In our perspective much like Q1, we expect Q2 to be another volatile stretch before we have greater clarity on the timeline of more price stability and sustained positive movement. The Fed, which ignored many signs early on, has not halted its effort to make up ground on inflation for the monetary policy mistakes with continuous fast-paced rate hikes.[RRHS1] This past quarter we saw what that type of rapid change can do to the economic environment, specifically as mentioned above in the banking system. Finding a balance between the inflation fight and the stability of the financial system will remain interesting, and something our team monitors closely.
Just a few short weeks ago the futures market expectation was at least two more 25-basis-point rate hikes by Q3, before the discussion to lower rates may have started in Q4. As of writing this article, the futures market is now expecting no further hikes, and cuts to start at the first Fed meeting of Q3 at the end of July. Although we are not as optimistic as the futures market with regard to the timing of the cuts, our current analysis has us close to split on whether or not we will see further hikes in early May, with signals pointing to the fact that this past meeting could very well have the last hike in this cycle. That said, looking at historical periods of inflationary instability it can tend to go up and down in spikes, and there is always the possibility we are far from done fighting it back down to the 2% level as the Fed intends. If we do not continue to see decline in CPI and PCE, the Fed will face some difficult monetary policy decisions.
The relatively recent yield curve inversion indicators have again raised concerns of recession risk, but unlike the false alarm in late 2019, the troubled signs have started to follow. Typically, this means a recession risk about a year later. Albeit minor, we do expect to see a mild recession later this year. If it remains somewhere between the Fed’s desired soft landing and a mild recession we would be happy with that result. This is what we currently project to be the most likely outcome on the back of strong household financials as well as corporate finances that have for the most part proven resilient with regard to the jobs market. Of course all of this can change, and will be a focus of ours as we move through spring into summer.
With all of this in mind we are satisfied with our portfolio performance across our benchmarks, and management strategies looking ahead will continue to regularly monitor the news, data, and statistics that drive our portfolio rebalancing and re-weighting. While a recessionary cycle will be a challenge for equity markets and corporate earnings, the result is often more favorable for the bond market. Despite that uncertainty ahead, equities’ long-term performance in a well-balanced portfolio are still strong, and a focus on quality stocks and defensive stocks, especially those in oversold areas can prove fruitful. Other sectors such as Healthcare, Consumer Staples, and Utilities will become more important to our overall holdings as well given its resiliency to recessions historically.
Based on our internal weighting metrics at the time of writing this we are Overweight (Health Care, Information Technology, Industrials), Neutral-High (Consumer Staples, Consumer Discretionary, Utilities), Neutral-Low (Real Estate, Materials), and Underweight (Financials, Energy, Communications). This will likely change throughout the quarter as we continue to monitor the economic situation and the central banks decisions. That said a few mainstays that have served portfolios well over the last 6 months will continue to play a big role going forward. We will maintain a large allocation to gold utilizing the iShares Gold Trust (IAU), which as our second largest holding, is up about 23% over the past 6 months as of writing this. Our largest holding, an Information Technology ETF (FTEC), which saw a past 6-month performance of 17.33% as of writing this will take a step down as our top allocation in favor of a wider range of Information Technology exposure where we remain overweight.
Looking further ahead, no matter how disconnected you may be, we are sure you have heard at least something about the Artificial Intelligence boom that is happening in tech. Here at Retirement Systems, we continue to develop and integrate technology into our daily processes, and Machine Learning and AI have and will continue to be a valuable asset to our team. From the Data Science behind our market outlooks and decision-making processes to sharing information and resources with our clients, we are excited about a number of projects in development. In the back half of 2023 we expect to launch a new portfolio focusing on exposure to this fascinating and exponentially growing new industry led by names like Google and Microsoft. GOOG, which will almost certainly be a part of this new portfolio will continue to be a large holding to start Q2, which is up just under 19% over the last month as of writing this. Soon thereafter we expect to unveil our first portfolios that will actually utilize these processes alongside our team aiming to drive decisions, allowing us to innovate faster, while exploring a wider range of data and investment opportunities. As always, past results are not indicative of future performance. Nothing contained in this newsletter is to influence any investment decisions, please remember to communicate with your Investment Advisor Representative for any buy/sell orders. More to come on that front, but until next quarter, thank you for putting your continued trust in us here at Retirement Systems, and if you have any please questions don’t ever hesitate to contact your advisor.
by James Tuccori