Rebalance Into Risk Assets

As you may have seen, the Global Asset Allocation Strategy purchased stocks on Tuesday 3/15. This brings the portfolios in-line with target risk allocations after the NASDAQ stock exchange, Russell 2000 Small Cap Index and many global stock exchanges fell by 20% or more from their respective peaks that were generally achieved late in the fourth quarter or at year-end. U.S. large company stocks, as represented by the S&P 500, was “only” down by about 13% at the time due to a couple of stocks that held up rather well and comprise a substantial portion of the index.

Fortunately, we had excess cash in accounts from the most recent rebalance out of risk assets on 1/3/22 when stocks were at all-time highs. Thus, additions to stock mostly came from cash.
As discussed in the year-end newsletter, in response to inflation, the Federal Reserve has pivoted from a very accommodative monetary policy to one in which conditions will be tightening. This sudden pivot was announced by Fed Chair Powell in November and since then the market has priced in seven 0.25% fed funds interest rate hikes. This is the primary reason why stocks have fallen. As rates rise, bonds become more attractive and stocks become less attractive. Stocks have been the only game in town with rates near zero.

The first hike took place on Wednesday 3/16. The chart below shows the drastic response by the bond market. As you can see below, the 2-year Treasury rate jumped in October once it was rumored that a shift in policy may be underway. Financial markets have already tightened conditions substantially and much of the Fed’s rate hikes are priced in at this point.

The rebalance into stocks was almost entirely across domestic asset classes. Specifically, U.S. growth assets and small and mid-sized positions were added at substantially lower valuations than just weeks ago. Small and mid-sized companies are trading at valuations that are well below mean levels of the last couple decades and are positioned for the highest expected returns going forward.

International stocks are down substantially, and we could be rebalancing to those positions upon further asset price weakness. However, we are more concerned with these asset classes given the horrific situation in Ukraine and a Covid resurgence and shut downs across Asia and parts of China. Some accounts may have seen purchases to stocks abroad if exposure was extremely underweight, but overall we have treaded lightly outside the U.S.

To be clear, this is not a directional call on a market bottom, but simply our systematic rebalance process beginning to kick in with asset prices down. Predicting geopolitical events is a tough game and financial markets could go either way from here based on the events in Ukraine and China. However, our priority is to allocate capital to asset classes and specific investments that can outperform over a 3-7 year time horizon and recent pricing was attractive compared to what we have seen in recent years. Technically, there has been price support at recent market low levels and conditions became oversold. We have greater confidence in domestic stocks given the extremely low unemployment rate, reopening economy post Delta and Omicron, and consumers and businesses flush with cash.

As always, please reach out if you have any questions or you would like greater detail about any of this week’s transactions. Our quarter-end newsletter is just weeks away and will have even more commentary on these transactions and the entire global state of affairs.

Registered Investment Adviser. Financial and exit planning services offered through Alliance Private Wealth LLC are separate and unrelated to Commonwealth.