Monroe Wealth Management Portfolio Allocations & Insights 7/21/22

Key Takeaways:

• Shift stock/bond split closer to benchmark and reduce sector and factor bets, as unusually acute uncertainty and competing economic crosscurrents cloud short-term visibility

• Trim exposure to inflation-protected US treasuries (“TIPS”) and other inflation-oriented hedges, attempting to lock-in gains and reduce active tilts as concerns over future recession risks rise relative to current inflation risks

• Maintain a preference for US stocks over international developed market and emerging market stocks, as the toll of war in Europe and chronic Covid shutdowns in China plague regional consumer sentiment and near-term economic prospects

• Increase credit quality and reduce long-held underweight to duration to better align with benchmark exposure, adding to longer maturity nominal US treasuries and investment grade credit

Trade Rationale:

• Mixed economic data, an emboldened Fed hiking into a cyclical slowdown, and stock and bond markets that have ostensibly already priced in a lot of bad news (but with still-elevated analyst earnings expectations) provide conditions to blueprint both bull and bear arguments. We don’t have much confidence in which reality firmly takes hold from here and believe the market’s current price action represents more noise than signal.
• Unemployment remains near historic lows, job gains remain solid, and even recent increases in jobless claims are relatively small, but consumer cash and wealth cushions have shrunk, business confidence has plummeted, and most of the yield curve has inverted as growth and inflation worries butt heads. We expect the Fed may frame the robust labor market and high headline inflation phenomena as sound justifications to energize their tightening campaign, with stock market volatility unlikely to dissuade their commitment to the cause. Indeed, a substantial pullback across risk assets is a targeted objective of the Fed’s mission, not a byproduct. Their goal is to cool growth, dampen investment, and eventually pulldown inflation via demand destruction – but these efforts also raise the risk of a potential policy error and therefore may increase the probability of a recession. Nonetheless we are mindful that the Fed has repeatedly demonstrated an ability to abruptly U-turn in recent years, and so we may be relatively quick to pounce on any meaningful hints of a dovish pivot.
• For these reasons, we continue to de-risk now to be nimble later. Our moves to reduce active risk over the last several trades have served us well amidst prolonged market stress, but by further balancing out our value/growth exposures, scaling back our energy and commodities positions, and targeting lower total portfolio volatility, we can seek to insulate the portfolio from the uncertainties of today and be better situated in the future to deploy risk as potential opportunities arise.