A. Stotz All Weather Strategy – May 2022

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The All Weather Strategy underperformed a traditional 60/40 portfolio by 0.3% in May 2022. War in Ukraine, recovery demand, and supply-chain bottlenecks to drive commodities and gold. Risks: Inflation quickly gets under control, new lockdowns, central bank tightening crash markets.

The A. Stotz All Weather Strategy is Global, Long-term, and Diversified:

• Global – Invests globally, not only Thailand
• Long-term – Gains from long-term equity return, while trying to reduce a portion of losses during equity market downturns
• Diversified – Diversified globally across four asset classes

The All Weather Strategy is available in Thailand through FINNOMENA. Please note that this post is not investment advice and should not be seen as recommendations. Also, remember that backtested or past performance is not a reliable indicator of future performance.

Review

The central bank dilemma

Inflation especially hurts the poor

• People with lower incomes have less bargaining power to raise salaries

Sri Lanka is one example of a country in trouble

African countries ran out of jet fuel

This can partly be blamed on the rich West

The consequences of underinvestment have started to show

The energy crisis may get worse

We begin to see food protests

• Continued high inflation could exacerbate inequality and lead to more unrest in the world

Protests have erupted over food prices

• Highlighted in red are countries where there have been protests over food prices in the past few months

Spikes in the high-yield spread often overlap with economic recessions

Performance of the World stock markets

• NASDAQ in the US was weak in the past month
• China rebounded
• Key European markets fell slightly

Find the updated Performance of the World stock markets here.

Asset class weights since March 2022

Regional equity weights since March 2022

World stocks have taken a hit in 2022

• In 2021, World stocks were up 19.0%
• YTD2022, they were down 12.6%
• In May 2022, World stocks gained 0.2%

US equity was flat in May 2022

• We had a 25% target allocation to US equity, which was up 0.2% in May 2022
• US equity was the third-best performing equity

Europe was the best-performing equity in May 2022

• We had a 5% target allocation to Developed Europe equity, which was up by 1.2% in May

China held up Emerging markets

• We had a 5% target allocation to Emerging markets equity, which was up by 0.3% in May
• China’s rebound held up Emerging markets in the past month

Asia Pacific ex Japan fell by 0.3% in May 2022

• We had a 5% target allocation to Asia Pacific ex Japan equity
• Besides China and Taiwan, which constitute about 55% of the index, most Asian markets fell in May

Japan was flat in May 2022

• We had a 5% target allocation to Japan equity, up 0.1% in May

Thai money market stayed flat

• Rather than Global Bonds, we had a small 5% target allocation to the Thai money market, which was flat as expected
• The main purpose of our money market allocation is downside protection

Commodities were up the most in May at 3.4%

• We had a 25% target allocation to Commodities
• Commodities have been on a bull run since April 2020

Energy saw a continued rise

• As mentioned, Energy prices rose based on geopolitical events related to the war in Ukraine
• WTI oil closed May 2022 at $115/bbl

Gold was the worst performer in May 2022

• We had a 25% target allocation to Gold
• Gold closed the month at US$1,837/oz or down by 3.3%

AWS has fallen but outperformed

• AWS: 2.0% above the traditional 60/40 portfolio
• Commodities was the best-performing asset, while Gold and US equity dragged on the strategy’s performance

May 2022: 0.3% underperformance by AWS

• AWS: 0.3% below the traditional 60/40 portfolio
• Commodities: Best performing asset
• US: Third-best performing equity
• Gold: Worst performer

Above a traditional 60/40 portfolio

• The strategy was 9.6% above a 60/40 portfolio by the end of April 2022

AWS has shown a strong performance

• Except in the past 1 month, AWS has had a higher return and risk-adjusted return in all periods
• The same holds for the drawdown-adjusted return, but it was 0.1x for both portfolios in the past month

AWS has experienced less volatility than a 60/40

• Mostly 25-65% target weight for equity has reduced volatility
• Since Gold is generally uncorrelated to equity, it has reduced the overall AWS volatility

AWS has lost less on 9 out of the 10 worst days

• A key feature of AWS is that it aims to lose less when equity markets fall
• On the 10 worst days of Global equity since the inception of AWS, the strategy has lost less than 60/40 on 90% of days

AWS outperformed a 60/40 in 64% of months

• In 25 out of 39 months, the All Weather Strategy has beaten a traditional 60/40 portfolio

Raise bonds, reduce equity

• We expect equity to remain volatile due to the war in Ukraine
• We reduce equity to 25% from 45%
• Increase bonds to 25% from 5%
• Keep commodities and gold at 25%

5% in each region

• We reduce US equity to 5% from 25%

Outlook

Federal Reserve chair Powell said on May 17th

• “What we need to see is clear and convincing evidence that inflation pressures are abating and inflation is coming down.
• And if we don’t see that, then we’ll have to consider moving more aggressively.
• If we do see that, then we can consider moving to a slower pace.”

The market has changed expectations to a less aggressive Fed

• The Fed has communicated that it’ll do what it takes to get inflation under control, though Powell doesn’t want to be too aggressive
• The market-implied rate has fallen slightly after the May 4th 0.5%-hike

Fed’s balance sheet didn’t grow in May

• We have yet to see if the Fed reduces its balance sheet, i.e., QT, and by how much
• Withdrawing liquidity is typically bad for financial markets
• We reduce US equity to 5% from 25%

European Central Bank President Lagarde blogged on May 23rd

• “I expect net purchases under the APP* to end very early in the third quarter
• Based on the current outlook, we are likely to be in a position to exit negative interest rates by the end of the third quarter.”

Rate hikes and tightening are in focus

• Bank of England raised its “Bank Rate” by 0.75% in May and guided for more hikes
• If ECB begins QT, it could lead to a recession in Europe, especially with its ongoing energy crisis, but we expect cautious tightening
• We keep our target allocation of 5% to Developed Europe equity

Bank of Japan wants to keep rates low and welcomes imported inflation

• Bank of Japan is the only large central bank in the developed world that wants more inflation
• The weak Yen leads to higher prices of imports, which leads to “imported inflation”
• Keep Japan equity at 5%

Strong US$ hurts Emerging markets

• Fed actions are likely to result in a stronger US$ and less global liquidity, which could hurt EM
• US$ is considered a safe haven; it can strengthen further as a result of the global turmoil
• Keep EM equity at 5%

China’s heavy weight matters

• Too early to tell if China equity is recovering; lockdown is harmful
• China’s heavy weight in the Emerging markets and Asia Pacific ex Japan indices could continue to drag
• Keep 5% in Asia Pacific ex Japan equity

Increase bonds to 25% from 5%

Bonds to remain flat

• We raise our target allocation to bonds to 25% from 5% as we see more risk in the market
• Our allocation is to the Thai money market, so a Fed, or other major central banks, rate hike should have little to no impact
• In addition, if we were to see rate hikes in Thailand, short-term paper is typically less negatively impacted due to shorter duration
• We keep 25% bonds to protect the downside

Keep commodities at 25%

Energy prices to remain high, WTI closed May at $115/bbl

• Europe’s Russian energy dependence is going to continue to influence the energy markets
• Russia is also an exporter of many industrial metals, and Russia and Ukraine are both important exporters of soft commodities

Metals prices are high and may be turning up again

• Russia supplies almost 20% of global high-quality nickel used in EV batteries
• The precious metal palladium is mainly used in catalytic converters for cars, and the EU gets more than 40% of its supply from Russia

World food price index hit a record 160 in March 2022, still at 158 in April 2022

• Russia and Ukraine account for 15-20% of the global supply of corn and wheat
• Export bans on food in countries like India and Indonesia could exacerbate food shortages and push prices further

High energy prices feed through to food

• Natural gas is used in fertilizer; higher fertilizer costs lead to higher grain prices
• Corn is a primary input for feed grain of livestock and poultry, driving up meat prices

Commodities set to go higher

• We keep our 25% target allocation to Commodities
• Demand for necessities (food and energy), inflation, and supply-chain disruptions related and unrelated to the war in Ukraine are going to drive the asset class higher

Keep gold at 25%

We keep gold as an insurance

• Keep our target weight of 25% as an insurance
• The war in Ukraine spurs uncertainty, and Inflation expectations could rise, making gold attractive
• Though expected rate hikes and recession concerns are negative

Regional Equity FVMR Snapshot

• Fundamentals: US has the highest ROE by far
• Valuation: EM has the lowest PE and Japan the lowest PB
• Momentum: Japan best in the past year
• Risk: Lowest gearing is found in Japan

Risks

Inflation quickly gets under control

• The strategy is still positioned to benefit from rising inflation through a 25% Commodities allocation
• A quick resolution of the war in Ukraine would ease the pressure on Energy prices
• The Chinese shutdown reduces energy demand and could lead to lower prices
• Other commodities could fall with energy prices too, as it’s part of the production cost

Global recession pushing down stocks

• New Covid mutations could arise, leading to new shutdowns globally or in specific countries, which would be negative for the related equity markets
• We have started to see indications of economic slowdown, which could mean central banks are raising rates into a recession
• Chinese lockdown reduces global demand

Central bank tightening crash markets

• If major central banks would surprise and not be cautious about rate hikes or QT, it could impact the stock markets negatively
• Since, the US stock market usually has a global impact, and US$ is a reserve currency, Fed decisions typically have the most impact on global markets

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DISCLAIMER: This content is for information purposes only. It is not intended to be investment advice. Readers should not consider statements made by the author(s) as formal recommendations and should consult their financial advisor before making any investment decisions. While the information provided is believed to be accurate, it may include errors or inaccuracies. The author(s) cannot be held liable for any actions taken as a result of reading this article.