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The reduction of risk worries, which led to rising risk-asset prices, continued into 2020 as equities rose steadily for nearly the entire month of January. An outbreak of a respiratory virus that started in China spooked risk-assets near the end of the month as new cases popped up around the world and in the US. The SARS-like infection, which has a notable death rate, also has a relatively long and symptom-less incubation period which makes it harder to contain. So far, the virus has hit emerging market equities harder than developed markets, reversing outperformance fueled from the signing of the Phase 1 US/China trade deal and threatening to stall economic growth in China and around the globe. The disruption may make it difficult for China to live up to the agreement of large increases of imports from the US. US interest rates flirted with moving higher in the first full trading week of 2020, after sky-high tensions cooled between the US and Iran. While rates ended up falling for most of the month, they accelerated lower late in the month due to the spreading virus and contagion fears, with longer dated maturities falling quicker. The yield curve ended January inverted, with the yield on a 10-year Treasury Note falling back below the yield on a 3-month Treasury Bill, and again raises recessionary fears for the medium-term. US growth is still solid though, with the initial estimate of 4th quarter US real GDP coming in as expected and in-line with 3Q19, at 2.1%, making the full year 2019 growth estimate equal to 2.3%. Personal consumption was the main growth contributor, with growth in government spending and a narrowing trade balance also contributing positively. Earnings season for 4Q19 have broadly lived up to lowered expectations, with 75% of S&P 500 companies who have thus-far reported, having been able to meet or beat consensus estimates.
The large-cap equity portion of Hanlon Tactical Models outperformed the large-cap proxy S&P 500 Index in January due to the tactical exclusion of the Energy sector from the strategy during the entire month. The Energy sector was by far the worst performing sector, as the Energy Select Sector SPDR ETF (XLE) fell -11%, as a result of the coronavirus potentially disrupting Chinese energy demand. The positive attribution delivered from the large-cap strategy was more than offset by late-month underperformance from tactical allocations to US small-cap, US mid-cap, and emerging market equity positions which ultimately led to the aggressive allocation of Hanlon Tactical Models to trail their respective benchmarks for the month.
The fixed income portion of the Hanlon Tactical Models slightly outperformed their respective benchmarks, on a gross basis, with outperformance from the Hanlon Managed Income Mutual Fund offsetting a slight lag from the 3rd party managed income fund allocations. A tactical allocation to a higher quality, longer duration, bond fund combined with small Real Estate Investment Trust (REIT) positions helped the Hanlon Tactical Managed Income Model to make-up for sluggish high yield positions in January.
The outperformance of US equity markets benefitted relative performance for the strategic equity allocation, however, that outperformance was confined mainly to large-cap stocks with some of the highest weightings in broad equity indices. Small and mid-cap, and especially those with value-like qualities, reversed course quickly and more dramatically than the most-loved large cap technology stocks. This attributed negatively to model performance versus the benchmarks, due to a strategic overweight to small-cap US equities. Emerging market equities were the main source of underperformance for the aggressive models for the month, reversing early-month relative strength by selling off due to the expected economic hit from the coronavirus.
The conservative portion of strategic allocations underperformed their respective benchmarks due to a drag from the relatively smaller allocations to emerging market bonds, high yield bonds, and senior bank loans. The reduction in interest rates during the month benefitted longer dated US Treasury bonds, boosting investment grade aggregate bond funds with exposure to the long end of the yield curve. The largest strategic fixed income holding, the PIMCO Active Bond ETF, was able to beat the broader index returns in January but was not enough to reverse the drag from the sub-investment grade and foreign bond allocations. Treasury Inflation Protected Securities (TIPS) were the best performing fixed income investments during the period, while the strong US dollar led to local currency-denominated emerging market bonds being the worst.
Despite having mixed returns on the month, it was a decisively poor month for the cumulative returns from alternative investments. Underperformance from the relatively small allocation to Master Limited Partnerships (MLPs) and natural resource stocks weighed on relative performance thanks to fears of stumbling commodity consumption in China, the global growth engine. Modestly positive, yet relatively solid returns from REITs and the multi-manager Litman Gregory Masters Fund helped attribution versus the benchmarks during the month, but not enough to offset the move in commodity prices.
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