December 2020
RiskBridge Advisors’ Managed Volatility Portfolio (MVP) strategy returned 2.92% for the month ending December 31, 2020, and 10.93% since inception (11/01/2020), outperforming a traditional 60% S&P 500 / 40% Barclays Aggregate benchmark, which returned 2.36% in December and 9.57% since inception. Past performance does not guarantee future results.
In December, contributors included non-U.S. equities (developed and emerging markets), U.S. small-cap stocks, and financial and energy sector exposures. Detractors were cash, long-duration Treasurys, and communications, discretionary, industrials sector exposures.
The U.S. economy continued to slow heading into year-end as the COVID-19 pandemic worsened. We believe vaccine approval and distribution should help drive economic recovery by the second quarter of 2021, but the vaccination pace will do little to stop the current wave of positive cases, hospitalizations, and deaths. Global markets are starting to reflect the risks of a further slowdown in economic activity in the first quarter of 2021.
The slowing recovery was evident in falling small business optimism in the most recent NFIB survey, which saw a sharp contraction in the number of businesses expecting the economy to improve. One bright spot in the report was a pick-up in hiring plans, consistent with the rebound in job openings data, which has bounced back much faster than in previous recessions. These positive signals of elevated labor demand suggest that once the fog of the pandemic lifts, we could see relatively rapid job growth in 2021. This would be consistent with one of the U.S. Federal Reserve's (Fed's) two policy mandates.
The other Fed mandate, targeting an average 2% inflation target (maybe a little higher or a little lower), remains a challenge. Market-based measures of future inflation expectations are at 2.3%, but the most recent reading of Personal Consumption Expenditure Core Price Index (core PCE) slipped to 1.38% from 1.41%.
Beyond the data, the market is focused on vaccination administration and the banana republic-esque antics in Washington, DC.
MARKET OUTLOOK
We conclude the business cycle downturn that began in 3Q2018 culminated with the 2020 recession, catalyzed by the global pandemic and the Great Lockdown. Based on our analysis, we expect to exit the recession around 2Q2021, and we look for the U.S. economy to recover to pre-pandemic levels by the end of 2021. In our opinion, we are entering the early stage of a multi-year upturn in the business cycle.
Our generally positive outlook for the economic and market environment is tempered by our expectations for a hand-off from financial asset inflation to real asset inflation due to a potent mixture of excess global liquidity, pent-up consumer and business demand, and supply-side shortages.
In 2021, the Fed will remain ultra-accommodative and keep monetary policy on hold, in our opinion. The Federal Open Market Committee (FOMC) pledged to increase its monthly purchases of Treasury securities ($80 billion per month) and mortgage-backed securities ($40 billion per month) "until substantial further progress has been made toward the Committee's maximum employment and price stability goals…" This infers that in 2021 the Fed's balance sheet will swell from $7.4 trillion to $9.0 trillion, or approximately 45% of U.S. gross domestic product (GDP).
We expect rising interest rate and currency volatility and declining equity and commodity volatility in 2021.
Our equity outlook reflects our view that the U.S., which recovered faster in 2020, will be outpaced by faster economic and earnings growth outside the U.S. Also, we believe markets will remain in a "reflationary" regime for most of 2021, which tends to favor stocks over bonds, momentum, and beneficiaries of accelerating growth and inflation (technology, discretionary, industrials, and energy). The consensus forecast for 2021 S&P 500 Index EPS growth is +21% y/y ($170/share). Equity risk premia for EAFE and Emerging Market equities are materially higher than in the U.S.
Our 2021 fixed income outlook expects higher bond yields and further steepening of the yield curve, after having steepened the most in three years in 2020. After a sluggish first quarter, we expect the U.S. economy to meet and exceed expectations. In our view, accelerating growth coupled with trillion-dollar deficits may put upward pressure on Treasury yields, although Fed policy tools may keep yields from rising too much. We think the 2021 trading range for 10yr Treasury yield will be between 0.75% to 1.75% (currently 0.91%). If our view is correct, Treasury securities may be one of the worst-performing asset classes in 2021.
Investment-grade and high-yield corporate credit spreads have recouped most of the widening witnessed during the credit market fractures in early 2020. We believe credit downgrades and defaults are already priced in. Further spread compression is possible, especially for high-yield and emerging market debt.
We expect a rising volatility regime for interest rates and currencies and a declining volatility regime for equities and commodities.
PORTFOLIO POSITIONING
From an asset allocation perspective, our current portfolio positionings are:
Risk budgets aligned with the strategic volatility target.
Underweight U.S. stocks relative to global equities. We prefer emerging markets over developed markets.
The model is overweight credit risk and underweight duration risk, with an average fixed income duration of 6.5 years.
Tactical equity tilts are toward value, commodities and commodity producers, dividend growers, late-stage venture, and long/short equity.
Tactical income tilts are toward emerging market debt, direct lending, and distressed commercial real estate.
We continue to hold extra cash (5% allocation, reflecting concerns about extended valuations for equities, credit, and Treasury securities).
DISCLOSURE: Past performance is no guarantee of future results. Investment involves risk.
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Benchmarks and indices are presented herein for illustrative and comparative purposes only. Such benchmarks and indices may not be available for direct investment, may be unmanaged, assume reinvestment of income, do not reflect the impact of any trading commissions and costs, management or performance fees, and have limitations when used for comparison or other purposes because they, among other things, may have different strategies, volatility, credit, or other material characteristics (such as limitations on the number and types of securities or instruments) than RiskBridge account. It should not be assumed that your account performance or the volatility of any securities held in your account will correspond directly to any comparative benchmark or index. We make no representations that any benchmark or index is an appropriate measure for comparison. Please see below for brief descriptions of some of the major indices mentioned in this material:
The S&P 500® Index is a market capitalization-weighted index of 500 of the largest U.S. companies, designed to measure broad U.S. equity performance.
The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based market capitalization-weighted bond market index representing intermediate-term investment-grade bonds traded in the United States.
The Core Personal Consumption Expenditure Price Index provides a measure of the prices paid by people for domestic purchases of goods and services, excluding food and energy prices. The core PCE is the Fed's preferred inflation measure.