Category: Monthly CRA Newsletter

Market Summary

Welcome back readers. As we proceed through the 4th quarter of 2022, and into the busy holiday season, we wanted to give you an update on some important developments in the markets.

As we discussed in our last newsletter, higher interest rates and inflation will be one of the largest drags on the on the markets investors have seen for years, and maybe a decade. In 2022 globally, we have experienced negative returns in nearly every asset class, market, sector and industry. Outside of a few areas including oil, natural gas, grains, select minerals and some segments of the commercial North America Real Estate market nearly everything is down, and in the double-digit realm. The once darling North America technology sector is off -30% this year, with nearly half stocks in Nasdaq down -30%. For investors there has been nowhere to hide. The standard 60/40 portfolio, consisting of 60% stocks and 40% bonds is down -15% which is the worst return in decades.

Since the beginning of the year, we have all become extremely familiar with hearing the terms “inflation” and “interest rates” in our daily lives; two terms that had hardly a mention over the previous few year(s). Volumes of books, and entire academic studies, have been dedicated to these two subject matters, so we are in no way going to cover any substantial ground here. But that said, we are going to briefly discuss how interest rates and inflation have deeply impacted markets in 2022 and what we see for 2023 for investors.

Inflation and Interest Rates

Inflation

Yes, we all see the price increase in our daily lives. From energy, rent, mortgages to a meal at our favorite restaurant. The reasons are debatable, and multiple factors are in play. The Labor Department reported last week that so-called core prices, which exclude volatile food and energy items, rose 0.3% from September, the smallest monthly gain in a year, and by 6.3% on a year-over-year basis, down from 6.6% in September. Investors and policy makers watch core readings closely as a reflection of broad price pressures and as a predictor of future inflation. While recent Federal Reserve data is showing an improvement and or a possible “leveling off” inflation is still way too high for the Federal Reserve. It is important to understand the Federal Reserve has 2 mandates. One is price stability, and the other is job stability. Despite the markets desire, and past misguided interpretations, investors should brace for more Fed hikes to tame inflation. The Fed raised rates in November by .075%, and most likely will raise .50% in December. In 2023, if inflation numbers do not come down substantially, they will increase again. Yes, at some point it will come to an end. Rates have a lag effect, and a pause will be needed to see the impact of raising nearly 500 basis points this year. But, having listened to nearly every word, and speech, by Chairman Powell for last year he has been as clear as anyone can be; he will not stop raising rates until inflation in well under control and in the 2% range. One month of improving numbers will not meet the Federal Reserve benchmark of 2% inflation rate. We still have a way to go.

Interest Rates

The Federal Reserve’s tool kit of implementing monetary and fiscal policy is large, but it is blunt. To fight higher inflation the Fed has two hammers. One, tighten monetary conditions, restricting the amount of money it lends to the markets. Second, and primary to reduce inflation is raise short term interest rates. While raising rates cools everything, from lending, borrowing, housing to demand from consumers it has negative side effects of being difficult to measure its results in real time (lag effect). Bottom line investors and markets won’t know when, and if, the interest raise increases will have their desired effect. The Fed is in a race to tame inflation without tipping the consumer and economy into a recession. Federal Reserve does not know if they will achieve this tight balance and Copper River does not know as well. The longer that inflation stays in the higher 6,7 to 8% range the more risk of extreme rate increases and the probability of a soft landing for the economy and consumer diminishes greatly. Investors should remain excessively cautious until we see the recorded inflation numbers come down steadily over a few months, and an official Fed stance taken publicly that they have ceased in their rate hiking campaign. Fed governor Chris Waller said recently that is was too soon to conclude inflation had peaked, and the Fed could end its rate increases; he was quoted as stating “I will not be head- faked by one good inflation report”.

If inflation and higher interest rates have created a bear market, why do we have a rally in October and November?

Stock and bond markets do not move in straight lines. The markets hit an inflated high last December 2021 before the Federal Reserve started raising rates and the world realized we had a real inflation problem. Individual positions, and sectors that make up a portion of one’s “equity allocation” will never price in a straight line. Investors were however lulled into a bit of a false sense of higher and higher returns coming off of 2020 Covid recovery which inflated the market. We are in a Bear Market, without a doubt, but we will see relief rallies inside the market. We have seen 3 of these since beginning of 2022, but we are very wary of over-allocating on these relief “bear hug” rallies as the core problem of reducing inflation and interest rates being held steady has yet to occur.

When will the equity markets will recover?

Advisors, analysts and market pundits have a way of over-analyzing nearly every piece of economic data released. We have been very clear to our investors, and it’s reflected inside our portfolios. This is that a higher than usual allocation to Cash, Private Equity and individual high-quality Bonds has been necessary in 2022. These higher-than-normal percentages should remain until the Federal Reserve pauses its rate hikes. Guessing “when” this will happen, and weighting equities prior to it happening in an attempt to” time” the market is not recommended. Investors make money slowly and or risk to lose it quickly, and large speculations on timing is one way to add excessive risk to a portfolio and suffer large setbacks. With so many indices, stocks and equity sectors down in deep double-digit territory we have lots of places with upside opportunity to start to redeploy cash once we see inflation numbers come down, and the subsequent Federal Reserve follow up of freezing rate increases. Investors need to be patient, but the time will come sometime in next 1-3 quarters.

Understanding returns inside a portfolio

Investors have been lulled into a bit of false security with the strong returns in 2020 and 2021 followed by this year’s correction. Markets coming out of Covid experienced little volatility spurred on by low rates, and governments of the world pumping unlimited funds into their economies. Historically, the S&P 500 average total return annually is at around +7% since 1934. Bonds have been around +3%. Investors need be careful looking at 2022 YTD returns and think something is terribly wrong with the markets. The returns of 2020 and 2021 were nearly double historical averages and the peak of the exuberance came at the end of 2021. Unfortunately, markets hardly ever move in s a straight line. With the current headwinds of inflation and higher rates investors need to show caution. On a bright note, these headwinds will pass at some point and we can begin rebuilding positions to take advantage of a better macro environment.

What areas& sectors are working inside portfolios?

2022 is really a screen of red across nearly all asset classes, indices, sectors, regions and countries. Only a few bright spots exist. These being commodities including; Oil, Natural Gas and Grains. The U.S Dollar is up YTD, and we have allocated a small amount into an ETF tracking the currency. Shorting “U.S Treasuries” has been effective hedge as rates and prices move in opposite direction. Certain parts of the credit market that capture the rising rates inside mortgages and credit have done well. We are starting to see really strong yields in Bonds again which we will cover below. Private Equity (PE) and specifically BREIT from Blackstone has been a real positive standout for our investors with a +9% YTD. Real Estate is holding up for time being. Here is a link if investors want to view those details a bit more. Cash has been a great spot to be in for 2022, and we have cash at a higher % of portfolios than almost at any time before. Globally only commodity producing nations like Brazil and Canada have fared well, but outside few small areas and sectors that can only be weighted in small percentage investors globally are seeing double digit negative returns for the year.

https://www.breit.com/?gclid=EAIaIQobChMIhK60kOrJ-wIV4i-tBh2-TQ5eEAAYAiAAEgL11vD_BwE

What about bonds? Yes, finally some good news

The equity market(s) have been on a roller coaster over the past 11 months, with a possible rocky landing soon to be determined in 2023. While at the same time the bond market is once again in the green. With the Feds historic rate increases this year comes higher yields, and finally relief for fixed income investors. Given our background and our client’s needs we are a firm that is heavily fixed income focused. With interest rates finally pushing bond yields to an attractive level, we are seeing strong applicability and interest in our individual corporate bond ladders for clients. The bond market has come a long way in past few years in terms of being accessible to the individual investor and transparent pricing. Our buy and hold strategy with laddered high-grade individual bonds are an efficient way to build a resilient asset class inside a portfolio and achieve steady and reliable stream of interest income. We are seeing yields at or near 5% annually on high grade bonds. We will be allocating a larger percentage to this asset class as we come into 2023.

Conclusion
At CRA each investors portfolio is customized based on age, risk tolerance and other individual factors. Being an independent firm, we have the luxury to quickly, efficiently and inexpensively shape a client portfolio to handle difficult macroeconomic events. This has been the case in 2022. It all starts with having designated a proper asset allocation, rebalancing when conditions change, and sector rotation of positions to the account level. Our goal is to aim for Institutional quality portfolio management, and very much what you would see at a leading pension fund, foundation, endowment. Using the best products such as ETF’s and partner managers like Blackstone and Ares for Private Equity we can achieve balance in even the most uncertain conditions.

While 2022 has been difficult, we understand and have managed assets in these types of markets in 2001, 2008, 2009, 2010 and 2020 (covid drop). While the positives have been few and far between this year, investors need realize that with so many great stocks and sectors down their will be tremendous opportunity ahead. We plan to position for these opportunities when we see inflation come into a reasonable place and when we see a Federal Reserve that stops raising interest rates. This situation will come, and we are certainly closer to the end than the beginning. We thank you if you continued reading up to this point and please call or email us at any time. Happy Thanksgiving.

-Team Copper River

Market Summary

Welcome back readers. We hope you are enjoying the spring and have made plans for a summer break. Let’s get to it. Yes, the first five months of 2022 have been a very challenging time for the equity and the bond markets. By now, we are all aware of the obvious keydrivers weighing on the markets: (1) Inflation running hot with an 8.3% April CPI print (2) the Federal Reserve’s plan to aggressively raise interest rates, (3) slowing corporate earnings (4) war in the Ukraine (5) ongoing COVID lockdowns in China and the impact on supply chains.

As of this print, year to date (YTD) the S&P 500 is down -17.9%, the NASDAQ down -26.9% and the DOW is down -13.8%. The carnage has been much worse under the main market averages. Over 50% of the stocks in the NASDAQ are down over -50%. The aggregate bond market has not been spared. Rising rates have had the expected negative impact on the bond market, as interest rates rise, the prices of bonds with fixed coupons fall. The AGG (iShares Core U.S. Aggregate Bond ETF) is down -9.86% YTD. As we will cover below in “Yields on The Rise”, those bond investors that hold to maturity can still effectively capture a steady stream of income and be repaid at par value if positions are held to maturity.

On a positive note, two main points to make, 80% of the companies that reported first quarter earnings beat analyst expectations. Secondly, the U.S consumer continued to show strength in spending though major retailers are beginning to report slower sales and providing lower guidance. While we are confronted with high inflation and Fed balance sheet reduction, we are not in a 2008/2009 scenario in which we saw global fundamental structural issues in the housing, banking, capital markets etc. If we are in a “Bear” market, which is TBD, it is always important to understand that Bear markets are generally short-lived, and recovery can be swift. See chart below.

The markets are, and always have been, a forward-looking mechanism on the economic outlook and are considerably impacted by investor sentiment. The stomach-churning volatility is present this year as bankers, financiers, private equity firms, portfolio managers and investment advisors have been adjusting, hedging, and speculating as they consider whether the Fed rate increase(s) over the next year or two will push the economy into a recession or if we will be able to achieve a “soft landing”?

Below we will cover in more detail how we are working to best address portfolio holdings in this uncertainty, and some ways to keep risk at bay if conditions deteriorate.

 

Investor Sentiment Matters

The recent downturn in stocks and bonds have left money managers with few places to hide, and data has shown that individual investors are becoming increasingly pessimistic. The share of investors who believe the stock market will fall over the next six months ended April is at its highest level since 2009. However, widespread pessimism isn’t necessarily bad news. Some view this as contrarian indicator, betting that when sentiment appears to have soured to an extreme level, markets are poised for a rebound. Given the downdraft in nearly all asset classes YTD (with some exceptions we talk about below) one can make the argument that the damage has been done, even if we enter a light recession in late 22 or 23.

For asset allocation specialists and tactical portfolio managers, these roiled markets are often a good time to put money to work and, depending on the investor and their individual portfolio strategy, is why we like to hold 10-25% cash at any one time. The Oracle of Omaha, Warren Buffett, a longtime adherent of value investing, has long advised that investors “be greedy when others are fearful.” That philosophy was difficult to practice for much of the past two years, during which investors’ mood largely seemed ecstatic and without fear. It should also be noted that Berkshire Hathaway is one of the few stocks, with the exception of those in the commodities sector, that is up year to date.

In summary, one should see sentiment as an important part of what moves the market. As the Fed and economic picture becomes a bit clearer, we see sentiment improving and see a tremendous opportunity to buy targeted holdings.

Bond Yields on the Rise

As global interest rates were relatively low for nearly a decade, dividend stocks didn’t have a lot of competition for income investors’ attention. But now, as the Federal Reserve continues to raise interest rates, and tighten monetary policy to fight inflation, the landscape has changed dramatically and swiftly. The Fed’s rate hikes have started to take hold, and this is reflected in yields. For fixed income investors, new issuances with higher yields/coupons are a welcome sight. For those retired and/or those having a more conservative risk profile, the prospect of higher bond yields and the steady income stream they provide is increasingly attractive.

Where to Invest

For the past two years rising tides have lifted nearly all market asset classes. 2022 is a different market, and while volatility is here to stay for at least the short term, there are sectors, industries and asset classes that are working this year. We will highlight these below:

Sectors: The industry sector picks that we highlighted in our January newsletter that are working this year include Energy, Agriculture, Metals & Mining, Industrials and High Dividend Producers. These sectors, particularly Energy (XLE +48.8% YTD), Metals & Mining (XME +15.8% YTD), and Agriculture (DBA +13.4%) performed particularly well and should continue to perform well due to macro conditions pushing them forward. In terms of technology, we remain focused on quality technology companies that have strong business models, material market share, strong cash flows and billions of cash at hand. While big tech has not been immune to recent sell-off, one can make the case that Apple, Amazon, Google, and Microsoft are strong, extremely profitable companies with excellent prospects and should be held thru nearly any market cycle.

Value: Relative to growth stocks, value stocks have performed better this year as rising rates weighed on growth stocks. Growth stocks are considered long duration because their cash flows are realized further into the future, and higher rates reduce the present value of these future cash flows. Value stocks are shorter duration with cash flows returned to shareholders earlier in the investment cycle. While value has performed better than the market is should be noted is still down -4% on one year basis.

Bonds: Our client’s bond positions are held in individual investment grade corporate bonds that are laddered in terms of maturity date. An individual bond position, held to maturity in a bond ladder, will be paid full face value upon maturity, absent default. Defaults in high grade corporate market are .002% over past 25 years. Higher yielding bonds, with higher interest income streams, are making bonds more attractive than they were less than two years ago. As mentioned previously, one needs to consider the impact that rising yields will have on a fixed income portfolio. This impact is magnified with longer duration portfolios.

Private Equity (PE): A traditional 60/40 weighted portfolio has not performed well in 2022. Coming into 2022, with storm clouds building, we looked to be proactive and overweight certain specific industry sectors, as well as add to alternatives and build up cash cushions. For our Accredited and Qualified Purchaser clients we have directed a significant percentage of their asset allocation into alternative investments. For a Qualified Investor an appropriate asset allocation should look different as we go through these market corrections. What this means is that an asset allocation of 25% Equity, 25% Bonds, 25% Alternatives and 25% Cash may be a more appropriate holding now than it had been in the past.

Private Equity has a lower correlation to equity market price movements and can add value and diversification. Our January 2022 newsletter provided some detail on this asset class and included two recommendations.
BREIT (Blackstone Real Estate Income Trust) which for the first four months of 2022 reported a total return of +6.0%.
BCRED (Blackstone Private Credit Fund through 3/31/22 had an annualized distribution yield of 7.8% and its ITD (Inception to Date Total Return) was 9.1%.

Each investor is different and adjusting one’s asset allocation is a detailed and private conversation that takes place between the investor and the advisor.

Please contact us if you would like to discuss, in more detail, these PE funds and or any of the other PE holdings the firm works with and to determine if this asset class is appropriate for your portfolio.

https://www.breit.com/wp-content/uploads/sites/23/2022/05/BREIT-Quarterly-Update.pdf

As an investor, having perspective beyond the recent market volatility and the latest news headline is important. Let’s look back to just twelve months ago. We began 2021 with a massive market disruption caused by a highly contagious virus that we did not fully understand. The rapid downward market spiral was tempered, surprisingly quickly, with news that multiple vaccines were being developed with high efficacy with the qualification that the vaccines would take time to develop and distribute. In early 2021 the way we worked, shopped, traveled, and spent time together had all changed. Fast forward to the end of year. Effective vaccines had been developed and had been made widely available. Schools reopened, workers headed back to the office and our lives started to return to a new “Normal”. As the world saw light at the end of the tunnel, the markets, to include equities, bonds, commodities and private equity continued their steady move upward. The equity markets ended the year with a remarkable gain of +20% for the Dow, +25% for the NASDAQ and +11% for the international markets.

For 2022, the consensus among most market strategists, and our firm’s view, is that the strong equity market returns of 2021 will be difficult to achieve as fiscal and monetary policy support fades. The expression that “The Federal Reserve is going to take away the punchbowl” is accurate. Inflation will require that the Federal Reserve raise rates, halt its bond buying more quickly and reduce its balance sheet. Expectations are that the Fed will raise short term rates three to four times in 2002, perhaps as early as March 2022. As we have seen before in 2018, concerns about rising rates have prompted a drop in growth stocks and, in particular, “high growth technology”. While we urge caution with the tech highfliers, we are still optimistic about “Big Tech” and “Older Tech”, in particular Apple, Amazon, Google and Microsoft. These four massive companies have comparatively low trading multiples, strong growth prospects, billions of cash on the balance sheet and make a strong case for investors maintaining and or adding to the positions.

Industries and Sectors for 2022

Our top sector picks for 2022 are: U.S. Financials, Metals and Mining (Lithium), Energy, Health Care, Agriculture, Industrials and high-grade North America Technology. Financials currently have low Price Earnings multiples relative to the overall S&P 500 average, and do well during periods of gradually rising rates and a rising yield curve. A rising yield curve increases the net interest income that a bank earns, and the strong economy bodes well for loan demand and credit quality. Industrials and other cyclicals also tend to do well during this period of the economic cycle. While we will continue to be more heavily weighted towards U.S. equities, we are adding to specific international countries and foreign sectors as the pandemic moves more to an endemic state. We also continue to believe in several smaller “transformational sectors” that have the ability to change the way we live, work and the ability to disrupt entire industries. Some of these include Fintech, Electric Vehicles and Green Energy, Quantum Computing, Artificial Intelligence and Cryptocurrencies. Please see the asset class returns for 2021 below in relation to prior years.

Fixed Income (Bonds)

With the 10-year Treasury bond currently yielding 1.76% and the AGG (ishares Core U.S. Aggregate Bond ETF) yielding 1.95%, investing in U.S. Treasuries and investment grade corporate bonds, in the near term, will generate negative real returns given the current rate of inflation. The FOMC (Federal Open Market Committee) of the Federal Reserve estimates that inflation will average 4.2% in 2022 and, over the longer term, up to 2024, 2.1%. It is important to note that clients that have kept a material percentage of their portfolio in medium-to-longer duration bond funds now have significant unrealized gains in their portfolio. Since there is an inverse correlation between bond prices and yields, these gains will decline as interest rates rise, all other factors held constant. For those clients, who maintain a position in corporate bonds, we moved to shorten the underlying duration to reduce interest rate risk. Of importance is that our client bond positions are in individual bonds that are laddered in terms of maturity date. A bond held to maturity in a bond ladder will be paid full face value upon maturity, absent default. Recent news headlines like the January 11th, 2022 article in Bloomberg “Buyers Strike Funds Sees Bond ETFs of Every Stripe Bleed Billions” does not impact our approach as we hold individual bonds for our investors and not bond funds, and/or bond ETFs.

Private Equity

Private Equity is considered an “Alternative” asset class consisting of capital separate, and distinct, from securities, commodities, bonds, etc., that are traded on public exchanges. Private Equity firms invest in private companies, credit, venture capital, leveraged buyouts and real estate. This asset class can be an excellent addition to one’s asset allocation in that it can enhance returns, provide asset class diversification, and reduce portfolio volatility. However, investments in private equity are illiquid for a minimum time period and require investment time horizons ranging from one-year to longer than five years before capital can be returned. In addition, shareholders are required to be “accredited” and/or “qualified” for the investment and the investor needs to meet minimum net worth and/or net income requirements. Because of the high due diligence and vetting of the investment the best funds raise capital most often exclusively from institutional investors such as pension funds, endowments, and sovereign wealth funds. Some PE funds have recently started offering windows of investment to high-net-worth investors through Registered Investment Advisory firms (RIA) that cater to High-Net-Worth investors.

While there is the potential for attractive returns in PE, a potential investor must take into consideration the capital lock-up periods, liquidity constraints and overall net worth. Copper River has clients invested in several “Alternative Asset” strategies including Private Real Estate Investment Trusts, Private Credit, Growth Equity, Global Secondaries, Multi-Strategy Funds, and Emerging Bio-Tech. We would be glad to discuss with you how this asset class might add value and long-term price stability to your investment portfolio. Below we will highlight two of the major PE holdings for our high-net-worth investors.

BREIT is a private real estate income trust managed by The Blackstone Group. Blackstone is the largest owner of real estate in the world. BREIT has a Total Asset Value of $78 Billion (as of November 2021) and is invested in 2,226 properties across the U.S. BREIT has paid a dividend for 55 consecutive months at an annualized rate between 4.5% -5.0% for Class D shares. The most significant real estate holdings in the fund consist of residential 46% (multi-family housing in the high growth south and southwestern U.S) and Industrial 34% (mostly ecommerce warehouses). For 2021, 90% – 100% of BREIT dividends will not be subject to federal taxation. Total Class D returns for 2021 were 26.4%. For reference, here is the link to BREIT: http://www.breit.com

BCRED is a Blackstone private credit fund with $25.1 billion under management as of 11/30/2021. Private Credit is an asset defined as non-bank lending where the debt is not issued or traded on the public markets. Private Credit has grown rapidly since the financial crisis in 2008 as banks have scaled back their lending to middle market companies and private equity firms have moved in to fill the space. BCRED’s loan portfolio is diversified by issuer (424 positions) and across industry sector (51). 99% of the portfolio is floating rate and 97% is senior secured with 90% secured, first lien. Loan-To-Value is < 50% which equates to better than 2:1 collateral coverage. The targeted pool of borrowers consists of U.S. middle market companies with EBITDA > $30 million p.a. The fund is targeting a total return + 8.0% which compares well with fixed income alternatives. For example, the 10-year U.S. Treasury was yielding 1.76% in early January 2022 and the U.S. Aggregate Bond ETF was yielding 1.99%.

Private Credit is an effective way to diversify and reduce overall volatility in your investment portfolio. Returns are reasonably predictable given that interest rate risk is, for the most part, eliminated. This is because borrower loan rates are floating rate, not fixed, and are reset at least quarterly. The major risk of this asset class is credit quality. This risk is mitigated by BCRED portfolio construction, diversification (by issuer and industry sector) and by the senior, secured loan composition of the BCRED loan portfolio. Historical loss rates in private credit over the period 2006-2021 averaged 1.4% (vs. historical yield of 8.8%). This compares favorably to High Yield Loans which have historical default rates and historical yields of 1.8% and 4.0%, respectively. Please contact us if you would like to discuss the fund in more detail and to determine if this asset class is appropriate for your portfolio: https://www.bcred.com/

Conclusion

While most market strategists predict returns in 2022 to be more aligned with the historical average in the 8.0% – 10% range, we should expect markets to remain choppy in the earlier part of the year given omicron, interest rate hikes, supply chain bottlenecks and mid-term election uncertainties.

As advisors we are always being asked what the best investment for a given year is going to be. For 2022 that investment just may be discipline. Discipline is one of the most important investing virtues one needs to have in order to achieve long-term success in the markets. When one drastically changes their long-term course based on a short-term event, they may be caught off guard and experience regret soon thereafter. Understanding where your risks are, and if are they appropriate to your long-term goals, will be more of a concern this year. Working closely with your Investment Advisor to achieve and understand that picture, and align your asset allocation and positions accordingly, will be key to a successful outcome.

As we begin 2022, you may have questions in terms of CPAs and/or estate planning. If so, please reach out to us. As Investment Advisors we should be involved in this process and working alongside these professionals is an important component to both tax and estate planning.

-Team Copper River