October 2022

The short maturity fixed income market is offering the most attractive yield opportunity since before the financial panic of 2008, thanks to the Federal Reserve’s aggressive reversal of Fed Funds.  We argue that the Fed has been forced into such an aggressive move by their years of ineptitude but, nevertheless, the move presents an attractive opportunity for investors to actually earn an attractive return on their cash.  Prior to this year, the idea of 60/40 investing (a portfolio strategy of holding 60% of assets in equities and 40% in fixed income) had been supplanted by “forget bonds and buy the dip in stocks when their price corrects.”  That strategy worked well prior to this year, but has proved catastrophic for portfolios this year, with the selloff in the darlings of the retail market, namely FANG stocks.  All are down double-digits in 2023, with META, the parent of Facebook, down 69% from its peak.  The best performing of the group is Apple with a year-to-date loss of only 27%.  Topping the FANG losses, Bitcoin, the favored trading vehicle of the more “sophisticated” retail traders has lost 75% of its value since last December.  With the cryptocurrencies printing new lows as we write, we wonder what’s stopping Bitcoin from plumbing the depths below 10,000.  It’s certainly not valuation, because it really doesn’t have any intrinsic value.

We’d argue that with equities continuing to face selling pressure, now would be an opportune time to revisit the 60/40 asset allocation model.  We’ve taken the opportunity to lengthen duration and increase the credit quality of our Reserve Cash Management (RCM) portfolio.  We’ve extended the weighted average duration from about one month out to six months.  In doing so, we’ve employed the tried-and-true fixed income strategy of a barbell, which is to say we’ve been rolling over T-Bills in the less than 3-month maturities, while simultaneous buying Floating rate Treasury-bills and buying corporate bonds in the two- to three-year sector of the curve.  For the corporate bucket, we’ve been finding securities that yield between 5% to 6%.  The Weighted average yield of the combined portfolio as of November 16, 2022 is 4.73%, providing a nice buffer to one’s overall portfolio should equities continue their downward correction.  As always, we strive to achieve broad diversification by targeting positions of approximately 2% of portfolio value.

The abysmal performance in the stock market is significant in that it’s becoming a drag on discretionary spending.  Rate hikes have all but stalled the housing and automobile industries and the trickledown effect is starting to reverberate through the economy.  Initial claims for unemployment insurance have risen from the low touched last month, but so far has not really caused a worry.  But what is worrying is the recently announced layoffs in the tech sector.  Meta is immediately cutting 11,000 jobs, Twitter is cutting 3,700 jobs, and Microsoft is cutting 1,000 jobs, just to name a few.  Taken in aggregate, the handful of tech firms firing workers does not in itself signal a recession.  But considering the headline effect on consumers and business leaders, the trend is troubling.

On the positive side, the October Consumer Price Index was a relief to investors, as it came in better than expected.  That’s not to say that prices are contracting.  In fact, taking it at face value, the inflation numbers are still too high.  But the rate of increase is falling, which is welcome news for consumers.  Core CPI, the measure the excludes food and energy, rose 6.3% year-over-year, falling from a year-over-year increase of 6.6% last month.  On a month-over-month basis the measure rose 0.3%, down from 0.6% last month.  That’s a welcome improvement and comes just in time for the Fed.

Since the release of CPI, there has been a steady stream of Fed official speeches and the message seems to be that the next rate hike is likely to be less than the recent 75 basis point moves.

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