The Barbell of Diversification
To our clients and associates,
The first quarter of 2022 featured the widely publicized banking crisis and continued fear of a recession. Despite this, bonds returned 2.96%, the S&P 500 Total Return index gained 7.50%, and the MSCI EAFE (international stocks) returned 8.47% in the quarter. Since the October 12th low of last year, the S&P 500 is up 15.84%.
We continue to maintain a barbell approach in our clients’ portfolios given the uncertainty of the economy. On one side, we have the exposure to the stock market across six different equity asset classes. In the international markets we maintain exposure to the emerging markets, small companies within developed countries and large companies in those same countries. In the United States, we maintain exposure to small, mid and large companies. These are the asset classes that we expect to drive the growth in the portfolio over time.
In our bond portfolio we are maintaining a significant overweight in US government backed bonds and US government backed inflation protected bonds. We have smaller exposures to high quality corporate bonds and mortgages. Government bonds tend to do well in times of economic turmoil making them a great diversifier to equities with the tradeoff that in boom times, they may lag behind (as stocks tend to perform strongly).
Last year, this barbell approach offered little in the way of protection as all broad asset classes fell due to inflationary fears. These fears have dropped considerably. As measured by the Consumer Price Index (CPI), inflation peaked in June 2022 at 9%. As of March of this year inflation has dropped to 5%. If you annualize the average inflation of the past 3 months, inflation is running at 4% indicating it is likely to continue its drop. As expected, this lower level of inflation along with the higher yields on bonds is enabling the benefits of diversification to return to the market.
For example, from March 6th to March 13th, the period representing the peak to trough selloff of the banking crisis news, we saw US stocks return around -5% while our longer dated government bonds returned nearly +5% during the same period and our intermediate term government bonds returned nearly 3%.
We feel this approach continues to be the right one given the murky economic environment as it gives us significant optionality. Should equities continue to recover we feel this gives us a good opportunity to cut back the risk of your portfolio and add to bonds. Should the market fall, the bonds should give us a good source of funds to add to stocks at cheaper prices.
Famed investor John Templeton once said, “Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.” It does feel possible that the birth of the new bull market was October of last year. I hesitate to write that indicating we may be in the skepticism phase. Only through time will we really know the answer. These volatile markets and uncertain time underscore why we believe that building diversified portfolio is consistent with having long term success in the markets.
Wishing you well!
Past Performance is not indicative of future performance. Loss of principal and/or loss of portfolio value are possible