Quick Take: Low Risk Equities—Well Suited to Economic Headwinds
Fed hikes aggressively to regain price stability, even at risk of recession
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Whereas the Fed’s July rate hike had merely brought borrowing costs back to 2018 levels, its latest 75bp increase pushed the fed-funds rate to its highest level in 15 years.
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Nonetheless, real rates remain historically low, suggesting that the Fed may still have a long way to go. Amid growing concern that hawkish policy will lead to a “hard landing,” the Treasury yield curve has inverted, a pattern that often is interpreted as a harbinger of recession, and the stock market has resumed its 2022 slide.
Low risk portfolios: Well suited to current economic headwinds
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With respect to inflation, low volatility portfolios typically overweight sectors, specifically staples, health care, and utilities, that have performed comparatively well during past periods of high reported inflation.
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With respect to recession risk, the top chart shows that, over a near century-long history, a hypothetical minimum variance portfolio generates strong active returns when equity multiples contract. The bottom chart explicitly maps the pattern to the business cycle, showing that the low vol portfolio produces significantly higher returns than the cap-weighted market during recessions, with nearly full upside capture in other periods.
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Looking forward, we see timely appeal in low vol equities, given the combination of stubbornly high inflation, the Fed’s apparent resolve to regain price stability and maintain its credibility, and U.S. valuation multiples that remain historically elevated despite the recent selloff.
Low Risk Portfolio Active Returns and Change in CAPE (3Y rolling)
Low Risk Portfolio and Market Returns (1933-Jul 2022)
Hypothetical Legal Disclaimer
The hypothetical examples provided in this presentation are provided as illustrative examples only. Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual performance results subsequently achieved by any particular trading program.
One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.
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