SPDR® SSGA Global Allocation ETF (GAL) – Q1 2022 Commentary
During the first quarter of 2022, GAL outperformed its custom strategic benchmark. The fund finished the quarter with an overweight to commodities and equities while targeting US and emerging markets. Within fixed income, targeted long bond allocations were funded from aggregate bonds.
Directionally, our preference for commodities over bonds positively contributed to relative performance. We held a consistent overweight to commodities during the first quarter, which was the largest source of value add as both stocks and bonds sold off over the period. Pre-existing support including firm economic growth, favorable momentum and curve structure, and broader inflationary pressures met with an energy supply shock which sent many commodity prices significantly higher. Additionally, the timing of our overall equity exposure was beneficial. We started the year at a roughly neutral equity allocation and shifted into an increasingly defensive posture in January on elevated MRI (Market Regime Indicator) readings amidst concerns around Fed monetary policy withdrawal and the Russia/Ukraine conflict. As of the end of January we had a ~5% underweight to equities in total.1
By late February, MRI had moved into crisis, which often represents an opportunity to become less defensive. Our reallocations into equity at the end of Q1 aided performance as stock markets recovered despite ongoing policy and geopolitical risks. Detracting from performance was an overweight to long bonds. Though our fixed income modeling has long been anticipating continued flattening in the US yield curve, the magnitude of the moves occurring during the first quarter was far more severe than anticipated and detracted from benchmark-relative performance as both long government bonds and long corporate bonds fell by more than 10%.2
Portfolio Positioning and Outlook
The macroeconomic environment is less certain than it was entering 2022. Despite solid underlying fundamentals, ongoing supply shortages and elevated commodity prices will keep upward pressure on inflation and the longer it persists, the more impactful the hit on demand will be. The risks point to lower growth, but at present, we are not forecasting a global economic downturn and still expect economic growth to remain positive which can support growth assets. However, at present, our proprietary risk sentiment gauge is signaling that investors have become especially cautious and currently resides in a regime that has historically been less supportive for risk assets.
At first glance our equity modeling continues to point to positive, albeit modest, equity returns ahead. To be sure, expected returns for Global developed equities are even a scant few basis points above historical averages. A greater scrutiny will reveal however that those same returns expectations have weakened meaningfully from where they stood at the start of the year. Certain aspects of our modeling, including a broad set of macroeconomic factors, sentiment as well as momentum indicators have been dampening our expected returns in equities for quite some time. But the weakness across those indicators has intensified in 2022, offsetting improvements in valuation factor which incidentally remain in neutral territory. Regionally, we prefer the US where improving quality factors, mainly a better return on assets and lower volatility, help offset rich valuations. Elsewhere, strong macro scores, positive sentiment and firm price momentum underpin our constructive outlook. Valuations are attractive for Europe and Pacific equities, but feebler price momentum and worse macro factors lessen the attractiveness relative to US equities.
While our equity models hinted at a moderation in otherwise positive return expectations, our quantitative assessment of fixed income sectors saw expected bond returns moving from negative to positive before ending the quarter expected negative returns across most fixed income asset categories. The main driver of this reversal in model expectations has was a deterioration in the momentum factors. Within macro factors, high nominal GDP also point towards higher rates while slowing PMI and current elevated inflation levels point towards lower rates, offsetting some on the negativity in aggregate model scores. Within fixed income, we prefer long Treasury bonds, which are supported by our forecast for a flatter curve. Specifically, strong leading economic indicators and inflation expectations imply tighter monetary policy and a flatter yield curve.
Within commodities, supply and demand fundamentals are strong across both energy and metals which should support prices. A prolonged war or escalation in sanctions could add further upward pressure on the commodity complex with contagion effects across multiple assets. Our outlook for gold remains strong with both fundamental and technical factors in our model supporting the precious metal. Impacts from the Russian invasion have reverberated through markets, including measures of credit risk, which have increased and imply positive future performance for gold. On the technical side, all our trend signals suggest higher prices ahead for gold. Overall, real assets are well positioned to continue to benefit from the current elevated inflationary environment.
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.
A Look at the MRI
1 State Street Global Advisors, as of 3/31/2022 2 FactSet, As of 3/31/2022
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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