Monthly Investment Overview – February 2020


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Market Commentary

For the second month in a row, US equity markets reacted to the spread of the COVID-19 coronavirus, wiping out monthly gains and leading to swift drawdowns from all-time highs. This most recent reaction sliced through multiple levels of technical support and ended as the worst week for major equity indices since the Great Financial Crisis. Supply chain issues have swelled, as evidenced by surveys of business activity in both the manufacturing and services sectors. Travel stocks including airlines, hotels, and cruise lines have borne the brunt of the sell-off, while falling expected demand for oil has taken its toll on energy companies already experiencing over-supply and rising leverage costs. Interest rates which were signaling broader issues before the equity volatility have cratered, with longer-dated Treasury notes falling to all-time lows. The market fully expected the Federal Reserve (Fed) to step in with emergency action, which they delivered early in March with a 0.50% federal funds rate cut. Equity market reaction was less than enthusiastic after the actual emergency rate cut, and the medium-term impact from the fear of the spreading coronavirus on economic activity remains uncertain. Official Fed 1st quarter real GDP estimates are still holding above 2-2.5%, though market estimates have been lowered as large cap earnings estimates continue to slip.

The Hanlon Proprietory Models Discussion
Tactical & All-Weather (Tactical Portion)
Tactical

The large-cap equity portion of Hanlon Tactical Models outperformed the large-cap proxy S&P 500 Index in February, as our tactical signals moved to mitigate risk during the last week of the month. We had remained out of the Energy sector for the entirety of February, which again trailed all the other major sectors. The large cap strategy and positive relative return from a tactical allocation to emerging market equities were ultimately insufficient to sustain outperformance versus the cash-heavy Tactical Growth Benchmark due also to the underperformance of small and mid-cap equity positions.

The Hanlon Tactical Managed Income Model underperformed its benchmark during the month, performing more in line with the benchmark constituent Markit iBoxx US High Yield Index than the more-conservative Merrill Lynch 3-Month Treasury Bill Index. In true risk-off fashion, spreads widened for corporate debt across the risk spectrum in the last week of the month. Recently out-performing small Real Estate Investment Trust (REIT) positions also negatively attributed to performance during the month.

Strategic & All-Weather (Strategic Portion)
Equity

The sell-off was widespread at the end of February, and while large cap US equities held up better than their small and mid-cap brethren, international equities actually held up relatively well during the month. US stocks that seemed to be immune to the growing threat from the coronavirus finally reacted to what bond and oil prices had been signaling and rejoined global equities in negative territory. Our strategic overweight of emerging market equities insulated the Strategic Growth Model versus its benchmark that has a higher weight to international developed markets. The All-Weather Growth Model benefitted from this paradigm, and despite slightly underperforming its own benchmark, the tactical portion led to outperformance versus the Strategic Growth Model.

Fixed Income

The conservative portion of strategic allocations underperformed their respective benchmarks due to slight underperformance from the largest strategic income holding, the Pimco Active Bond ETF (BOND). Smaller positions with lower duration dragged on relative portfolio return as interest rates moved swiftly lower and spreads widened. Emerging market bonds suffered from a strengthening US dollar due to a flight to safety outweighing expectations for swift Federal Reserve intervention. This offset positive attribution from an underweight to international developed market sovereign bonds which continue to lag as global investors shun negative yielding debt.

Alternative

Falling inflation expectations led to the alternative segment underperforming the rest of the portfolio holdings. Even recently outperforming REITs went risk-off in the last week of February, joining Master Limited Partnerships (MLPs) and natural resource stocks to weigh on relative returns during the month. The multi-manager Litman Gregory Masters Fund, held in the All-Weather Models, slipping during the month also highlights the breadth of the late-month move across usually less-correlated asset classes.

Benchmark Returns.

Table created by Hanlon Investment Research.


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