Portfolio Shield – July 2022

Last month I wrote that it appeared we were at the beginning stage of a big Bear market rally. Investors and money managers were extremely bullish, and money poured into stocks.

After a brief move higher, stocks reversed direction and headed lower. Not even quarter-end rebalancing and a flood of corporate share buybacks before the blackout period begins could make stocks rally.
Why is this Bear market different?

This past Bull market was born on a combination of fiscal and monetary stimulus. It was a liquidity-driven market.
Now that Fed is aggressively tightening monetary policy and fiscal stimulus programs are largely over, stocks are unwinding their liquidity-fueled rally.

The risk to stocks remains to the downside.

This is why, despite the formula’s decision to remove the bond hedge for June, I felt it was prudent to continue to hold the two Simplify funds (SPD & QQD) with the embedded downside put options, to further control any downside risk in equities.

Relative to other strategies, we performed very well in June due to our large allocation to the S&P 500 which was the top-performing equity index last month. We also continue to perform well against our peers over multi-year periods.

Due to further downside risks in the market, I intend to continue holding the two Simplify funds (SPD & QQD). Be aware, that if there is a big Bear market rally, the performance will lag to the upside due to the embedded put options.

Our new Chief Strategist, Jeff Snider, agrees with this decision to keep the additional downside hedging in place for the following reasons:

After the initial shock from March (oil/gasoline, financial markets), there was a period of reassessment that centered on Asia, specifically China as one possible upside catalyst. The global economy had entered 2022 in a weakened state, the subsequent price spike in energy likely proving one blow too many to have suffered.

However, if the Chinese reopening from Zero-COVID lockdowns could have proved enough momentum, there had been a (slim) chance to avoid a further slide in the global economy. Over the intervening period, as restrictions in Shanghai and other regions have been lifted, markets particularly those for industrial commodities and shipping rates have conclusively traded in favor of downside risks becoming too much (and China’s reopening potential too little).

The wild card in bond markets and rates has been the so-called “reaction function” of the Fed, and the FOMC’s ability to pressure the short end of the market (yield curve like eurodollar futures) in single-minded political pursuit of making the public believe it could tame CPIs. The balance earlier had been tilted toward a clear(er) path for more rate hikes in the near term, thereby creating the basis for the selloff in longer-term instruments (but also inversion).

Given so many visible and growing deflationary pressures along with increasing downside macro risks (no longer just recession, the growing prospect for serious maybe prolonged recession), over the last several weeks the market balance has shifted decidedly in favor of the contrary longer end (deflation, falling future yields) regardless of Fed/mainstream expectations and projections for further rate hikes.

Portfolio Shield™ decided to reinstitute its bond hedge for July, as I mentioned last month it was likely to do in the coming months.

Due to the amount of equity volatility, it has instituted a relatively large percentage based on its historical hedging size. This indicates the formula believes the downside risks to stocks are very high and the downside risks to bonds are rather low.

We are also seeing the conditions where the strategy can shine and even rise during a Bear market. When growth and inflation expectations fall, as they both eventually due during a Bear market, bond prices rally.

I am excited to see the strategy reinstitute its hedge as the bond market is beginning to signal the Fed is making a mistake by continuing to tighten monetary policy.

When the bond market rallies during periods where the strategy is hedged, it can quickly, and strongly outperform which is very exciting!

For those in Balanced, Income, Conservative, or bond-heavy models, hold tight – your day is coming soon.
Thank you for your continued trust in allowing me to manage your money with Portfolio Shield™.

Portfolio Shield™ reduced its allocation to SPD & QQD and added a position in TYA across all models for July.

As a reminder, all strategies are rebalanced on the first trading day of each month and at that time, any new monies are invested according to the model strategy you are in.

For those who want to change between strategies, changes will occur at the next rebalance on the first trading day of each month.

Zero balance accounts that have had a zero balance for six months or more will automatically be closed and the advisory agreement terminated, where applicable.

There is only a 0.3% allocation to cash in each model. Due to a misreporting between Morningstar® and the ETF providers, the Asset Allocation box on the fact sheets may show a higher cash position than is actually in the model.

If you have any questions or would like to change which Portfolio Shield™ strategy you are invested in, please let me know.

Linked below are the latest Morningstar® Investment Detail Reports for the Portfolio Shield™ family.

Thank you,

Steven Van Metre, CFP®