Is The Market Reaching New Highs

Aug 16, 2021

The Federal Reserve set financial markets on a wild roller coaster ride at its May 4th FOMC meeting. The Fed stuck to its plan with another 50 basis point interest rate increase, noting core PCE is showing signs of flattening out. By avoiding the hawkish surprise that would come with a rumored (and feared) 75 bps increase, the Fed fueled the peak Fed/peak inflation narrative that remains a key bullish theme. Investors initially celebrated the move with a rally in stocks, before giving it all back the next day and sending the yield curve on a bear steepening move with yields above 3% from the 5-year point on. Attention turned to the CPI report on May 11th where a cooling of inflation was expected (hoped). A surprise increase in core CPI poured cold water on the peak inflation narrative and drove further weakness in stocks. Consumer sentiment hit its lowest level since 2011, preceding Walmart’s May 17th show-stopping reveal of an unexpected consumer mix shift from discretionary items and name brands toward staples and private labels. Target doubled down the following day. Refusing to go quietly, the peak inflation narrative made a fashionable comeback on more data shifts, sparking a month-end rally that would take the S&P 500 from down almost 8% intramonth to a flat close of 0.01%. Underneath, market structural data deteriorated further. Daily return volatility continued its monthly rising trend, climbing to 1.97%, as did the month’s largest daily decline, which crossed the -4% mark.

The Lyons Tactical Allocation strategy remained fully allocated to equities in May with a small risk hedge and an equity positioning that is balanced across the style-box. The strategy declined -3.57% net of fees for the month compared with 0.50% for the benchmark. Performance relative to the benchmark is attributed to our full equity allocation. Consumer stocks across both discretionary and staples sectors have been hurt by the inflationary environment and rising rates, particularly retailers and travel & leisure companies. Holdings in these industries weighed particularly on our portfolio, led by a -29% decline in Target stock (NYSE: TGT) for the month and Expedia’s -25.99% decline (NAS: EXPE). Staples names Costco (NAS: COST) and Church & Dwight (NYSE: CHD) were dragged down by similar inventory and mix shift dynamics, declining -12.32% and -7.42%, respectively. Quick market reversals amid high volatility prevented our hedge from maintaining its intramonth contribution, ultimately detracting 32bps from return for the month.

The current market environment may be the next test of our Quantitative Risk Indicator, which seeks to reduce equity exposure during sustained bear markets. Our philosophy is that large, tactical moves out of equities should be reserved for risk of markets that wipe out years of compound growth and take even longer to recover. Our risk management mechanisms are in place for potential downside protection in such extreme drawdowns.

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