Portfolio Management Actions Summer 2022

Non-recessionary bear markets have seen cheaper cyclical sectors outperform expensive defensive sectors about six months into a bear market, on average according to NDR research. Cyclical Growth stocks seem to be bottoming given no recession or just a shallow one. Defensives could outperform cyclicals if there is a recession. After broad market bottoms the worst four sectors, cyclicals sectors such as Consumer Discretionary, Industrials, Technology, Financials, outperform over next 12 months according to CFRA. Technology stocks underperform most sectors at the beginning of a tightening cycle; however, the tables turn after mid-recession outperforming early defensive leaders in the tightening cycle. Financials outperform when the yield curve steepens in the recession anticipating expansion ahead.

I bought defensive Healthcare sector stocks but not ignoring better long-term buying opportunities in high quality growth stocks in cyclical sectors. Consumer Staples and Health Care stocks are by far the best-performing sectors once a recession begins. However, leadership changes to cyclicals by mid-point. It is too late to buy expensive Utilities and Consumer Staple stocks. Utilities and Consumer Staple stocks trade at multiples higher than the S&P 500 Index and beneficiary of extreme cash inflows (a contrarian sell signal). Overall, equity multiples have normalized and trade below latest 10-years average suggesting that equities offer decent long-term forward returns. Growth stock multiples were shaved by as much as 40% now trade at historically average valuations.

I am overwhelmingly in high quality stocks that can weather a recession and can be counted on to rebound in a recovery. Collectively, quality companies have healthy financial statements, profitable, positive free-cash-flow, sales growth, and dividend growth. A few specific stock names are Devon, United Healthcare, ConocoPhillips, Microsoft, Merck & Co. Many of these stocks are growing dividends anywhere from 3-10% annually. A real hedge against inflation is an investment that is going to increase cash flow over time and use cash flow to raise its dividend. Dividend growth is an inflation hedge because it helps maintain purchasing during inflationary periods.

Given my stagflation view, I am favoring more defensive Large-caps over Small-caps. Large caps are more defensive because they are less economically sensitive. When the 2-Year Treasury yield peaks it is time start buying Small-caps again. That might happen by quarter end.

I am at extreme underweight exposure to Foreign equities. Global slowdown and higher energy prices should hurt foreign economies more than U.S. Moreover, the U.S dollar strength favors buying U.S Equities over Foreign stocks.

I am holding onto overweight position in the Energy sector even though global economy is slowing. Oil supply and demand will remain imbalanced for next five years says CEO of Exxon. Chinese demand for oil projected to rebound in Q4 from COVID related slowdowns. That provides support for high oil about $100. Russia might cut off gas supplies to Europe this winter. Oil embargo on Russian oil creates even more shortage in supply. Energy is the biggest contributor to forward estimates for the S&P 500 Index in 2022. The energy sector’s profits and free cash flow has never been higher and it is still selling at a multiple that is lower than S&P 500 Index, Utilities, and Consumer Staples.

I am now in the camp that bond yields will peak by year-end. The Bond market has discounted a Fed Funds Rate terminal rate 3.8% when it could be lower if inflation heads lower. The Bond market is way ahead of Fed with its discounting bond prices lower. The Bond market had its worst half year in fifty years creating attractive prices and higher yields that compensate investors for risk. I am dollar cost averaging into investment grade long term bonds while prices are cheap and to get higher current income.

Fixed-Income assets are invested in investment grade securities only. Portfolios own securities that offer floating rates. The Fed will continue to hike into beginning of 2023. Floating-rate securities rates will be adjusted upward every time the Fed hikes, so their price will not decline like a fixed rate security. Attractive floating rate securities are preferred stocks, and floating rate loans. Preferred stocks have interest rate risk like bonds, but some offer floating rate option. Preferred stocks are mostly issued by investment grade banks.

Portfolios adjusted last year to investment grade short-term corporate bonds to reduce interest rate risk. Short term bond prices drop less than long term bonds as interest rate rise. I am holding and adding to corporate short-term bonds until Yield curve steepens.

I recently sold fixed income position in Senior Loans. Senior Loans invest in the most liquid segment of the bank-loan market. Senior Bank Loans are non-investment grade issuance. Given the U.S economy is vulnerable to a recession, investment grade bonds usually outperform non-investment grade bonds during periods of recession.

I sold my commodity ETF position in all accounts. Commodities are rolling off as the global economy slows. I am holding onto material sector securities. Next year could be a better year for the Global economy and demand for materials.

Cash-equivalents invested in ultra-short bond ETFs, and investment grade floating rate notes, as well as investment grade short-term corporate bonds. These investments manage credit risk, interest rate risk, and reinvestment risk better than most areas of the bond market.