Market Update - Tactical Portfolio Adjustment

Kyle Thompson, CFP®, CPA
03.14.22

“In many ways, the stock market is like the weather in that if you don’t like the current conditions all you have to do is wait a while” – Louis Simpson


The start of 2022 has been volatile. There have been numerous adverse headlines, which was recently capped by the senseless war on Ukraine. Our hearts are with the innocent Ukrainian victims and all of Eastern Europe that is being impacted by the tyrannical actions of Russia and Vladimir Putin.

Headlines that have stirred fear for investors to start 2022 include:

  • Russia invading Ukraine
  • Highest inflation level in 4 decades
  • Rising energy prices
  • Chatter of an oncoming recession
  • Fed looking to tighten monetary policy (i.e. slowing growth via increased interest rates)
  • Growth stocks crashing
  • One of the craziest housing markets on record
  • Labor market and supply chain shortages
  • The ongoing pandemic

A quick read of this list would make most uncomfortable. As investors, I think it is important to not get bogged down or worry about the things that are out of our control. Your financial plan and investment allocation has been built to account for these volatile events and unknown future market movements. I can’t tell you how any of these events will ultimately play out, but I still believe that history will repeat itself and this difficult period will come to pass. Just like the weather we will have brighter days on the horizon.

If you have worked with us for any period of time it is no secret, we are a long-term buy-and-hold firm. We firmly believe this strategy is a guiding principle to building long-term wealth, but it also based on empirical evidence that illustrate the challenges and costs of trying to time markets. As the chart from Dimensional illustrates, the cost of timing the market and missing the best performing days has a tremendous drag on your overall return. Staying invested in all market cycles has proven overtime to be the most prosperous outcome.


While our long-term strategic views are set in stone, we do acknowledge there are tactical adjustments that can make sense in the ever changing macroeconomic and geopolitical environment we live in today. A little over a year ago, we entered into a new partnership with BlackRock to expand the depth of our investment team and research capabilities. Today, we have a 5-member team from BlackRock that acts as an extension to our internal investment committee and has been tasked with helping us refine our models/asset allocations on a quarterly basis. In rare events, during heightened periods of volatility or perceived market opportunity, they can suggest intra-quarter ad-hoc adjustments, which is the premise for this letter.

As Aaron Williams shared in his, February 28th write-up, geopolitical selloffs are typically short lived and have little impact on investment results over the subsequent 6-month and 1-year time horizons. However, when you combine the current geopolitical pressures with the other adverse events impacting the economy, BlackRock felt there was an opportunity to make a tactical shift to provide some additional downside protection relative to the indices.

Role of Market Street and BlackRock

Before I discuss the upcoming portfolio adjustments and trades, I would like to briefly provide an overview of how BlackRock’s investment thesis intertwines with our long-term market views. The relationship with BlackRock was an attractive fit as we were able to maintain our independence and autonomy while also continuing to use the funds families of our choice (DFA, Vanguard, etc.). In conjunction with BlackRock, we built a framework for our portfolio models that is adhered to at all times. Below is an overview of our guiding principles and the approach we have taken to portfolio construction.

Guiding Strategic Principles:

  • +/- 5% Max deviation from equity target (maximum over-or-underweight we could ever have at any point is 5%)
  • Maintain moderate US equity overweight (we target a minimum of 2/3 US exposure and 1/3 Intl exposure to our equity allocations)
  • Include exposure to targeted factors, styles, and sectors (these can rotate as the macro environment shifts). These are where most of our tactical shifts can/will occur
  • Believe that fixed income shouldn’t be “fixed” – we allow duration and credit to be managed based on what is happening in the economy with a focus on allowing fixed income to be a true hedge against our equity positioning
  • Seek to control active risk and provide consistent outcomes (we are not timing the market, but rather making subtle shifts within our active risk budget to benefit from macroeconomic shifts)
  • Disciplined trading schedule (quarterly) with ad-hoc flexibility (if we see severe market disruptions

Approach to Portfolio Construction (4 disciplined pillars):

  1. Strategic Asset Allocation = Start with a long-term strategy (this does not change)
  2. Tactical Asset Allocation = Adapt to changing market conditions. Allowing us and Blackrock to seek investment opportunities or provide additional downside protection based on changing market conditions
  3. Investment Vehicle Selection = We review our funds/holdings to ensure they are performing as expected
  4. Help Protect the Portfolio = Use a proprietary BlackRock software called Aladdin to manage risk (we allow 3% of active risk management at all times). This budget can be used to increase risk when markets are poised to perform or cut risk when volatility has increased

March Ad-Hoc Trade

Many of you will see trades in your portfolio this week as we implement our current ad-hoc adjustments. These will be rolled out in client accounts held at Schwab. These trades will not show up in held-away accounts where we are limited to what we can invest in. You also may not see these trades in your taxable accounts if you have taxable capital gain limitations from your existing holdings. Our internal investment team had a lengthy call with BlackRock this past Friday, to review the proposed portfolio adjustments discussed below and we agree with their research and recommendations.

The March ad-hoc trades lean further into the tactical shifts that we made back in January. In January, we reduced our overweight to stocks from 4% to 3%. We also cut our exposure to developed markets and in particular Europe, while maintaining an overweight to energy stocks and commodities. These tactical shifts that were implemented in January have proved beneficial in the early part of 2022. On average, we have seen our YTD performance outperform the benchmarks between 1% and 3.5% in our 60/40 model[1]. This can vary depending on a client’s account types and specific holdings but overall, we have seen the subtle shifts from the January quarterly trade to be quite successful.

Trade Breakdown

The tactical shifts we will be implementing this week are poised to address the escalating conflict in Eastern Europe and rising inflation. The prospect of a protracted conflict and ongoing economic sanctions in recent weeks which could have meaningful downstream effects on European growth, global inflation, and global energy prices. These events are why Market Street and our BlackRock investment team believes there is an opportunity to layer on these tactical adjustments to deleverage risk when compared to our respective benchmarks:

  1. Moving more underweight non-US developed stocks and overweight US – The idea is to get ahead of potential upcoming earnings misses and downgrades as financial and economic disruptions hit Europe
  2. Increasing our overweight exposure to energy stocks and commodities – Expecting continued upside pressure on oil, wheat, fertilizer, and industrial metal prices in response to unprecedented sanctions now levied on Russian exports
  3. Exiting global financial stocks – Global financials are facing numerous headwinds as earnings have lost momentum and the appetite for IPOs have evaporated

Summary

As stated above our long-term strategic allocations remain steadfast. Overall, we remain generally risk-on in our positioning while adapting to short-term macroeconomic changes to address the escalating conflict in Europe. We believe these adjustments will better position our portfolios to remove unnecessary risk while still being positioned to capture the next bull market cycle. The goal is to weather the storm in a disciplined manner so when the tide turns, or the weather changes, you can continue to reap the rewards.

We remain so grateful to your continued trust in us. If you have any questions, please don’t hesitate to reach out. We hope you have a wonderful Spring season!



[1] Performance range was from a sampling of our clients in our core 60/40 model. The performance timeframe was between 1/1/2022 and 3/11/2022. The performance noted was net of fund and advising fees and compares to the blended 60/40 benchmark (42% MSCI ACWI USA Index, 12% MSCI USA Index, 6% Russell 2000 TR USD Index, 38% Bloomberg Barclay’s US Universal Index, and 2% ICE BofAML US T-Bill 0-3 Month Index)

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Interested in discussing how the current market environment impacts your portfolio? Give me a call to discuss.

Kyle Thompson, CFP®, CPA
Partner | Senior Financial Planner | Chief Investment Officer

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