SPDR® SSGA Global Allocation ETF (GAL) – Q2 2022 Commentary
During the second quarter of 2022, GAL outperformed its custom strategic benchmark. The fund finished the quarter with an overweight to commodities and cash. Within fixed income, the fund had targeted allocations to long and intermediate Treasuries.
Directionally, our preference for commodities and our tail risk basket, both cash and gold, aided relative performance. We held a persistent overweight to commodities throughout the second quarter. Despite plunging in June on demand concerns from growing recession fears and China’s Covid lockdowns, strong outperformance in April and May supported commodities which finished ahead of other risk assets and aided relative returns. With our proprietary risk sentiment indicator suggesting fragile risk appetite, we held a healthy allocation to cash throughout the quarter which proved beneficial as both equities and bonds sold off. Elsewhere, targeted allocations to energy and utilities supported relative performance. Offsetting some positive relative performance was an allocation to long bonds. Though our fixed income modeling has long been anticipating continued flattening in the US yield curve, the re-acceleration of US inflation combined with aggressive rate hikes offset growing recession fears and pushed yields across the curve up with the long end more impacted. We removed our allocation to long credit at the beginning of April, but the position to begin Q2 along with our consistent overweight to long treasury dented returns with long bonds underperforming shorter maturities.
Portfolio Positioning and Outlook
Headwinds to global growth have intensified while sources of resilience have softened and we have downgraded our growth forecast. While global shocks have continued to compound on each other and weigh on our outlook, the downgrade reflects a much faster monetary tightening pace that shifts the economy from the prior path of a gradual deceleration to one of a more abrupt downshift. Inflation is forecasted to accelerate again in June, but the Fed, and other central banks, have confirmed their dedication to curbing inflation at all costs. Inflation is broad based and proving more sticky than anticipated, geopolitical risks from the war in Ukraine have seemingly increased and we are becoming less convinced the Fed can administer a “soft landing” with the current trajectory of both interest rates and growth.1 Risks remain skewed to the downside and we’ll be monitoring developments closely.
In our view, the risks to equity markets still outweigh the potential for a meaningful rebound. In addition to the challenging risk environment mentioned above, our equity modeling has also steadily deteriorated since late last year. Valuations have improved, but high inflation and slow manufacturing data has turned cycle indicators in a less productive direction. Price momentum has weakened, but the most dramatic area of weakness has been around earnings and sales expectations. With that as the backdrop, we prefer a relatively defensive stance as it pertains to our overall equity market exposure.
From a regional equity perspective, a deterioration in our US forecast has made non-US developed equities relatively more attractive in our quantitative framework. In the United States, macroeconomic factors remain robust and valuations have improved, but a sharp drop in both earnings and sales estimates lessens the relative attractiveness. Outside the US, attractive valuations and positive sentiment underpin our positive forecast.
Within fixed income, we see vulnerability within bond markets is at the short end of the yield curve and in credit assets – both investment grade and high yield. Even with a flat or inverted yield curve, our fixed income research continues to suggest that interest rates at the short end are not where they need to be, this despite some of the mixed economic data that has transpired of late. And with higher interest rates translating into a dearer cost of capital for corporates alongside a weakening in economic trends, we have very limited exposure to corporate bonds at this juncture. Long-term government bonds continue to look attractive and, in the event recession risks escalate, should provide some resilience to a multi-asset portfolio.
We still see a favorable risk/return trade-off in commodity markets. The short term balances between the bullish supply pressures and the bearish demand drag from fears of economic slowdown as central banks adjust their policies to higher inflation continue to fuel short term volatility. While a fundamental backdrop of tight supply, low inventory and limited excess capacity in energy sectors remains supportive for prices, rising recession risk, and demand destruction from higher commodities prices tempers this outlook to some degree compared with our outlook from earlier in the year. But contango across commodity curves remains scarce and the June sell-off has not shaken our regime-aware momentum signals. Though risks do appear more balanced at this point, relative to other asset classes the outlook for commodities remains firm.
Market Regime Forecasts
The Market Regime Indicator (MRI) employs a quantitative framework and forward-looking market indicators, including equity- and currency-implied volatility, as well as credit spreads, to identify the current market risk environment. Tracking risk appetite shifts in the market cycle helps frame tactical asset allocation and volatility targets.
1 State Street Global Advisors, as of 30/06/2022.
Commodities Basic goods used in commerce that are interchangeable, or “fungible,” with other commodities of the same type. Commodities are most often used as inputs in the production of other goods or services For example, crude oil is a commodity that is used to make motor fuels, and heating oil and lubricants.
Emerging Markets Developing countries where the characteristics of mature economies, such as political stability, market liquidity and accounting transparency, are beginning to manifest. Emerging market investments are generally expected to achieve higher returns than developed markets but are also accompanied by greater risk, decreasing their correlation to investments in developed markets.
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