SPDR® SSGA Global Allocation ETF (GAL) – Q4 2022 Commentary
During the fourth quarter of 2022, GAL finished with positive absolute returns and outperformed its custom strategic benchmark. The fund ended the quarter with a small overweight equities, commodities, and cash. Within fixed income, the fund had targeted allocations to long and intermediate Treasurys. The fund is also tilted toward non-US developed market equities.
Performance
The fund’s positioning within equities and US equity sector rotation aided performance in Q4. A preference for non-US developed market equities, both European and Pacific, relative to US large-cap equities, aided performance. Within our quantitative models, non-US developed market equities exhibited stronger sentiment and more attractive valuations than US equities and we held a sizable overweight. While equities were higher across the board, international equities outperformed their US counterparts, buoyed by a weakening US dollar, which sank over 7.5%.1 Targeted allocations to Energy and Financials, which we held throughout the quarter, supported relative performance. The Energy sector, aided by strong earnings, continued to perform well, finishing up over 22%, and was the top performing sector.2 Elsewhere, strong performance for asset management and custody banks, along with financial exchange companies, propelled the Financials sector higher. It finished up over 13% and outpaced the S&P 500 Index.3 Directionally, defensive positioning, including an overweight to cash and long Treasury bonds and an underweight to equities, dented returns. With our fixed income modeling pointing to continued curve flattening/inversion and expectations that the Federal Reserve (Fed) will continue to pressure rates at the front end of the curve higher, we held an overweight to long government bonds. Despite rallying in November on increased recession fears and better-than-expected inflation data, long government bonds struggled during the bookend months of Q4 and underperformed most fixed income assets. Additionally, we held an overweight to cash which proved beneficial most of the quarter, but significant underperformance relative to aggregate bonds in November weighed on performance.
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 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 toward 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 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. 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 and regional positioning. In the latter, we have relatively less exposure to the United States and emerging markets and have chosen to express our positive equity outlook though an overweight to European and Pacific equities. Although these regions have their lot of challenges ahead, local equity markets have begun to reflect a more constructive outlook and valuations remain attractive.
Furthermore as the US dollar’s rate advantage begins to erode and other central banks ramp up their tightening efforts, a weaker US dollar (USD) could boost returns for unhedged-USD investors. From a sector perspective, Consumer Staples and Financials remain our favored sectors while Materials was upgraded to a full allocation as dollar weakness helped improve price momentum while sentiment and attractive valuations help bolster our forecast for Materials.
Looking to US bonds, the yield curve is deeply inverted with consensus for steepening, but its timing is more questionable. In our view, it is getting closer. Our models have positioned us for slight curve inversion, but there are signs that it won’t be the case for long. Inflation expectations have moved lower while our leading economic indicators have also slowed, both indicating the potential for curve steepening.
Elsewhere, we anticipate further spread widening for both investment grade credit and high yield bonds. Overall, we are neutral to duration and find longer-dated bonds more attractive given the Fed’s impact on short-term rates and growing fears of recession.
One area that may also benefit from the normalization in investors’ risk appetite is the commodity markets. 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.
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
