Performance Report: 03/31/2023
All performance data for our strategies is net of all fees and expenses. All performance data for indexes or other securities is from sources we believe to be reliable. All data is as of 03/31/2023.
Administrative note: Previously, I have tracked performance by averaging the returns across all program accounts participating in our managed strategy (MAP) as our exposure was fairly standardized prior to 2022. But as I integrate more derivative (1256) contracts into our strategy, exposure will vary depending on account size. For this reason, I will report performance based on various bands which are determined by account size.
We had a really nice month in March with all program accounts outperforming our primary benchmark (AOM). Interestingly enough, where we made money in March is almost exactly where we lost it in February. Our gains were focused in the real asset space with precious metals, oil and gas, and alternative energy names doing very well this month after experiencing declines in February. The risk management tools I use helped to limit those losses in February and the MAP helped me to rebuild our exposure in March.
In last month's update, I wrote, "I picked a less-than-ideal time to increase our exposure to real assets. But as I said in my thesis, 'I suspect I am early and I can't dictate the exact timing, but to get the best seats for the show, we have to show up early.'" If March is any indicator, we may not be all that early after all. Real assets rebounded in an impressive fashion in March which bodes well for our strategy over the intermediate term. For some time, I have been hearing the "train coming down the track", now, I can feel the train approaching. Our economy is nearing an inflection point and soon we'll see what happens after a central bank openly manipulates real asset prices for over a decade.
The banking panic that hit the stock market this month served to shine an even brighter light on the FED's true character. In response, they created a new lending facility that explicitly guarantees the value of underwater bonds held on the balance sheets of our nation's banks. Further, they have implicitly guaranteed the deposits of all of our nation's banks. Moving forward, the FED cannot retreat allowing bank customers to lose their deposits even when they exceed the FDIC limit of $250,000. So, despite their "inflation-fighting" mantra, the FED continues to be an endless source of monetary inflation. And this monetary inflation will invariably lead to continued and heightened inflation in real assets.
There were fireworks in the stock market this month as several good-sized banks failed in a matter of days. The speed at which these banks collapsed is unprecedented. Pundits across the financial services industry have been quick to offer their opinions on what could invariably prevent the future collapse of banks such as what happened with SIVB, CS, and others. Thus far, I have yet to hear a single "expert" propose the one true solution. The only means of preventing banking panics is the reinstatement of The Glass-Steagall Act (GSA). GSA resulted in seven decades of remarkable banking stability. With GSA, banking panics were the exception. Without GSA, banking panics always were and will again become the norm.
Banks like the one I work with who stick to sound banking principles will weather this storm. Banking cannot be exported, our country needs sound banks. But banks that violate the principles of GSA are likely to continue to fail. I have often written about the irrefutable merits of GSA, here are a couple of the more salient posts applicable to the current environment.
The FED's newly created lending facility allows banks to loan their underwater loans to the FED for 100c on the dollar. While the concept is quite frankly ingenious, it is at the same time horribly flawed. First, it is wholly predicated on the assumption that interest rates will decline over the next few years. If rates do in fact decline, then the facility may be a success. But if rates stay level or increase, the losses due to interest-rate discrepancy could prove catastrophic for banks holding long-dated bonds. Second, the new facility is hyper-inflationary which may prove to be terribly ironic. The core problem is interest rates have risen due to inflation. So by creating more inflation, rates are likely to increase even further. Is not an inflationary policy that is wholly dependent on rates falling entirely self-defeating?
Despite the contradictory nature of the FED's new lending facility, it certainly worked to calm markets in the short term. In fact, stock markets appreciated impressively in March. Tech stocks had their best quarter since 2020. Will the stock market continue to shake off the banking panic and resume its ascent as it has done time and again over the past 14 years?
Without a doubt, monetary inflation has always served equities well. To paraphrase what I wrote in last month's update, "The primary driver of long-term equity market returns is valuations, the secondary driver is liquidity (read: monetary inflation). For the past decade, liquidity has been driving equity prices higher. The 'moon-shot' experienced by equity indexes starting in late March of 2000 through December of 2021 was wholly a function of liquidity."
And in March of 2023, the primary driver of higher equity prices was again an increase in liquidity. For over a year, equity markets have suffered from a withdrawal of liquidity as assets flowed out of equities and into fixed-income. But in March, the FED's newly created lending facility forced newly "minted" dollars into equity markets giving them a heckuva a boost. The trillion-dollar question is can this be sustained?
In the short term, I'm skeptical. While stocks, especially tech names, saw big price jumps in March, financial stocks lagged by a remarkable margin. IYF, the largest financial ETF, fell over 10% in March. Throughout my entire career, I have never seen the broad stock market go anywhere without the financials leading the way. For me to develop any sort of bullish tilt toward the stock market, I would need to see financials start to outperform.
As for the long-term, I don't see how the FED's new lending facility accomplishes the task of stabilizing the banks. It's a band-aid, but not the cure. Over the past 14+ years, the FED has met a string of deflationary events with an even bigger dose of monetary inflation. They have walked an incredibly fine line between price inflation and price stability. Their ability prior to 2022 to print a seemingly endless amount of dollars while keeping price inflation in check has been nothing short of remarkable. But recently, their efforts have started to fail. While the recent banking collapses could have a deflationary impact, the root cause of the problem is rising rates which is a direct result of inflation. The problem of inflation cannot be solved with more inflation. And, as I've written in past updates, the FED can't solve the inflation problem because they are the inflation problem.
While I'm glad to see a strong rebound this month, I still have considerable ground to make up. Your accounts are still below their high-water mark set this time last year. I have made adjustments to my MAP system which have paid dividends thus far. And adding additional exposure to real assets has served us well. While we have had a nice run the past few months, your accounts have gone 12 months without appreciation which I find unacceptable. Given the model I am using, I should be able to generate gains more consistently than we have experienced.
With that being said, I feel blessed to have the performance we have had. This morning I read a fluff piece celebrating the performance of the Fidelity Equity-Income Fund (FEQIX). Fidelity hand-picks funds like this to be featured on the CNBC website. Of course, they only pick their top-performing funds for these articles. And even their best funds cannot compete with my MAP strategy on a risk-adjusted basis. Since inception, my strategy has delivered slightly more than 75% of the total return of FEQIX but with less than half the risk. FEQIX has a Value Over Risk Ratio (VORR) score of .561 versus my full strategy which scores .718. Possibly the best performing Fidelity fund over this cycle, one that a Fidelity client may have at most 10% of their account allocated to, has generated a fraction of the risk-adjusted return of my strategy, which my clients have 100% of their assets allocated to. For this, I'm thankful. I'll continue to be diligent and iterate on my process. When the macro picture I see starts coming together, our gains should be substantial. Until then, I'll continue to manage risk and buy securities at attractive prices.
As always, please do not hesitate to call me at 512-553-5151 if I can be of assistance.
1) Inception date of 4/30/2019
2) All benchmark prices are obtained through the Yahoo!Finance website. S&P 500 Index is calculated using the index price. AOM is the iShares Core Moderate Allocation ETF. Global Balanced is calculated using a 40% allocation to the S&P 500, a 40% allocation to BND and a 20% allocation to IEFA.
3) VORR is our "Value over Risk Ratio": Calculated by taking the total return divided by the sum total of all negative months. Ideally, the ratio represents how much loss does an investor have to endure to get X gain. A negative RORR score implies there is more risk in the investment than return.