL ETF) helped performance in large part due to an overweight to Western Europe. Our rotation from JEPI (JP Morgan Premium Income ETF) to BAUG and BFEB (U.S. Equity Buffered ETFs) also helped returns. However, our position in GEM (Goldman ActiveBeta EM ETF) detracted from performance as countries such as Brazil, China and South Korea underperformed.

Moving forward, we are near-term cautious on equities but medium-term bullish. We expect elevated volatility and prefer low-beta defensive exposure to U.S. equity via buffered ETFs.

Fixed Income

In Fixed Income, our short duration profile helped performance relative to the longer duration benchmark. As yields rose in expectation of higher-for-longer Fed policy, our short duration positions such as IBHY (iBonds HY 2023 ETF) and IBDP (iBonds IG 2024 ETF) outperformed. On the negative side, (EDD) Morgan Stanley EM Domestic Debt Closed End Fund hurt returns as did our position in IVOL (Interest Rate Volatility and Inflation Hedge) due to continued yield curve inversion.

We are moderately underweight fixed income as we move into March. While we believe inflation has peaked, it remains high, therefore eroding real returns. We are taking advantage of higher yields primarily through our bond laddering approach using diversified target-term fixed income ETFs.

Alternatives

Our position in gold (GLD) detracted from performance in February. We anticipate market volatility, and despite recent price action, we expect gold will act as a defensive real asset offering an attractive risk-reward profile.

Detractors from Performance

Contributors to Performance

Emerging Market Sovereign Debt (EDD)
Interest Rate Volatility and Inflation Hedge (IVOL)
Emerging Market Equity (GEM)

International Developed Equity (GSIE)
Innovator U.S. Equity Buffered ETFs (BFEB and BAUG)
Laddered iBond ETFs

Overweight

UnderWeight

Gold

Fixed Income

The reader should not assume that any investments in sectors and markets identified or described were or will be profitable. Investing entails risks, including possible loss of principal. The use of tools cannot guarantee performance. The charts depicted within this presentation are for illustrative purposes only and are not indicative of future performance. Past performance is no guarantee of future results. Actual results may vary based on an investor’s investment objectives and portfolio holdings. Investors may need to seek guidance from their legal and/or tax advisor before investing. The information provided may contain projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved and may be significantly different than that shown here. The information presented, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.