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Another difficult week... Thumbnail

Another difficult week...

There is no way to sugar coat it - 2022 has been a brutal investment environment.  The S&P 500 has registered seven straight weeks of negative returns. The last time the stock index had a similar run was in 2001.  The culprits are well- know at this point.  Surging inflation and the Fed's interest rate response, combined with the war in Ukraine, still snarled supply chains and continued lockdowns in China have dented most asset classes including stocks, bonds, real estate and crypto currencies. 

This week has been particularly difficult as earnings reports from US retail giants Target and Walmart revealed that increasing costs, supply issues and lethargic sales weighed on profits.  In many ways, these results shouldn't have been a surprise as consumers have redirected spending from goods to services with the worst of COVID well behind us.

Investors' attention remains on the Federal Reserve and its ability to engineer a "soft landing" where interest rates rise high enough to dampen inflation, but not high enough to nudge the economy into recession.  The Fed's track record for accomplishing such a feat is checkered at best, so we remain on high alert.  Even with the recent volatility in the financial markets, the Fed remains steadfast in increasing short-term interest rates and withdrawing COVID-related stimulus measures as the most direct way to combat inflation. 

While the last few weeks have been difficult, there are some positive developments bubbling under the surface:

2-year Treasury yield is anticipating future Fed hikes

As detailed in the chart below, the two year treasury yield has risen well in advance of the Fed funds rate.  This indicates the bond market has likely priced in a significant portion of the negative effects of higher short-term rates on bond prices:

Chart: Fed Funds rate vs 2-year Treasury

While we don't know when rates will plateau, the data suggest that the worst of this year's bond decline could be potentially behind us. Time will tell if this is in fact the case, but in the meantime bonds are offering higher yields than we have seen for quite some time allowing for coupons and bond proceeds to be reinvested at higher rates.  Additionally, after falling in tandem with stocks for much of the year, the diversification benefits of bonds are beginning to re-emerge. 

The US Dollar remains strong

With the Federal Reserve raising short-term rates more aggressively than other central banks, the US dollar has gained strength against its major trading partners:

Chart: U.S. Dollar index has climbed in 2022

A stronger dollar makes imports cheaper for American consumers which has the potential to help aid the Fed in subduing  inflation.  Hopefully this benefit will outweigh the effect of U.S. exports being more expensive due to a stronger dollar.

Managing the risks ahead

Below are the key actions we are taking as we continue to assess the current environment:

Maintaining diversified portfolios - In 1952, Nobel award winning economist Harry Markowitz made the case that diversification "is the only free lunch in finance."  This concept demonstrated that portfolio diversification can reduce overall risk without sacrificing expected returns over the long-term.  This is one of our core tenets and is why we diversify portfolios across multiple asset classes.

Avoiding market timing - Over the last 20 years ended 12/31/21, the S&P 500 returned 9.5% on an annualized basis.  If the 20 best trading days were missed, the return of the S&P 500 would have been reduced to 2.6%.  Missing the 30 best days distilled the S&P 500's return to 0.4%.  Missing 40 days or more resulted in negative annual returns.1

Rebalancing portfolios - As portfolio allocations have shifted over the last few months, we are continuously looking for opportunities to rebalance portfolios toward long-term asset allocations.  While the current environment has provided fewer opportunities to rebalance than in the past, we remain at the ready to make adjustments as market conditions dictate. 

Tax loss harvesting - In taxable accounts, we are in the process of assessing opportunities to sell selected positions in order to realizes losses.  Realized losses can be carried forward to offset future gains and provide a tax benefit.  Such decisions are highly dependent on individual portfolios, our assessment of replacement positions, and their potential impact on overall investment strategy.

Strategic financial planning - Our financial plans typically incorporate market conditions and scenarios that are more severe than what we have currently experienced.  That said, we are monitoring the potential impact of current developments on strategic financial plans and will recommend adjustments as warranted.  

Our focus on these actions will help us make the most out of the current market environment and position portfolios for whatever lies ahead.

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1. J.P. Morgan Asset Management analysis using data from Bloomberg. Returns are based on the S&P 500 Total Return Index, an unmanaged, capitalization-weighted index that measures the performance of 500 large capitalization domestic stocks representing all major industries. Indices do not include fees or operating expenses and are not available for actual investment. The hypothetical performance calculations referenced are for illustrative purposes only and are not meant to be representative of actual results while investing over the time periods cited. The hypothetical performance calculations for the respective strategies are shown gross of fees. If fees were included, returns would be lower. Hypothetical performance returns reflect the reinvestment of all dividends. The hypothetical performance results have certain inherent limitations. Unlike an actual performance record, they do not reflect actual trading, liquidity constraints, fees and other costs. Also, since the trades have not actually been executed, the results may have under- or overcompensated for the impact of certain market factors such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. Returns will fluctuate and an investment upon redemption may be worth more or less than its original value. Past performance is not indicative of future returns. An individual cannot invest directly in an index. Data as of December 31, 2021.

Advisory services are offered through Darrell Capital Management, LLC, an Investment Advisor in the Sate of California.  All content is for informational purposes only.  It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. Nor is it intended to be a projection of current or future performance or indication of future results. Investing always involves risk and the possible loss of capital. Opinions expressed herein are solely those of Darrell Capital Management, LLC.  The information contained in this material has been derived from sources believed to be reliable but is not guarantee as to accuracy and completeness and does not purport to be a complete analysis of the materials discussed. Being registered as an investment advisor does not imply a certain level of skill or training. Social media posts reactions and comments should not be viewed as endorsement or testimonials. The information contained herein should in no way be construed or interpreted as a solicitation to sell or offer to sell advisory services to any residents of any state other than the state of California or where otherwise legally permitted.