MARKET COMMENTARY:
Summary of our views is as follows:
- The price of money is a significant driver of asset prices and economic activity. This has been the largest, fastest increase in rates ever in the US. We believe the full impacts are still unfolding.
- While the rate of inflation is clearly declining, we doubt it will return to the very low levels targeted by the Federal Reserve anytime soon. The inputs that kept inflation so low for so long (cheap labor; cheap goods; cheap energy as an input to manufacturing) have all changed.
- We caution using a lens from the 2000 – 2021 period as a mechanism to evaluate investments today. A significantly higher price of money, the desire to shrink the Federal balance sheet, and a US Central
Bank bias to not cut rates until inflation returns to target, and global protectionism are all reasons why we view the current investing landscape is quite different than the past.
- From 1968‐82 the equity market experienced multiple violent rallies and subsequent selloffs, and 70% of purchasing power was lost to inflation. We could see a mini period that is similar ‐> choppy markets with multiple large rallies and declines and steady erosion of purchasing power.
- The risk of a credit crunch remains. Investors are no longer willing to accept zero interest from bank deposits and have been reallocating capital into money market funds or other short duration investments. Regional banks have historically been a major provider of CRE, C&I and personal loans. Regional bank business uncertainty could result in tighter lending standards or even an unwillingness to extend credit.
- Demand for downside protection in the US equity markets remains anemic. Put option skew remains low, while market liquidity has been on a general downtrend. Don’t underestimate the potential for either a grind lower or a violent downside repricing in equity indices, followed by significantly reduced potential for a rapid recovery in prices as long as the Federal Reserve is unwilling to aggressively cut rates.
An Absence of Momentum:
Momentum investing is an investment strategy that involves buying securities that have shown recent positive price trends. The underlying idea is that assets that have performed well in the past will continue to do well in the future, at least for a certain period. Momentum investing has consistently outperformed buy and hold equity strategies and there have been multiple studies that have shown this has been true for more than one hundred years.
Investor behavior factors into the success of this strategy, as investors generally underreact to good news and overreact to bad news. A key component of momentum investing is position management and specifically letting winning positions run and cutting losing positions quickly. This strategy also works best when the trend of the stock market is up.
But is the US stock market currently in an uptrend?
Generally, equity momentum strategies have not generated any gains over the past 12 months. An easy way to see this is the Momentum ETF (Ticker: MTUM) which has gone sideways for a year.
Source: TradingView
How about the broader markets? The below graph shows the performance of the following ETFs starting January 2022:
- S&P 500 (SPY)
- S&P 500 equal weighted index (RSP)
- Mega Cap ETF (MGK)
- Midcap ETF (MDY)
- Small Cap ETF (IWM)
Source: TradingView
This certainly doesn’t look like much of an uptrend. So, while the S&P 500 month to date and year to date performance looks quite positive, the overall trend has been choppy and sideways. Clearly not a great environment for momentum investing.
Fortunately, robust momentum strategies tend to keep losses small when market conditions are less favorable. And when market conditions improve, we expect momentum strategies to return to generating large gains. This asymmetry is why we like to use these strategies in our portfolios in conjunction with buy and hold equity positions.
Monthly Podcast Recommendation:
Mastering Market Trends with Technical Analysis: Insightful Trade Strategies with Michael Hewson
https://leadlagreport.substack.com/p/mastering‐market‐trends‐with‐technical?utm_campaign=email‐ post&r=2iyhmu&utm_source=substack&utm_medium=email#details
STRATEGY COMMENTARY:
As a reminder, our Sundial Dynamic All‐Weather Portfolios attempt to achieve positive returns regardless of the macroeconomic regime, such as positive or negative growth, or an inflationary or deflationary environment.
This is achieved through a few key principles:
- Utilize multiple asset classes and strategies, beyond traditional equity and fixed income markets
- Utilize both active (tactical) and passive (buy and hold) strategies
- Recognize that some investments are stability seeking (short volatility bias) and others are instability or dislocation seeking (long volatility bias) and it is critical that a portfolio contains both.
The desired result is a portfolio of non‐correlated revenue streams, that exhibits attractive asymmetry through tactical allocations and return stacking, truncates the downside in adverse markets, and is fully offensive in constructive markets.
Tactical Equity Strategies:
Allocation: High end of the target range
Comment: As indicated above, our momentum related tactical strategies have not generated any gains in 2023. We will continue to keep them in portfolios as they tend not to have large drawdowns when conditions are unfavorable, and this asymmetry of small losses and big gains is valuable. We have, however, reduced exposure throughout the year to the momentum specific strategies and rotated that capital into other tactical strategies that are better suited for the current environment.
Passive Equity Strategies:
Allocation: Low end of the target range
Comment: Our passive equity longs remain at the low end of our targeted range. These positions are mostly in ETFs and other diversified exposures. As mentioned in last month’s letter, we did increase exposure slightly when SPY was at 410 as we believed the technicals along with option market dynamics (put walls) would result in a limited additional selloff from that point.
Yield Generating Strategies:
Allocation: High end of the target range.
Comment: A full allocation reflects both our defensive stance and the attractive opportunity set. There are so many strategies that can generate a high single digit and even mid to high double digit annual returns with modest risk. We continue to utilize mostly alternative yield generating investments that focus on private credit, bridge lending, and tranched insurance risk related strategies.
Trend Following and Inflation Benefitting Strategies:
Allocation: High end of the target range
Comment: Trend following strategies have suffered over the past month which is no surprise when you look at the sharp reversals in yields once again (graph below). These strategies generally were invested in the trend higher in bond yields and with the aggressive decline of more than 50 bps since the end of October, performance has suffered. Despite the recent setback, we continue to believe the uncertain macro environment continues to be constructive for “dislocation seeking” trend following strategies. We were never believers in the stock and bond only portfolio, and we continue to hold the view that owning government bonds will not act as much of a portfolio hedge as long as inflation remains above target. Trend following strategies are a far better portfolio diversifier.
Long Volatility / Long Convexity Strategies:
Allocation: High end of the range
Comment: We continue to maintain maximum exposure to these strategies, and when we take on a new portfolio, this is also one of the first positions we initiate. The cost of tail protection (skew) remains extremely low, the potential for a left fat tail is elevated in our opinion, and we are strong proponents of this exposure in all portfolios.
CHARTS & TABLES:
Below, the S&P 500 year‐to‐date returns are split between the "Mag 7" and the "other 493." We see arguably the most concentrated rally in history. Over 12% of the S&P 500's gain has come from seven stocks. ~3% from the "other 493."
Source: https://twitter.com/biancoresearch/status/1727802082114335060
Source: https://twitter.com/biancoresearch/status/1727802078368829444
Source: https://twitter.com/biancoresearch/status/1727802085998252401
VIX – lowest levels since January 2020.
Source: https://twitter.com/MikeZaccardi/status/1728120259700273335
Source: https://twitter.com/BobEUnlimited/status/1726962750361092143
Source: fred.stlouisfed.org
Source: https://twitter.com/biancoresearch/status/1726003223759319150
The volatility in US 10Y Treasury Yields is getting extreme.
Source: https://twitter.com/elerianm/status/1720159635800498294
Source: https://twitter.com/GameofTrades_/status/1728113753189720564
Source: https://twitter.com/GameofTrades_/status/1723423186749149597?t=A9jaEMuQMjFyb7cuainCaQ&s=09
Source: https://twitter.com/biancoresearch/status/1727106674723524930
Source: CRE Daily 11/20/2023
Source: https://twitter.com/charliebilello/status/1726265323392008379
Disclaimers
This commentary does not constitute an offer to sell any securities or the solicitation of an offer to purchase any securities nor does it constitute tax advice. This information is for informational purposes only and is confidential and may not be reproduced or transferred without the written consent of Sundial. Past performance is not indicative of future results. Statements and opinions in this publication are based on sources of information believed to be accurate and reliable, but we make no representations or guarantees as to the accuracy or completeness thereof. These materials are subject to a more complete description and do not contain all of the information necessary to make any investment decision, including, but not limited to, the risks, fees, and investment strategies of an investment.
This correspondence may include forward‐looking statements. Forward‐looking statements are necessarily based upon speculation, expectations, estimates and assumptions that are inherently unreliable and subject to significant business, economic and competitive uncertainties, and contingencies. Forward‐looking statements are not a promise or guarantee of future events.
Benchmarks and indices are presented herein for illustrative and comparative purposes only. Such benchmarks and indices are not 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 the Firm. 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 index. We make no representations that any benchmark or index is an appropriate measure for comparison. The S&P 500® Index is a stock market index from S&P Dow Jones Indices. It is a market capitalization weighted index of 500 of the largest U.S. companies, designed to measure broad U.S. equity performance.
Asset allocation and diversification will not necessarily improve an investor’s returns and cannot eliminate the risk of investment losses. There are no assurances that an investor’s return will match or exceed any specific benchmark.
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