During the fourth quarter of 2022, XLSR finished up and outperformed the S&P 500 Index on both a NAV and market value basis. The fund finished the quarter with overweight positions in Consumer Staples, Financials, Materials, and Energy.
The equity sector allocations benefited the fund during Q4 with persistent allocations to Energy and Financials driving much of the value add. The Energy sector, aided by strong earnings and buybacks, finished strong for the quarter, up over 22% and the top-performing sector. Robust performance for asset management and custody banks, along with higher net interest income, strengthened the Financials sector with still resilient credit demand and overall performance. Elsewhere, our timing into Industrials was favorable as we initiated an overweight in November and the sector outpaced the S&P 500 Index for the remainder of the quarter.
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 Market Regime Indicator (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.
Within equity markets, a continued preference for value over growth exposures continues to characterize our sector positioning. Consumer Staples and Financials remain favored sectors. Consumer Staples continues to ascend up our rankings and is now our top-ranked sector. Strong price momentum, positive quality scores and stellar sentiment support Consumer Staples. Financials continue look attractive across most factors, but appealing valuations, coupled with strong and positive momentum in particular, boost our outlook. Materials have benefited from recent dollar weakness which helped improve price momentum. Sturdy sentiment and attractive valuations also helped bolster our forecast for Materials. Elsewhere, Energy slipped down in our rankings while Materials was upgraded to a full allocation. Our forecast for Energy remains positive with robust price momentum and favorable valuations, but a drop in both earnings and sales sentiment, coupled with a better outlook for Materials led us to lower the allocation.
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
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