Updated: Nov 2, 2021
SUMMARY. This week at the Federal Reserve Jackson Hole meeting, Chairman Powell all but confirmed our concern that "tapering" of asset purchases (ie QE reduction) is more than likely before year end. Our assumptions, given 2018 events whereby markets declined more than 15% on such news, was that it would be negative for asset prices overall. The reaction in markets on Friday, was OPPOSITE vs expected, as markets, particularly small capitalization stocks (most heavily shorted by hedge funds) soared. Whether this is temporary and a buy on the negative news event we are perplexed by the reaction especially in light of slowing economic growth. Admittedly, more stimulus to come may benefit growth short-term but may cause more inflation which is why we had thought the Federal Reserve would act soon vs later. The amount of noise in the market introduced by the abundance of liquidity & leverage may be the cause of this disconnect or maybe its the stimulus to come. Possibly, the large short positions using significant leverage taken by hedge funds in smaller stocks and them buying to cover their positions could have added to the reaction. To be frank we can only guess. Either way we remain cautious about economic growth going into 2022.
INVESTMENT IMPACT. Price anomalies in the markets are at extreme levels in our view tied to liquidity & leverage as well as high levels of retail or individual involvements in markets. This has introduced high levels of volatility particularly in smaller capitalization names which models are exposed to. The broader market dominated by large technology names has yet to experience this volatility nor any sort of price correction...if anything the opposite. We entered the week hedged (ie short to protect portfolio downside tied to "tapering"), but given markets positive reaction we eliminated those on Friday and added to our long equity positions somewhat. We believe its prudent to maintain higher than normal cash levels, given uncertainty in the direction of markets and higher volatility as well as maintain flexibility in non-core positions to bought or sold if market direction changes. Our long exposure remains over-weighted in healthcare or those companies we believe can grow even if economic growth slows (ie secular growth stories) and provide attractive valuations with compelling risk/reward.
As a result of all of the above both our cash/bond levels remain elevated across all our model portfolios while equity exposure remains much lower than normal (25%-30% lower in some cases). In our view its one of the most challenging investment environments in many decades.
Our model portfolio performance has been updated on our website as of 7/30/21.
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