SPDR® SSGA Multi-Asset Real Return ETF (RLY) – Q4 2022 Commentary
During the fourth quarter of 2022, RLY finished up in absolute returns and outperformed its custom strategic benchmark. The fund ended the quarter with overweights to natural resource equities, commodities, global infrastructure, and cash.
Performance
Driving fund outperformance during Q4 were overweights to natural resource equities, both core and a targeted allocation to Energy, and global infrastructure equities, which was funded from Treasury Inflation Protected Securities (TIPS). Investors were encouraged by the prospects for a soft landing in the US engineered by the central bank but were wary of the near-term economic uncertainty, and sought out defensive assets with reasonable valuations and reliable cash flows, which included global natural resource and global infrastructure stocks. The Energy sector, boosted by strong earnings, continued to perform well and finished up over 22%, aiding performance. TIPS provided positive returns as real yields fell and inflation expectations, as measured by breakevens, rose during the quarter. However, TIPS underperformed the more equity-oriented assets. A healthy allocation to cash, which we reduced in December, dented relative performance. Over the quarter, global policy rates drifted higher and cash provided a buffer against heightened volatility amid an uncertain economic outlook. The redeployment of cash in December was warranted by our Market Regime Indicator (MRI), but the overall overweight during the quarter proved to be a detractor to performance as it significantly underperformed equity.
Fund Performance
Portfolio Allocations
Portfolio Positioning and Outlook
Disinflationary signs have started to gain traction with moderation across both headline and core inflation in the US. The Federal Reserve (Fed) appears close to a pivot and while rates are likely to remain higher for longer, the pace of tightening has slowed. While slowing economic growth and uncertain policy risks remain headwinds, the macro environment appears more favorable for risk assets than it was six months ago, even if just a little bit.
The turn into 2023 seems to be setting up as one in which more muted risk regimes may be pointing towards a better environment for share prices. Our MRI spent nearly all of 2022 in the High Risk Aversion or Crisis regimes. It wasn’t until the US dollar peaked in the fall that we saw the first meaningful shift toward easing investor sentiment. The interrelated improvement in longer-term interest rates and ongoing evidence that worst-case inflationary outcomes will likely be avoided also contributed to the easing of our proprietary signal. Importantly, however, we should note that we’ve yet to see risk sentiment breach the thresholds that we would consider to be a clear buying opportunity for riskier assets. To us this makes sense. Market developments appear to be moving in the right direction, but our growth expectations are depressed and there remain uncertainties associated with the digestion of 400 -500 basis point interest rate hikes — more than enough to pause and think twice about any volatility or vicissitudes that might lie ahead.
One area that may also benefit from the normalization in investor’s risk appetite is the commodity markets. At first glance there might not be much support for the asset class, whose historical performance has been associated with periods of economic expansion, given that we appear to be moving toward one of the most telegraphed slowdowns or recession in post-war history. While we certainly can’t ignore the risks that a global recession and weaker demand could have on commodity prices, an examination of the supply-side dynamics of key sectors gives us reason for more optimism in our near-term outlook.
Both global natural resource equities and infrastructure equities stand to benefit from infrastructure spending along with longer-term trends of decarbonization and other green energy thematics. The price of raw materials has taken a step back, but holds some support given limited spare capacity and an easing of restrictions in China this year which could increase demand.
Overall, inflation seems poised to moderate, but is likely to remain above central bank targets in 2023 — leading central banks to keep rates higher for longer. This, along with geopolitical stresses, would dent economic growth, but the severity is uncertain. The demand side of the balance can vary widely, and supply limitations have the potential to provide dislocations in the short term along with potentially higher longer-term expectations, which may extend the leadership of real assets relative to traditional equities and bonds for a third year.
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
